Term
Return On Investment (ROI)
noun
Return on investment, or ROI, is a financial ratio used to evaluate the efficiency of an investment.
What Is Return on Investment (ROI)?
Return on investment, or ROI, is a financial ratio used to evaluate the efficacy of an investment.
Generally, bankers and investors use it to compare the profitability of several different investments. However, entrepreneurs can also use ROI to see whether their investments in tools, products, etc., are yielding a profit.
ROI is expressed as a percentage of profit yielded by an amount of investment after deducting expenses and costs.
How to Calculate Return on Investment?
The simplest way to calculate ROI is to divide net income by the cost of the investment. Net income represents the final value of the investment after the initial value of the investment has been subtracted from it.
ROI = Net income / cost of investment
For example, if someone invested $5,000 in new technology and it directly resulted in a $7,500 profit, the net income comes out to $7,500-$5,000 = $2,500. The ROI then becomes $2,500/$5,000, which is a 50% ROI on the original investment.
Importance of Return on Investment
Here are a few reasons why it makes sense to calculate your ROI:
Make Better Hires
Many companies onboard sales staff but find it difficult to track whether they are performing well. Make it easy on yourself by calculating your employees’ ROI in relation to the sales they bring in compared to their salary.
Track Marketing Success
It is hard to track the success of a marketing campaign, but you can change this with ROI. ROI focuses on the cost of marketing a product compared to sales earned by the marketing campaign. This way, you can find out if the campaign helped you break even, surpassed your expectations, or did not perform well at all.
Evaluate Product Performance
ROI can be an indicator of the success of a new product after you launch it to the market. It analyzes how much revenue the product generates against the cost it took to produce, market and sell. For instance, if it took $25,000 to research, create, promote, and sell a new product, and the company earned $32,000 in the first year of sales, then ROI = $7,000/$25,000 or 28%.