Return on Investment (ROI) is a valuable tool for businesses and individuals. It is a measure of performance used to evaluate how efficient an investment is or to help compare the efficiency of different investments.
ROI is not the same as profit, it deals with the money you invest and the return you realize on that money based on the net profit of the business. Profit measures the performance of the business.
There are methods to figure the ROI. In one method, you look at your investment of dollars spent and divide your net return by that initial cost. The other method involves in the subtraction of the initial value of the investment from the final value of the investment and dividing the difference by the beginning amount of the investment. No matter the method that you choose, you will get the same result that is expressed as a percentage.
Advantages and Disadvantages of Return on Investment
There are both advantages and disadvantages of a return on investment. The biggest advantage is that it is an easy metric to calculate and easy to understand. It means that is often used to use profitability and is not misinterpreted because it has the same meaning in any context.
One of the disadvantages to ROI is that it does not take into account the holding period of an investment. This can be problematic when comparing investment alternatives. ROI also does not adjust for risk and the ROI figures can be exaggerated if all the expected costs are not included in the calculation. Lastly, ROI only emphasizes financial gains when considering the returns on an investment.
What Is a Good Return on Investment Ratio?
Depending on the situation, a good ROI will vary for businesses and investors as they each have their own goals and objectives. If you have any questions about ROI and dealing with more complex ROI calculations, seek an accountant who will be able to help you out.