Return on investment is a crucial analytical tool used by both businesses and investors. In this lesson, you’ll learn the basic formula, discover a variant used for shareholders, and be provided examples.
ROI Defined
Return on investment (ROI) is the ratio of a profit or loss made in a fiscal year expressed in terms of an investment.
Best services for writing your paper according to Trustpilot
It is expressed in terms of a percentage of increase or decrease in the value of the investment during the year in question. For example, if you invested $100 in a share of stock and its value rises to $110 by the end of the fiscal year, the return on the investment is a healthy 10%, assuming no dividends were paid.
Basic ROI Formula and Example
The basic ROI formula is: Net Profit / Total Investment * 100 = ROI. Let’s apply the formula with the help of an example.You are a house flipper.
You purchased a house at the courthouse auction for $75,000 and spent $35,000 in renovations. After sales, expenses, and commission, you netted $160,000 on the sale of the renovated house. What is the ROI?Your net profit is going to be what you netted ($160,000) minus what you spent ($75,000 + $35,000), so it is $50,000. Your total investment is also what you spent ($75,000 + $35,000), which is $110,000.ROI = Net Profit / Total Investment * 100ROI = 50,000 / 110,000 * 100ROI = .45 * 100ROI = 45%If only house flipping was that easy. Keep in mind that you can certainly lose money on an investment.
If there is a loss, the formula will yield a negative number. Here’s a simple example:ROI = -1,000 / 5,000 * 100ROI = -0.2 * 100ROI = -20%
Formula for Shareholders and Example
Shareholders can calculate the value of their stock investment in a particular company by use of this formula: ROI = (Net income + (Current Value – Original Value)) / Original Value * 100.Let’s say you have stock in a tech company.
You originally purchased the shares for $5,000 and they’re now worth $5,200. You’ve also been paid $75 in dividends. What is your ROI for this stock holding?ROI = (Net Income + (Current Value – Original Value)) / Original Value * 100ROI = (75 + (5,200 – 5,000)) / 5,000 * 100ROI = (75 + 200) / 5,000 * 100ROI = 275 / 5,000 * 100ROI = .055 * 100ROI = 5.5%
Lesson Summary
Return on investment, or ROI, is the ratio of a profit or loss made in a fiscal year expressed in terms of an investment and shown as a percentage of increase or decrease in the value of the investment during the year in question.
The basic formula for ROI is: ROI = Net Profit / Total Investment * 100. Keep in mind that if you have a net loss on your investment, the ROI will be negative. Shareholders can evaluate the ROI of their stock holding by using this formula: ROI = (Net Income + (Current Value – Original Value)) / Original Value * 100.
ROI Notes
 |
- ROI is ‘return on investment’, the ratio of profit or loss made in a fiscal year
- Basic ROI can be calculated as ROI = Net Profit / Total Investment * 100
- A shareholder can evaluate the ROI of their stock as ROI = (Net Income + (Current Value – Original Value)) / Original Value * 100
Learning Outcomes
When you are finished, you should be able to:
- Define ‘return on investment’
- State the equations used to calculate basic ROI and shareholder ROI
- Use the formulas to calculate ROI
