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Return on Investment (ROI)

 
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Return of Investment is a performance measure used to evaluate the efficiency of an investment that can help to compare the efficiency of several different investments. ROI is calculated accordingly:

 

Formula for calculating ROI:

 

(Gain From Investment - Cost of Investment)

ROI =

Cost of Investment

 

If the potential investment does not have a positive ROI, or other investments show a higher ROI, the investment should potentially not be made.

 

It is fairly easy to manipulate ROI to suit the situation, because it is a fairly qualitative task to evaluate coming gains and costs. Therefore ROI should only be seen as a guiding financial metric, because the metric only "attempts" to evaluate the efficiency of an investment.

 

If gains and costs have been realized, the formula can still be modified by e.g. not including all costs of an investment. A good example of this is, when products are produced without any specific demand and put in stock. By doing so, the average cost pr. unit of each SOLD item appears smaller in the financial statement, because the costs of the entire production has literally been stocked.

Therefore, people using ROI as a financial metric should make themselves perfectly clear what inputs and figures are being used.

 
 
 
 
 
Date Created: 2009-10-16
Posted by: Admin
 
 
 

Related resources:

Return on Assets (ROA)
Return on Equity (ROE)
Return on Sales (ROS)
Return on Capital Employed (ROCE)
Contribution Margin and Contribution Margin Ratio
Reference(s)
 
Advanced Management Accounting
Kaplan, R. & Atkinson, A; (1998); Prentice Hall
Keywords:
Online MBA, Online MBA Courses, Return on Investment, ROI, example, calculation, formula

 


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