Return on Investment (ROI) refers to the performance measure of the investments. ROI gives a clear picture about the investment efficiency. The gain or loss resulting from an investment, relative to the amount of money supplied, is expressed in ROI. In simpler words, ROI is nothing but the measure of a profit earned by a person or a company from each investment. To mathematically compute ROI, the return or profit on an investment is divided by the cost derived from the investment, and the outcome or the result is suggested as a ratio or a percentage.
The formula for the return on investment:
ROI = (Gain from Investment – Cost of Investment) / Cost of Investment
In the above-mentioned formula, the result obtained from the sale of the investment of interest is referred to as “Gain from Investment”. Since the measurement of ROI is taken as a percentage, returns from other investments can be compared with it easily, helping one to measure different types of investments against each other. ROI is used generally for personal financial decisions which include comparing and contrasting the efficiency of different investments and the profitability of a company.
To be precise, ROI = (Net Profit / Cost of Investment) x 100. Return on investment is used as an indicator to compare various project investments within the portfolio of a project.
ROI and related measurements offer a clear idea of profitability, adjusted for the sum total of the investment assets pooled up in the enterprise. ROI, though, is not a net present value- adjusted though most of the books portray it in a wrong way. To the numerators of ROI, marketing decisions have a sure potential connection, but the usage of the assets and capital requirements (for example inventories and receivables) are often influenced by these decisions. Marketers should be able to understand the returns expected and the company’s position. According to a survey, 77 percent senior marketing managers acknowledged that the ROI metric is very useful.
Because of the flexibility of the ROI, it is one of the frequently used profitability ratios. A major negative characteristic, however, is that it can be manipulated, thus results may vary among different users. Hence, while using the method to compare investments, it is an important to use the exact same inputs to receive an accurate comparison. It is also important to note the fact that time is not taken into consideration while applying the basic ROI calculation to find a result.
To gauge the profitability of the business, ROI can be used in different productive ways. For example, measuring the performance of the pricing policies, capital equipment investment, inventory investment and so on are a few. To determine the market ROI, the primary need is to identify what constitutes the “return” and what the true investment is. To gain a better perspective, marketers consider the following for return:
Total Revenue produced for a campaign (or gross turnover, depending on the type of the organization and location)
Gross Profit, an estimate of the gross profit, which is revenue deducted from the cost of goods to deliver/produce a product or service.
Net profit, which is gross profit deduced from the expense
While calculating the market ROI, the components for each organization may vary, but with accurate ROI calculations, campaigns that deliver the greatest return can be focused on. Additionally, ROI helps to justify marketing investments. By focusing on the ROI, the company can reject the notion that marketing is an unnecessary expense that can be cut short when times get tough. Taking the advantages of ROI into consideration, the most important fact of ROI is its ability to provide better measure of profitability. ROI guarantees goal resemblance between the various divisions and the firm. It helps in creating a comparison between various units of business in terms of asset utilization and profitability. ROI helps a great deal in making appropriate decisions regarding acquisition and disposal of capital assets and on earning maximum profit. It serves as a standardized measurement for calculating the financial efficiency of investment opportunities.
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