In a broad sense Return on Investment simply means how much money you get out compared to how much money you put in, in regards to an investment. Whether that be buying shares, purchasing a house, starting a business – the list is endless. How you get to that figure is the important part and if you can forecast what you can get out of an investment, it can mean the difference between a profitable business venture and financial ruin.
If you have already made your investment, for example you bought shares and then sold them; the return on investment calculation is very simple. Just take away your sale revenue from the original price you bought the shares at and hope the end figure is a positive number and you’ve made a profit. It’s simple but quite a useless figure. It’s no good knowing what you made afterwards because you may now be in financial ruin. The real purpose of Return on Investment is to calculate the result before you make the investment. This is commonly called the Return on Investment formula, but it still has little use if you can’t research the other variables.
The only true benefit of ROI is to determine a business’s sole profitability without taking in to account re-investment or money spent elsewhere in the business, e.g.
ROI = Net Income – Direct Business Costs = Sole Profit.
Because ROI is so simple it is also easily to manipulate for somebody’s own biased reasons. For example a manager may display his investment idea:
“By boat can ferry 20 passengers a day who pay $2 each and only costs $30 per day in fuel”
ROI = $40 - $30 = $10 profit.
But the manager may have failed to note that you need to pay a captain $5 a day and every two days the engine needs servicing.