What is Return on Investment (ROI)?

Return on investment, commonly abbreviated as ROI, is a simple formula that measures the profitability of an investment. It essentially compares how much you made on an investment compared to how much you put into it. This is a metric that businesses and investors use to determine the value of their investments.

• For investors, ROI is calculated in strictly financial terms, focusing on the amount of capital invested and the return received.
• For businesses, ROI is often calculated using various factors including monetary costs, time invested by employees, and opportunity costs.

Ways That ROI Can Be Expressed

• As a percentage: The most common way to express ROI, providing easy understanding. E.g., a $7 profit on a $100 investment represents a 7% ROI.
• As a ratio: Less common, representing ROI as a ratio. E.g., the 7% ROI above would be expressed as 0.07:1. This method is better for ROIs above 100%.
• As a multiple: Similar to the ratio, but expressed as a multiplier. E.g., 500% ROI could be expressed as 5x.

How to Calculate Return on Investment (ROI)

Basic ROI calculation helps make sound financial decisions.

The ROI Formula

Two formulas can be used to calculate ROI, both yielding the same result.

• ROI = (Net Profit/Cost of Investment) x 100
• ROI = ([Present Value-Cost of Investment]/Cost of Investment) x 100

Calculating ROI for a Marketing Campaign

Here's an example of how a hypothetical ecommerce business, Buy Cute Stuff, can calculate the ROI of their "Cuter Than a Basket Full of Puppies" campaign:

Cost of the Investment (Marketing Cost)

• Facebook ad spend: $5,000
• Google ad spend: $7,500
• Social media and ad graphics: $1,000
• Landing page creation: $700
• Total Cost of the Investment: $14,200

Net Profit (Sales Growth)

Total sales generated by the campaign: $60,000

Net Profit = $60,000 – $14,200 = $58,578

Marketing ROI = ($58,578/$14,200) x 100 = 413%

The total ROI of this campaign is 413%, which can also be expressed as a ratio (4:1) or a multiple (4x).

What Is a Good ROI?

A good ROI varies depending on the investment type.

• In marketing, 500% is considered solid, 1,000% is stellar, and 200% is disappointing.
• In stocks, an annual ROI of 7% is standard, and above 10% is good.
• In real estate investing, an ROI above 10% is considered good.

How to Use ROI

ROI can be used to calculate the value of spending, serving as a key performance indicator (KPI) to determine the value of investments in areas like:

• Hiring new employees
• Purchasing equipment
• Marketing efforts
• Sales strategies
• Expanding the business
• Acquiring another business

Projecting ROI for Future Business Decisions

Businesses use ROI in cost-benefit analysis before pursuing new projects or expenditures.

• ROI helps determine the financial value of potential investments.
• It helps to compare different investment options and select the most profitable ones.
• It is often used in budgeting and financial planning to allocate resources effectively.

What Can’t ROI Do?

ROI has limitations and shouldn't be the sole basis for financial decisions.

• It doesn't tell you about the risk of an investment.
• It doesn't indicate if you have the necessary funds to make the investment.
• It doesn't assess if a campaign aligns with your overall marketing strategy.
• It can't measure factors like team satisfaction or intangible benefits.

Are ROI and IRR the Same?

ROI and IRR are different metrics, though both relate to investment return.

• IRR (Internal Rate of Return) provides more nuance and is typically used for capital investments by investing professionals.

What Is Annualized ROI?

Annualized ROI measures the average ROI of an investment on an annual basis, commonly used for long-term investments like stocks and real estate.

• It accounts for the time value of money and provides a consistent metric for comparing investments with different holding periods.
• For instance, if an investment property is held for 5 years, annualized ROI reflects the average yearly return.

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