Return on Investment

Definition

Return on Investment (ROI) is a way to measure how much profit or loss you've made on an investment compared to what you initially put in. It's like checking if the money you spent is bringing in enough returns to make it worthwhile.

To figure out ROI, you use this formula:

ROI = (Net Profit / Cost of investment​) × 100

In this formula, Net Profit is the total money you've made from the investment minus what you spent on it, and Cost of Investment is how much you initially invested.

For example, if you bought a piece of equipment for $1,000 and it helped you earn an extra $1,500, your net profit is $500 ($1,500 earnings - $1,000 cost). So, your ROI would be:

(500 / 1000) × 100 = 50% 

This means you've made a 50% return on your investment.

Why it matters

Return on Investment matters because it gives you a straightforward way to gauge whether an investment is worth the money and effort you put into it. Think of it as a report card for your investments—if you’re spending money, you want to know if it’s paying off. By calculating ROI, you can see exactly how much profit you’re making in comparison to the cost, which helps you decide if the investment is bringing in enough value to be worth it.

This is important because businesses (and individuals) often have several opportunities to choose from, whether it's buying new equipment, launching a marketing campaign, or investing in training. With a clear ROI, you can compare these options based on their returns and focus on the ones that give you the most for your money. For example, a new piece of software might have a lower ROI than investing in an updated machine that boosts productivity significantly. ROI simplifies these comparisons and helps you prioritize investments that actually help you grow.

It’s also a metric that investors, lenders, and stakeholders use to measure a company’s decision-making and financial health. They want to see that the business is putting its money into assets and projects that yield high returns, showing that it’s being managed wisely. Without knowing the ROI, you’d have a harder time understanding whether each investment is helping or hurting your overall financial health.