WHAT IS A ROI?
ROI is the acronym for Return On Investment and it is a percentage that is calculated based on the investment and the benefits obtained, from the ratio of return on investment. The ROI is a value that measures the performance of an investment, to assess how efficient is the spending that are planning to do. There is a formula which gives us the value calculated based on the investment made and the benefit earned, or are planning to get.
We can set an example. Suppose that in our company of Bicycle accessories we decided to spend $200 in advertising on Google (source of attribution) and 100 in Yahoo (source of attribution). At the same time, we established that we would reverse $300 only in campaigns that deliver us a return on investment over a 40% in a month. We decided to invest $200 in Google and $100 in Yahoo. 30 days later, we noticed that by advertising on Google, we recover only $70 in sales, or a 35% ROI (70/200). While Yahoo, we recover $45, with an ROI of 45% (45/100).
In total, we invest $300 in our campaign, and recovered 115, which gives us a whole campaign of 38% ROI (115/300). Not meet our goal to invest above 40% return. But if we had invested more in Yahoo, it would have been a different case. And this is what we will do next month to achieve the goal of having one greater than 40% ROI. As the example explains, thanks to the ROI we can make better decisions and optimize our budget.
ROI is a popular metric in terms of finance and is used primarily for the evaluation of the financial consequences of a particular investment and the actions that follow. The cash flow metric of ROI compares the timing of investment gains with the timing of the costs involved. A higher the rate of the return on investment is, the gains are more in comparison to the costs of the investment.
ROI For Measuring Profitability
The financial metric of ROI has gained significant popularity over the years for the general purpose of measuring profitability in relation to investments, business acquisitions, programs, initiatives and stock exchange investment. The financial analysts and decision makers have been using ROI for a long time to determine the profitability of a particular business undertaking. In the field of general economics in relation to business organizations, ROI has been used to effectively use the funds for maximum profitability.
Concept Of ROI
The simple form of ROI compares the cost of investment with the return on investment by deriving a ratio or percentage. A result that is more than zero, means that the return on investment is greater than the cost of the investment (positive ROI). When the cost of the investment is greater than the return on investment, it is regarded as a negative ROI.
However, financial analysts must realize that ROI figures are not entirely sufficient to provide a validated profit or loss scenario. Since the market trend can change the profit or loss margin of the business or investment, the ROI figure can constantly change and are not completely dependable for accurately depicting the profitability. The concept behind using return on investment calculations is to provide a clear picture of the financial condition of the investment. The decision makers and financial analysts use the figures to help in improving the ROI increasing gains, reducing unnecessary expenses, accelerate the growth rate of the investment.
Financial analysts derive ROI from an action as “return” (incremental gain) by dividing it by the cost of the action. In order to calculate the simple version of the RIO, you must divide the net gains from the investment by the cost of the investment. The result of this division is noted in percentage and is regarded as the RIO of the particular investment.
Simple ROI = Gains – Cost Of Investment / Investment Costs
For example: If your investment is to be $500,000 with the estimate of delivering a profit of $700,000 in the next 10 years, your ROI should be:
700,000-500,000 / 500,000 = 40
Hence, the return on investment you could expect from your investment of $500,000 in the coming decade should be 40%.
While ROI has become one of the most commonly used financial metric for calculating profitability of a business investment or program, most financial analysts and decision makers must look into other additional financial metrics for a dependable forecast of the financial future. Since the financial and marketing trends are constantly evolving with good and bad alternations all the time, the return on investment figure must be used as a supporting metric for profit analysis, and not be depended on completely.