Why would you care about Return on Investment? Because it’s going to evaluate the investment you made and tell if you made a good choice or not. It is a way of helping you gauge whether you are on the right path to obtain your desired goals.
So the core objective of calculating ROI is to know what kind of returns you would get on putting the money and taking a risk.
Return on Investment or ROI is used to estimate the returns one can get by investing. ROI can be calculated while investing in stocks, insurance, FD, Mutual Funds etc. ROI is widely used when a huge amount of money is risked while making a purchase or making important business decisions or any investment made that involves risk.
What is Return on Investment?
Return on investment or ROI measures the performance of an investment based on the amount invested and profit gained from the investment. Not only that, it also helps in comparing the performance of various investments for a certain period. Return on Investment calculator is used to calculate the profit an investor will receive with regards to the investment cost.
Return on Investment is generally calculated as net income divided by the original cost of investment and the result is stated as percentage or ratio. The higher the net income higher is the profit gained. Bankers, managers and investors use ROI to calculate and compare the productiveness of different investments made.
What is Return on Investment Formula?
We invest our money with some expectation of gaining profit. So to gauge the returns we need to calculate them using the Return on Investment formula. It is widely used for fixed-income investments.
The mathematical representation of the ROI formula is;
ROI= (Net Income – Investment Cost)/(Investment Cost)
ROI= (Gain from Investment – Cost of Investment)/ (Cost of Investment) x 100
The result is expressed in the form of a percentage. Here the Investment Cost refers to the amount of money invested and Net Income is the total amount gained from the sale.
Examples of Return on Investment:
Let us simplify the calculation by understanding with an example.
For Example, let us assume Investor X incurred a cost of $100 and Investor Y incurred a cost of $1000. Investor X gained a profit of $300 and Investor Y gained a profit of $2000. So let us calculate the ROI,
ROI for Investor X= ($300-$100) /($100) = 200%
ROI for Investor Y=($2000-$1000) /($1000) = 100%
Thus Investor X gains more profit.
Let us understand better with another example.
Let us assume Mr A has invested Rs. 1,00000 in an equity fund. On maturity, after 5 years the amount credited after redemption is 1,25,000. So as per the formula given above Return on Investment is calculated as follows.
ROI for Mr. A is = (1,25,000-1,00000) /(1,00000) = 25%
Return on Investment Calculator:
A return on investment calculator is a simple way to calculate the profitability of the investment. Various websites have online calculators which make it easy for you to calculate your ROI within seconds.
An online formula box is provided wherein you enter the cost of investment (or the amount you invested), investment gained, and the period of investment. The ROI calculator immediately shows the total gain or returns from the investment, annualized return on investment and the compound annual growth.
Absolute Return Calculation:
The ROI calculations have to be done based on the time period of your investment. If your stock investment is done for less than one year the calculation of the absolute return is used. It is calculated using the formula;
(Investment Gained- Investment Cost)/ (Investment Cost ) X 100
For example, let us assume you have invested an amount of Rs. 50,000 and you have gained a net income of 75,000. Then according to the formula, the absolute return would be calculated as 75,000-50,000/50,000 x 100 = 50%
Annualized Return Calculation:
The annualized return on investment is used to calculate the productivity of the stocks that are held at different periods of time. It can be calculated using the formula;
(Investment Gained- Investment Cost)/ (Investment Cost) X 100 X (1/ Time Period)
For example, let us assume that you have bought a property for 45,00,000 in 2015 and sold the property for 75,00,000 in 2020. Your investment cost is 45 lakhs and your investment gain is 75 lakhs. You have been holding your investment for 5 years. Then the calculation would be;
Annualised ROI= (75,00,000-45,00,000)/ 45,00,000 * 100* (1/5) = 13.33%
The time period can be changed based on the factor. For example, if it is in months then it should be calculated as (12/Time Period). If it is in years it has to be calculated as(365/Time Period). If it is in years then it has to be calculated as (1/Time Period).
Calculating ROI in Excel Sheet:
You can easily calculate ROI using an Excel sheet. You just need to enter some inputs and formulas and you are good to go. Let us take a deeper look at Return on Investment in excel.
- Open your Microsoft Excel or Google excel sheet.
- Start by labelling your cells.
- Type “Investment cost” in cell A1
- And “Net Income or Gain from Investment” in cell B1
- And “Return on Investment or ROI” in cell C1.
- Now enter the amount you invested in cell A2 and the amount you gained in cell B2.
- Now apply the formula in cell C2 under the label, ROI and write the formula (B2-A2)/(A2)*100 and drag it to apply it to the entire column. You will get the ROI calculated in seconds.
- Now you can calculate ROI for various investments by just entering the amount in the cell.
Where is ROI Used?
- ROI is used for making many important decisions and one of them is to determine whether a new sales plan will be profitable to the company or not.
