This is an article on a guide to calculating Return on Investment (ROI), which will help you better understand what Return on Investment is, and how you can calculate it.
What is Return on Investment?
Return on Investment (ROI) is a metric that measures the gain or the loss made on an investment relative to the amount invested, which is calculated with the aid of simple formula (i.e.) net income which is divided by the original capital cost of investment. This is a ratio that compares the gain or loss from an investment relative to its cost and is very useful in evaluating the potential return from a stand-alone investment, as it is in comparing returns from several investments.
Methods of Calculating Return on Investment (ROI)
There are four methods of calculating return on investment calculation. Here there are:
Net Income Method
ROI formula = ( Net Income /Investment Value) * 100
Capital Gain Method
ROI Formula = (Current Share Price – Original Share Price) * 100 / Original Share Price.
Total Return Method
ROI Formula = (Current Share Price + Total Dividends Received – Original Share Price) * 100 /Original Share Price.
Annualized ROI Method
ROI Formula = [(Ending value / Beginning value) ^ (1/no. of years)] – 1
Benefits of Return on Investment
The following are the benefits that you enjoy on Return on Investment:
- Return on investment is easy to calculate and can be calculated by two figures which are benefit and cost.
- The ratio of Return on Investment is universally understood and is very popular and commonly used.
Demerits of Returns on Investments
- Firstly, ROI is susceptible to manipulation. This is because the calculation differs based on investors, while some consider one aspect, others ignore it, thus it can be easily manipulated.
- Secondly, returns on Investments disregards the factor of time. The investor is expected to compare two instruments under the same time period and same circumstances.
- ROI only emphasizes financial gains when considering the returns on investment, this means that it does not consider ancillary benefits, like social or environmental goods.
- Returns on Investments figures can be exaggerated if all the expected costs are not included in the calculation.
How to Calculate Returns on Investments (ROI)
Returns on Investments can be calculated using two different methods:
The first method is:
ROI = Net Returns on Investments / Cost of Investment × 100
The second method is:
ROI = Final Value of Investment – Initial Value / Cost of Investment × 100.
Interpreting the Returns on Investments (ROI)
In calculating ROI, have the following in mind:
First ROI is typically expressed as a percentage. Because it is intuitively easier to understand (than when it expressed in the ratio).
Second, the ROI calculation includes the net return in the numerator. This is because returns from an. Investment can either be positive or negative.
In a situation where ROI calculations yield a positive figure, it implies that the net returns are in the black (because total returns exceed total costs).
On the other hand, when. ROI calculations yield a negative figure, it implies that the net returns are in red because total. Costs exceed total returns. Simply put, the investment produces a loss). Lastly, in order to calculate ROI with the highest degree of accuracy, total returns and total costs should be considered.
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