How to calculate return on investment: an in-depth guide

By Indeed Editorial Team

Published 15 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Return on investment is a common financial metric that a company can use to determine the possibility of receiving a return on any investments it makes. This ratio, in combination with other metrics like internal rate of return and net present value, assists financial analysts in calculating the profitability of an investment. Learning how to calculate return on investment can help you to develop your professional and business analytical skill set. In this article, we explain what return on investment is, discuss how it benefits businesses and describe how to calculate it.

What is return on investment?

Return on investment is a ratio that analysts commonly use to determine the profitability of a single investment. This formula works well when comparing one investment to another to analyse which is the most profitable for a business. Financial analysts combine return on investment with various theories, concepts and formulas to create a comprehensive business case. A company may hire analysts to perform a thorough evaluation to determine its economic health, which indicates how well it's performing.

The return on investment formula is simple and easy to learn, with versatile applications for all areas of business. You only need two financial figures when calculating the most basic formula, which are available on public company records. Take the net income of the company's investment and divide it by the cost of the investment, then multiply it by 100. The formula looks like this:

ROI = Net income / cost of investment x 100

Related: What is profitability? (Definition, common factors, types)

How to calculate return on investment

Here's a step-by-step guide on how to calculate return on investment :

1. Understand ROI

It's important to understand why you're conducting an ROI calculation and what you aim to find out. You could ask yourself questions such as 'What are the long and short-term benefits of the investment?' or 'What would I do with a positive or negative return on investment?'. Asking these preliminary questions can prepare you to take necessary action when formulating a business plan. Understand that not all cost-benefit analyses provide the same insight, and a return on investment calculation may not be relevant to your needs in a particular situation.

2. Measure your costs

Measuring costs is simple when the information is readily available in a public financial report, but if you don't have access to this information, it may be necessary to perform the calculations yourself. Ensure you're diligent when measuring and noting all the costs of an investment, as the more information you have, the more accurate the results. When measuring costs, consider consultation fees, labour costs or the costs of any software or tools. To reduce costs and improve return on investment, companies can consider acquiring funding to subsidise certain operational factors, such as internship wages.

Related: How to reduce costs (plus common mistakes to avoid)

3. Identify and quantify the benefits

Examine and evaluate the performance of an investment to determine whether it's economically viable and healthy. There can be many benefits to an investment, and return on investment can help you identify them. Set up key performance indicators that you can track, such as retention rate, viewing time or customer return rate. Quantifying the benefits of a campaign or investment allows you to certifiably determine whether the project is successful.

4. Measure ROI

To measure and calculate ROI, keep a detailed record of your costs. Investments are fluid projects that often require constant attention, additional resources and finances. If you miscalculate the costs of a project, you risk skewing the data and producing incorrect information. Select the appropriate formula for the investment you're looking to calculate and, if needed, use an online calculator for help. Return on investment is most useful in combination with other business metrics and formulas to create a comprehensive report.

Example of return on investment

Consider the following example that demonstrates how you can use the formula to calculate ROI:

An investor puts £10,000 into a company with no additional fees or costs attached. The company generates a net profit of £50,000. Thus, the investor sees profits of £40,000. The return on investment formula is as follows:

50,000 / 10,000 x 100 = 500

This means the investor's return is 500%. When analysing the results, the investor can claim that they saw a 500% return on their investment.

What is return on investment used for?

Organisations in any industry can use the return on investment formula. Businesses use the total cost and total returns to accurately evaluate profitability. Additionally, individuals could use return on investment to calculate the profitability of their personal investments, such as stock holdings or financial stakes in a company. If the return on investment has a positive ratio, it indicates a positive investment. Conversely, a negative ratio shows the investment is generating a loss.

Benefits of return on investment

ROI is a basic formula that has many variations and uses, but they all offer advantages. Companies can use it to:

Assess financial health

Performing a comprehensive ROI calculation can help businesses to better understand their finances and determine which projects and ventures are performing well and which are struggling. Analysts, business owners and individuals can find out how much each of their investments is generating and compare it to how much they cost. When combined with other calculations and metrics, it provides a detailed view of a company's operations, allowing analysts to determine which factors contribute to profitability and advise businesses on what changes to make.

Related: 11 ways to increase organic growth in business (with tips)

Understand competitors

Companies often compare their investments to those of their competitors to make a comparative analysis of the market. Analysts evaluate competitors' financial statements, where they can find financial information pertaining to their investments and use it to perform ROI calculations. If a company notices a weak point in its competitor's investments, it may decide to focus its operations on displacing the competitor to gain a competitive advantage.

Related: The different types of competitive analysis framework

Prioritise operations

An in-depth business analysis that includes return on investment allows business owners and executives to find out which operations and factors contribute to or hinder an investment's profitability. With this information, decision-makers can allocate additional funds or resources to an investment or project if it needs assistance. If an investment is performing well, business owners may decide to prioritise lesser-performing ones to increase their revenue. For example, if a company finds that it has a negative marketing return on investment, it may decide to allocate new management to the department to refresh operations.

Prepare for future projects

When an organisation finds a positive return on investment for a particular venture, it can note what it did to achieve those results so it can replicate them in the future. This can help improve management and refine strategies to grow the business and capture a larger market share. For example, if a company finds it had a positive return on investment in its marketing department, it could aim to replicate those results in a different digital campaign. Alternatively, a company could learn from a negative ROI by analysing its mistakes.

Easily determine profitability

You don't need complex figures or statistics to calculate an investment's return. All the information you require for the formula is on a company's public financial statements. In its basic form, it's a simple formula, but with additions and variations, it can be complex and powerful. There are various types of return on investment, such as annualised, social, marketing statistics and social media statistics.

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