Helping You Understand The Concept Of What Return On Investment Is !
The financial term ‘return on investment’ (ROI) is often referred to as rate of return and is a percentage indicating the profits or losses from money invested.
Many companies also calculate ROI for future investments and use estimated figures for such a calculation. It is usually done for a specific investment project or marketing campaign over some period or term but it can also be calculated as an average over a whole quarter or year.
The ROI metric is flexible and simple and can be adjusted to any situation when you calculate ROI. This calculation is vital in any investment review.
Why this calculation is necessary
It is not possible to compare the performance of investments in monetary values simply because not all investments require the same financial input. It would be incorrect to compare the profit of a $100 investment to that of a $10 000 investment unless you calculate it in proportion to the investment.
In this case and $30 return on the smaller investment could be better than an $700 profit made on the bigger investment. In order not to try and compare this $30 and $700 and make correct investment decisions, a formula was written to measure investment profitability as apposed to the size of an investment.
Calculating ROI
When calculating ROI there are many factors that should be taken into consideration: These include the sales over the period, latent sales, value; average rate of return of an investment project. Latent sales can sometimes make up a significant part of the return on a item that has a long sales cycle like a big ticket item.
To calculate straight return on investment the profits made from the investment is divided by the cost of the investment. Many prefer to calculate the rate of return that takes short term and long term sales cycle into consideration. The overall rate of investment is calculated based on a timeline of costs and returns.
Investments may have many hidden cost that should be included when you calculate ROI, these include maintenance costs, taxes, research costs and the time that the investment will demand. Because very few investments are straightforward and often include additional payments or lumps sum pay-out, many companies now offer spreadsheet software that make ROI calculations simple and more accurate. This software comes highly recommended as complicated ROI calculations may be very time consuming and errors may lead to poor investment decisions.
What ROI calculations are used for?
When companies draw up budgets of how they will apply capital during a specific period, they rely heavily on return on investment calculations to identify the most profitable investment projects.
This study is vital in maximising profits to be made from investments. Investors look intensively at inflation estimations and the risk of an investment when calculating the ROI at which they are willing to invest at. More recently the rate of investment is not only being used for traditional capital investment calculations but also when purchasing assets or programs like marketing or recruitment software.
