Return on investment (ROI) is a business tool applied in the business world to analyze or evaluate an investment in regard to its efficiency or to make a comparison between two or more investments. The ROI serves the purpose of measuring returns associated with money that has been invested in a particular business at a particular time frame. By applying the ROI an investor is able to compare the viability of a wide range of projects and as such, prioritize the project that yields the best ROI.
To calculate the ROI, an investor ought to divide the total expected financial gains by the total costs of project. Thus, the formula for calculating the same can be presented as follows:
_ ROI= (Expected net benefits / Total costs) * 100.
The net benefits are usually arrived at by subtracting the total benefits from the total gain. A high rate of ROI serves as an indicator of the viability of a project whereas a lower rate indicates an incremental financial loss. For instance, an investor planning to carry out a business project costing $100,000 to implement out and is able to demonstrate a return of $50,000 in the net benefits can be able to calculate the ROI as follows:
_ (50,000 / 100,000) * 100 = 50%
In the above example, an ROI of 50% serves as an indicator of positive returns on the particular project that the investor wishes to carry out. In simpler terms, any ROI ratio that is greater than zero gives an investor the green light to pursue the particular project. However, it is prudent to note that not all projects are expected to yield a greater than zero rate of ROI. This therefore insinuates that not all sub-zero rates of ROI indicate the ‘death’ of a particular project. For instance, all government functions and projects are not entirely in the business world. This is because the Government is usually mandated with the task to provide certain services free of charge to the public and as such, tolerates low ROI since the projects are not expected to yield any financial benefits to the government.
Overall, return on investment as a business tool to measure the efficiency of a certain project or make comparison between different projects has proven over the years to be quite efficient. However, there are cases where complications arise while calculating the ROI, for instance, where property has been refinanced as in the case of a second mortgage. These situations therefore call for more complex calculations and as such, more advanced ways of calculating the ROI are called for.