What is ROI (Return on Investment)

What is ROI (Return on Investment)

Rhema Hans
Rhema Hans
Table of Contents
Table of Contents

As business owners, it is essential to know whether the money you are investing in your business is worth it or not. You must especially know whether or not the developments made in your business are yielding any fruits.

An active evaluation of your business, your investments is necessary to strengthen your financial success and not hinder your it on the the longer run. Financial wellness and financial success should be the first goals of your organization. But the question that we will address today in this article is, how will you determine the performance of your investments? After all, you have spent years generating revenue to see your company fly, you must know how well your business is doing.

Return on Investment (ROI) can help you with that.

You have heard about ROI, but don’t know what it means?

Worry not!

In this article, we will not only tell you what ROI is but the importance of ROI in your business. To start with, let us look at the meaning of ROI.

What is ROI?

Return on Investment is a Key Performance Indicator (KPI) to determine the profitability of any investments made. It measures the amount of return on a particular investment, relative to the investment’s cost.  ROI is meant for companies of all sizes and industries of all types.

ROI is remarkably valuable for evaluating accomplishments over the long run and eliminating the mystery of future business decisions. Not to mention, ROI also assists investors to make decisions on investing in a company/project.

ROI seems rather important, isn’t it?

Let us see ways in which ROI can prove beneficial for your company.

Benefits of ROI

Divisional Profitability

It compares net earnings to investments made in a particular division giving the right measure of divisional profitability. It reflects how well the assets have been utilized to earn profits, this encourages the company to make optimum use of assets. Also, it ensures that assets are acquired only when they are sure to give returns.

Hence, the focal point of ROI is the required level of investments that must be made for a given unit at a given time. There is an ideal point of interest in every stock that augments income.

ROI helps managers in determining the pace of return that can be anticipated from different investments in various departments. This allows them to make an investment that will improve both divisional and organizational performance. Maximum utilization of the existing investments too.

Comparative Analysis

ROI helps in making a comparison between various departments in the company with other companies in the market in terms of profitability and asset utilization.

Indicator of Different Performance Ingredients

ROI is viewed as the most significant performance measure which incorporates various performance aspects of a company. A higher ROI implies that there have been exceptional outcomes in different fields such as cost management, effective asset utilization, selling price strategy, marketing, and promotional strategy, so on and so forth.

No Need for Separate Accounting System

ROI depends on the financial accounting of your company. It doesn't require a new or separate accounting measurement to produce data for ROI. Every number required to calculate ROI is easily available in your financial statements.

Achieving Goal Congruence

ROI guarantees objective consistency between the various divisions in the company and the firm itself. Any good or bad developments in divisional ROI will result in the overall performance of the company.

We hope you have understood the compelling advantages of ROI.

Now, before we get to the how-to calculate ROI section of the article, we have a bonus for you- How to use ROI. Let’s delve right into it.

How to Use ROI?

ROI gives you various benefits that we looked at. The first and self-evident? Knowing your business's profitability. If the ROI shows that you're putting the money in the wrong department, it's a no-brainer that changes, developments have to be made.  There are several ways in which ROI can help you settle on significant business choices, including the following that is primarily done using ROI.

Recruiting Employees

Is your new employee adding to the profit of the company or decreasing it? By measuring the ROI of your employees you will know the basis for hiring a new employee or letting go of one.

Adding New Departments

Similar to recruiting new employees to maximize the profit of the company, adding a new department in the company can be a helpful move to increase profits too. However, you would not like to play a guessing game here while you introduce a new department.  

Make use of ROI. Identify the ROI for different departments, check their profitability and find out if you have room for expansion.

Buying New Tools

Adding new tools, equipment, and software to your business can be a positive addition to your company. However, they should be bought wisely. By calculating the ROI on the existing tools you will get an idea of what kinds of equipment to invest in and how much value will they add to your business.

ROI in Marketing

In addition to calculating the profitability of a company as a whole, calculating ROI can be particularly helpful for marketers. The purpose of marketing is to spread the word about your product or service. This means good marketing directly translates to sales in good numbers too.

By calculating ROI you can make a comparison between different campaigns and determine which campaign brought you the best returns. For instance, you may run your campaign online and offline, you can check the ROI for both and conclude which one yielded the best outcomes.

These are some of the ways in which ROI can prove helpful to your company. Now, let us get to the math of things- How to calculate ROI.

How to Calculate ROI?

A Return on Investment is not calculated by one but several different formulas depending on the requirement. The two most commonly used ROI formulas are:

                                 ROI = Net Income / Cost of Investment    

                                                                   Or

                                 ROI = Investment Gain/ Investment Base

For example:

You buy a hotel valued at $21,00,000. Two years later, you sell that hotel for $27,000,00.

ROI = Investment Gain / Investment base

Note: To calculate the investment gain subtract the actual price from the selling price.

Investment Gain= Cost Price - Selling Price

= 1,000,000 - 500,000

=  500,000

ROI = (1,000,000 – 500,000) / (500,000)

= 500,000 / 500,000

=1%

Hope the example helped you understand how to calculate ROI. Before we conclude, let us take a look at the developments in ROI that you must know about.

Developments in ROI

Certain investors and organizations have looked into the development of another type of ROI metric, called "Social Return on Investment," or SROI. It was first introduced in 1990. SROI considers values that are not traditionally reflected in financial statements.  It mainly includes social, economic, and environmental factors. They can identify how effectively a company uses its capital and other resources to create value for the community.

As the world progresses with time and the economy changes, a few other types of ROI will also be introduced.

The Bottom Line

As a business owner if you are not sure whether or not your efforts are yielding any results, how will you perfectly optimize your profitability? Calculating your ROI gives you valuable insight into where you should put your money and the improvements that can be made.

ROI is crucial for any company to succeed, yet it is not the only way to check your profitability. Another popular technique to check the financial performance of your company is Financial Ratios. Head over to our article on Financial Ratios to learn about it.

In calculating or understanding the performance, the profitability of your company, Deskera can come in very handy and assist you with your calculations. You can find all your balance sheets, profit and loss statements, maintained over the years in one place. You can update the financial statements in real-time with all the required details. Moreover, it is easily accessible on your phone as well.

Hope this article helped you understand all about ROI- What ROI is, the benefits of ROI, how to use it, calculate it, developments in ROI, and how Deskera can help you optimize the process.

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