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Return On Investment, How To Calculate?

LLloyd Legoabe
Lloyd Legoabe
18 minutes
Return On Investment, How To Calculate?

Understanding and effectively utilising Return on Investment is paramount for businesses and investors alike. Return on Investment or ROI serves as a barometer for evaluating the profitability and efficiency of investments. In this article, we will explore ROI meaning, the benefits of it while acknowledging its limitations. Additionally, we will provide insights on how to calculate ROI, steps to enhance it, and alternative metrics tailored to the specific demands of the market.

What is ROI?


Return on Investment (ROI) is a financial metric that evaluates the profitability of an investment. It is expressed as a percentage and represents the ratio of net profit to the initial cost of the investment. 

What Are Pros of ROI? 

Pros of ROI include:

  • Simple and Easy to Calculate: ROI's simplicity is a distinct advantage. Its straightforward formula is easy to understand and compute. This simplicity facilitates quick assessments, allowing businesses to make informed decisions without the need for complex calculations.
  • Universally Understood: ROI is a universally recognised metric, transcending industry boundaries. In a diverse market, where sectors vary from mining to technology, the universal understanding of ROI enables consistent evaluation and comparison of investments across different industries.
  • Comparative Analysis Capability: One of the strengths of ROI is its ability to facilitate comparative analyses. This allows companies to benchmark their performance against industry standards, helping identify areas for improvement and strategic adjustments.

What Are Cons of ROI?

Here are cons of ROI:

  • No Risk Adjustment: One limitation of ROI is its inability to account for risk. In the market, where external factors can impact investments, ROI may not fully capture the associated risks. Investors and businesses need to complement ROI with additional risk assessment tools for a comprehensive view.
  • Some Costs May Be Omitted: ROI focuses on easily measurable costs, potentially omitting some hidden or intangible expenses. In case of arising unforeseen costs, relying solely on ROI may lead to an incomplete financial picture. A thorough cost analysis is essential.
  • Some Issues May Be Ignored: Not all issues affecting investment success may be reflected in ROI. For instance, social or environmental factors might not be fully captured. A broader assessment, including social ROI, may be necessary for a comprehensive analysis.
  • Inability to Consider Time in the Equation: ROI doesn't account for the time value of money. Not factoring in the time element could lead to suboptimal investment decisions. Businesses should consider using metrics like annualised ROI for a more time-sensitive evaluation.

How to Calculate Return on Investment?

The Return on Investment Formula for ROI is straightforward:

ROI = (Net Profit / Cost of Investment) × 100

Let's consider a practical example: A manufacturing company invests ZAR 2 million in new machinery, incurring additional operating costs of ZAR 500,000. The machinery generates an extra ZAR 1.5 million in annual profit.

Net Profit = Revenue − Costs

Net Profit = ZAR 1,500,000 − ZAR 500,000 = ZAR 1,000,000

ROI = (ZAR 1,000,000 / ZAR 2,000,000) × 100 = 50 %

This indicates a 50% Return on the Investment.

ROI Interpreting 

Interpreting ROI is crucial for making informed decisions. Here's how to interpret ROI effectively:

  • Benchmarking: Compare the calculated Return on Investment with industry benchmarks to gauge how well the investment performs relative to sector standards. This provides context for understanding whether the return is competitive.
  • Setting Expectations: Establish realistic expectations based on industry norms and economic conditions. Understanding the local market dynamics is essential to interpret whether the ROI meets, exceeds, or falls short of expectations.
  • Considering Risks: Recognise that ROI does not inherently account for risk. It's crucial to consider the risks and uncertainties. A high ROI might be commendable, but it should be evaluated in the context of potential risks.
  • ROI in Context: Interpret ROI within the broader context of the business strategy. For instance, a lower ROI in the short term might be acceptable if the investment contributes to long-term sustainability.

Steps to Increase ROI

Increasing Return on Investment requires strategic planning and execution. Here are key steps to enhance ROI:

Localised Market Analysis

Conduct a thorough analysis of the market to identify trends, risks, and opportunities specific to the country.

Operational Efficiency

Streamline operations to reduce costs, enhance productivity, and maximise the efficiency of resources, aligning with the nuances of the local market.

Wider Applications of ROI

Here are broader applications of Return on Investment:

  • Annualised ROI: Particularly relevant for industries with varying seasonalities or economic cycles, annualised ROI provides a standardised measure for comparison across different time frames.
  • Social ROI: Given the increasing emphasis on corporate social responsibility, measuring the social impact of investments is crucial. Social ROI assesses the positive social and environmental contributions a business makes to the community and society at large.

Bottom Line and Key Takeaways

Understanding and effectively utilising ROI is paramount. It serves as a compass for decision-making, enabling investors and businesses to optimise their financial strategies.

Lloyd Legoabe

Lloyd has been trading, investing and teaching about financial markets for over a decade. He has a thorough understanding of financial services provider legislation as well as investment asset classes and categories. Lloyd is a certified RE5 representative and holds a COB Investment certificate from the Moonstone Business School of Excellence.

How is ROI relevant to small businesses?

ROI is crucial for small businesses to assess the profitability of investments, guiding resource allocation for sustainable growth.

Can ROI be negative, and what does it signify?

Yes, a negative ROI indicates that the investment has incurred a loss, highlighting the need for reassessment or strategic adjustments.

How can social ROI be measured?

Social ROI is measured by assessing the societal impact of an investment, considering factors beyond financial gains, such as social and environmental benefits.

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