What is Return on Investment?
Return on Investment is used as a performance measure used to gauge efficiency on the amount of profit that has been gained through a certain investment in any sort of share market, organization, or shareholding. It is used to measure the efficiency of numerous different investments and does so by comparing the amount invested and then evaluating the amount that has been profited through the same investment over some time. How is ROI calculated? Why is ROI so popularly used? What is the importance of it? and lastly What can be considered a good ROI? Let’s tackle all such questions and study the various aspects of ROI.
Why is ROI so important? Why is it commonly used?
ROI is a very popular metric system for business purposes and has been used for a long time ow to calculate the return value on investments. It is, as the definition defines it a common method to evaluate the profit gained through various investments. Various types of ROI need evaluation too. For example, it can be the return value for a stock investment, the amount of profit that a company has gained and the value it would require on expanding the business, or even the investment made through a real estate transaction.
ROI is generally represented in the form of a ratio or percentage and it is very simple to calculate it. The evaluation is also very easy to determine as it can be formed in the words of either positive, negative, or neutral. However, every stock market requires hawkeye capturing skills as opportunities with higher ROIs come in and you would have to grab that investment as soon as possible. Although markets are highly unpredictable it is important to avoid investing in something that has a negative ROI.
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Hence, ROI is very important to judge the market predictability and understand when is it necessary to invest and when it would be smarter to let go of the investment.
How do you calculate ROI?
ROI can be calculated with a very simple formula and as we have discussed earlier, the result would either be in the form of a ratio or percentage. The percentage would usually determine the amount that has been hiked upon that investment whereas the ratio form can express if it’s a positive ROI or not.
Mathematically, ROI can be calculated by the following formula:
Return on Investment = (Present Value of the investment – Cost of Investment) / Cost of Investment
Let’s take an example. Let’s say a random investment has resulted in a profit of $10 and the amount that was invested was also $10, this means that the ROI of this investment would be 1 if expressed in terms of ratio and 100% if counted as a percentage as it profited the same amount that had been invested.
Although this may be a great way to calculate the profit on investments, some drawbacks are faced by it. Some of them include no concept of time taken into consideration and also lack to acknowledge the present value of the money. Some investments take years and years to gain a decent amount of profit and the value can be disregarded as per the inflation period that is being faced by the entire world. Hence, as useful as it is, it does have some pretty serious drawbacks that have to be considered.
What is considered a good Return on investment?
There is no standard benchmark for ROI as it depends on every investor’s patience and risk-taking level. Some investors don’t wait out a lot to gain a good ROI whereas others wait for a long time until it’s considered a good ROI and then proceed the take out the profits.
Sum-Up
To sum up today’s article, we have understood the various factors involving ROI and how it is important for all business owners to use the metric system to have a better knowledge about the growth and profits of the business. Waiting for a better ROI may provide you with a good one however, as per every risk in the share market, it is never pre-defined nor guarantee that you would be able to profit from the investments. Choose wisely, research about the stocks you might plan on investing in, and go ahead. Hope this article helped to tackle all the questions that had been raised above and provided you with a general idea about the various factors.