How to Calculate Return on Investment (ROI) – Step-by-Step Guide

Return on Investment, or ROI, is a financial metric that measures the profitability of an investment. It tells you how much profit or loss you've made relative to the amount invested, usually expressed as a percentage.

The formula is:
 

ROI (%) = (Net Profit / Investment Cost) × 100

Example:

Suppose you start a small tiffin service by investing ₹50,000. After 12 months, your total revenue from customers is ₹70,000. Your net profit is:

₹70,000 (revenue) − ₹50,000 (initial investment) = ₹20,000

So, your ROI is 40%, meaning you earned ₹40 for every ₹100 invested. ROI helps compare different investment options to choose the most profitable one.

Why is ROI Important?

Return on Investment (ROI) is important because it helps individuals and businesses assess whether an investment generates a worthwhile return. It simplifies decision-making by showing which options are more profitable.

Example:

Imagine you have two business opportunities:

• Option A: Open a food stall with an investment of ₹60,000
• Option B: Start an online bakery with an investment of ₹40,000

After one year, here are the results:

Although both options have the same ROI (30%), this tells you that each investment is equally efficient. Without calculating ROI, one might wrongly assume the food stall is better because it made more profit in absolute terms. ROI ensures you compare returns proportionally, which is key for smart investing.

Step-by-Step Calculation

Calculating Return on Investment (ROI) is straightforward if you follow a clear step-by-step approach. Let’s break it down using a practical example.

Example:

Suppose you invest ₹80,000 to start a mobile accessories shop. After one year, your total return (sales revenue) is ₹1,00,000.

Step 1: Identify the Investment Cost

This is the amount you initially put into the business:
 ➡ ₹80,000

Step 2: Calculate the Total Return

This is the money you earned from the investment.
 ➡ ₹1,00,000

Step 3: Find the Net Profit

Net Profit = Total Return − Investment Cost
 ➡ ₹1,00,000 − ₹80,000 = ₹20,000

Step 4: Apply the ROI Formula

ROI (%) = (Net Profit / Investment Cost) × 100
 ➡ (₹20,000 / ₹80,000) × 100 = 25%

So, the ROI is 25%, meaning you earned ₹25 for every ₹100 you invested. This step-by-step method helps you evaluate the profitability of any investment clearly and accurately.

Interpreting the ROI Result

Understanding what the ROI percentage means is just as important as calculating it. ROI tells you how efficiently your money is being used and helps compare different investment options, regardless of their size.

Example:

Let’s say you invest ₹1,00,000 in a home décor business and earn ₹1,30,000 after one year.

Step 1: Calculate Net Profit

₹1,30,000 (Return) − ₹1,00,000 (Investment) = ₹30,000

Step 2: Calculate ROI

ROI = (₹30,000 / ₹1,00,000) × 100 = 30%

What Does 30% ROI Mean?

• For every ₹100 you invested, you earned an additional ₹30 as profit.
• A positive ROI (like 30%) means the investment was profitable.
• A negative ROI would indicate a loss.

• A higher ROI typically reflects better investment performance, but it must be considered alongside factors like time, risk, and effort.

   

So, interpreting ROI helps you judge not just if you made money, but how well your investment performed compared to others.

Limitations of ROI

While ROI is a useful tool to measure profitability, it has certain limitations. It doesn’t consider the time taken to earn the return, the risk involved, or hidden costs. Relying solely on ROI can lead to misleading decisions.

Example:

Consider Ramesh and Priya, who each start a different business:

• Ramesh invests ₹1,00,000 in a garment shop and earns ₹1,40,000 after 1 year.
• Priya invests ₹1,00,000 in an event planning service and earns ₹1,30,000 after 6 months.

ROI Calculations:

On the surface, Ramesh’s ROI of 40% seems better than Priya’s 30%. However, Priya earned hers in half the time. If she reinvested and repeated the same return in the next 6 months, her annual ROI would effectively be 60%, higher than Ramesh’s.

Conclusion

Calculating Return on Investment (ROI) is a simple yet powerful way to assess the profitability of any financial venture. By using the formula ROI = (Net Profit / Investment Cost) × 100, individuals and businesses can clearly understand how much return they are getting on their invested money.

It allows for easy comparison between different investment opportunities, helping you make more informed financial decisions. However, while ROI gives a useful snapshot of performance, it should not be the only factor considered—time, risk, and other costs are equally important.

In short, ROI is an essential tool in the investor’s toolkit, best used as part of a broader financial evaluation strategy.

FAQ’s

1. What is ROI?
Return on Investment (ROI) measures how much profit you earn from an investment compared to the amount you spent, expressed as a percentage.

2. How do I calculate ROI?
Use the formula: ROI = (Net Profit ÷ Investment Cost) × 100. It gives a clear percentage showing the return gained on your original investment.

3. Why is ROI important?
ROI helps compare different investment options, showing which one gives better value for money, regardless of the size of the investment.

4. Can ROI be negative?
Yes, a negative ROI means your investment made a loss, as the returns were lower than the amount originally invested.

5. Does ROI reflect time or risk?
No, ROI only shows return percentage. It does not account for the time taken or the risk involved in achieving that return.
 

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