- To analyse if a new project would bring productivity to your sales.
- You can review the performance of an employee by tracking the ROI and determine whether they are bringing in profits to the company.
- If you are deciding to purchase a new property or business tools the ROI calculation will help you to decide if the decision taken is right or wrong.
- It can be used to compare the returns gained from different investments and gives you an idea about which investment is more efficient than the other.
Benefits of Using Return on Investment:
The benefits of using an ROI are numerous. To mention a few;
- ROI is very simple to understand and gives efficient results.
- It helps in achieving the objectives of various departments in the company.
- Thus the productivity of various divisions and investments can be easily calculated and necessary measures can be taken to improve the efficiency.
- This also motivates the employees to work efficiently and give good tangible results. It creates healthy competition among different divisions in the company. The main aim of the employee would be to increase the ROI.
- It helps in comparative analysis between various investments made. The right decision can be made when large chunks of money are involved in investments.
- The managers of the company will have a better view of their goals by targeting the desired Return on Investment. This will encourage to use of the resources effectively to yield the desired ROI.
- It plays a major role in measuring the performance of any type of investment you make.
- It also helps to analyse the competition in the market.
- The simplicity of the formula makes it a universal form of calculation in all types of finance and investments.
- It saves the investor a lot of time and money while taking financial decisions.
Limitations of ROI Performance Measure:
We have seen that the ROI calculator is quite efficient however it also has certain limitations.
- One of the main limitations in using ROI is the time factor. When comparing two investments concerning the time the results could cause certain confusion.
For example, if Mr Raj bought some stocks from company X for Rs. 50,000 in 2010 and sells his stocks in 2012 for Rs. 60,000, his ROI would be 20%. Whereas he buys another set of stocks from a different company Y for the same amount of Rs. 50,000 in 2010 and sells his stocks in2015 for Rs. 60,000, his ROI for this investment would be 20%. We can see that Mr, Raj bagged a 20% profit from company X in 2 years whereas he took 5 years to earn a profit of 20% from company Y. Though the ROI seems to be the same but Raj gained a profit from the company X.
- The Return on Investment calculations differs according to the type of investment made. For example, a businessman’s calculation would differ from a real estate investor and a marketing manager. So this might create some confusion among investors. Thus the investor should incur all possible costs concerning the investment.
Social Media ROI:
Just as Return on Investment analyses the productivity of your investment, Social Return on Investment or SROI is a means of measuring net income received on investing through social media channels. Why is it necessary to measure the SROI? Since social media is growing to be the greatest platform for marketing campaigns insurance agencies are making use of these channels as a marketing strategy. So while you are investing your money and time in social media it is vital to learn if it is getting you any profits in return.
By measuring the social media return on investments it will give you an idea of whether they are effective or being wasted. By calculating SROI the insurance agencies obtain a panorama of how social media is impacting their business.
Easy Ways To Start Calculating SROI:
- Have a target or purpose in your business. Ask yourself what is my business target? If your target is to gain leads and convert them then your core objective is to capture the leads and redirect them to your service page. This can be achieved by running email campaigns. And if your target is to provide customer service then you should target on improving your customer experience by replying to their concerns and helping them.
- To accomplish your goals it is important to determine whether the strategy is working or not. So it is crucial to decide if you need to opt for paid social media or the free tools available. If you are opting for the paid and premium version it is important to calculate the ROI and determine if they will give the desired results.
- For example, if you are paying for Facebook ads to capture leads and you can convert 10 leads from it then you need to assign a customer value to each lead. So if your customer value for each lead is Rs.3000 (so for 10 leads it would be 30,000) and you have invested an amount of 20,000 for ads then the ROI is calculated as;
ROI= ( CUSTOMER VALUE – TOTAL INVESTMENT ) /( TOTAL INVESTMENT ) * 100
ROI= 30,000-20,000 /20,000 * 100 = 50%
About Rule 72, Rule 114 and Rule144:
- Rule 72 is an effective measure to calculate how much time is required to double your return on investment. It is calculated by dividing 72 by ROI. For example, if your ROI is 15 then it will take (72/15)= 4.8 years to double your investment.
- Rule 114 is used to calculate how much time it would require to triple the amount. It is calculated by dividing 114 by ROI. Eg, if your ROI is 15 then it will take (114/15)= 7.6 years to triple your investment.
- Rule 144 is used to calculate how much time it would require to grow your money four times the ROI. It is calculated by dividing 144 by ROI. Eg, if your ROI is 15 then it will take (144/15)= 9.6 years.
Every business or investment requires proper planning for which ROI plays a key role. Understanding ROI will practically benefit every financial decisions taken before investing. It is the smart way to gain the desired profits without wasting your money and time. Evaluate your ROI based on the factors like risk tolerance and the time required to generate the profit. So basically investments with lower risk can have lower ROI and investments that require a longer time to get returns will require a higher ROI.