Return on investment or ROI is sometimes called return on costs. It is a simple ratio between the investment and surrounding costs in comparison to the net income over time. Return on investment is commonly used to gauge the efficiency of any investment.
Return on investment is commonly used in many different areas but is most prominently mentioned in financial markets, real estate investments, and marketing campaigns.
When a return on investment is positive, it represents profits. Naturally, when the opposite occurs and a return on investment is negative, it represents net losses. It is also important to note that ROI is usually shown as a percentage and not a ratio. This is usually done for the ease of understanding it.
ROI or return on investment, can be calculated by two different methods.
The first is: ROI = net return on investment / cost of investment x 100%
The second is: ROI = final value of investment – initial value of investment / cost of investment x 100%
Let’s use an example: a property investor purchases a condo for $100,000 without any additional costs. In a year the property increases in value and reaches a market price of $150,000 according to an evaluation. This means that the investor made an unrealized profit of $50,000 on the property. Dividing $150,000 by $100,000 equals 1.5 which we later need to multiply by 100. This brings us to an ROI or return of 150% for the year.
The biggest criticism of ROI is that it tends to not consider time as part of the equation. Another is that it cannot factor in non financial benefits.