Understanding Return on investment (ROI) analysis

Smart investments generate valuable returns, such as cost savings, new profit, or appreciation in value of the company’s equity.

Companies use return on investment (ROI) analysis to compare returns on money spent internally with returns available elsewhere, such as investment in government bonds. An investment’s ROI should be reasonably high which is more than the company could expect to get by investing in external opportunities.

ROI analysis has several advantages:

  • It’s easy to convey to upper management.
  • It reminds everyone that wise expenditures pay off financially.
  • It adopts a long-term perspective.
  • It helps you compare different investment options.

Calculating ROI

To calculate ROI, start by figuring the “net return” from an investment, using this formula:

Net return = Total benefits – Total costs

Total benefits can be in the form of savings or additional income. To calculate the ROI, the ratio of the net return to the cost of the investment can be calculated by using this formula:

ROI = Net return ÷ Cost of investment

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Categories: Personal Finance

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