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Return on investment

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This article is about the term in investing. For articles on other subjects having the same
abbreviation, see ROI.
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Return on investment (ROI) is the benefit to an investor resulting from an investment of some
resource. A high ROI means the investment gains compare favorably to investment cost. As a
performance measure, ROI is used to evaluate the efficiency of an investment or to compare the
efficiency of a number of different investments.[1] In purely economic terms, it is one way of
considering profits in relation to capital invested.
Contents

1Purpose
o

1.1Risk with ROI usage

2Calculation
o

2.1Property

2.2Marketing investment

3See also

4References

Purpose[edit]
In business, the purpose of the "return on investment" (ROI) metric is to measure, per period, rates
of return on money invested in an economic entity in order to decide whether or not to undertake an
investment. It is also used as indicator to compare different project investments within a project
portfolio. The project with best ROI is prioritized. Recently, the concept has also been applied to
scientific funding agencies (e.g. National Science Foundation) investments in research of open
source hardware and subsequent returns for direct digital replication. [2]
ROI and related metrics provide a snapshot of profitability, adjusted for the size of the investment
assets tied up in the enterprise. ROI is often compared to expected (or required) rates of return on
money invested. ROI is not net present value-adjusted and most school books describe it with a
"Year 0" investment and two to three years income.
Marketing decisions have obvious potential connection to the numerator of ROI (profits), but these
same decisions often influence assets usage and capital requirements (for example, receivables and
inventories). Marketers should understand the position of their company and the returns expected. [3]
In a survey of nearly 200 senior marketing managers, 77 percent responded that they found the
"return on investment" metric very useful.[3]

Return on investment may be calculated in terms other than financial gain. For example, social
return on investment (SROI) is a principles-based method for measuring extra-financial value (i.e.,
environmental and social value not currently reflected in conventional financial accounts) relative to
resources invested. It can be used by any entity to evaluate impact on stakeholders, identify ways to
improve performance, and enhance the performance of investments.

Risk with ROI usage[edit]


As a decision tool it is simple to understand. The simplicity of the formula allows to freely choose
variables e.g., length of the calculation time, if overhead cost should be included, or details such as
what variables are used to calculate income or cost components. To use ROI as an indicator for
prioritizing investment projects is risky, since usually little is defined together with the ROI figure that
explains what is making up the figure.
When long term investments take place, the need for Net Present Value adjustment is high. Similar
to Discounted Cash Flow you should use Discounted ROI instead.

Calculation[edit]
For a single-period review, divide the return (net profit) by the resources that were committed
(investment):[3]
return on investment = Net income / Investment
where:
Net income = gross profit expenses.
investment = stock + market outstanding[when defined as?] + claims.
or
return on investment = (gain from investment cost of
investment) / cost of investment[1]
or
return on investment = (revenue cost of goods sold) / cost of
goods sold

Property[edit]
Complications in calculating ROI can occur
when real property is refinanced, or a
second mortgage is taken out. Interest on a
second, or refinanced, loan may increase, and
loan fees may be charged, both of which can
reduce the ROI, when the new numbers are
used in the ROI equation. There may also be
an increase in maintenance costs and property
taxes, and an increase in utility rates if the
owner of a residential rental or commercial
property pays these expenses.
Complex calculations may also be required for
property bought with an adjustable rate
mortgage (ARM) with a variable escalating rate
charged annually through the duration of the
loan.

Marketing investment[edit]

Marketing not only influences net profits but


also can affect investment levels too. New
plants and equipment, inventories, and
accounts receivable are three of the main
categories of investments that can be affected
by marketing decisions.[3]
RoA, RoNA, RoC, and RoIC, in particular, are
similar measures with variations on how
'investment' is defined.[3]

See also[edit]

Bang for the buck

Rate of profit

Rate of return (RoR), also known as 'rate


of profit' or sometimes just 'return', is the
ratio of money gained or lost (whether
realized or unrealized) on an investment
relative to the amount of money invested

Return on assets (RoA)

Return on net assets (RoNA)

Return on capital (RoC)

Return on capital employed (ROCE)

Return on invested capital (RoIC)

Return on marketing investment (ROMI) is


"the contribution attributable to marketing
(net of marketing spending), divided by the
marketing 'invested' or risked

Return on equity (ROE)

ROI for Information Technology is used to


evaluate applications portfolios and
information systems

Public ROI is used to evaluate initiatives in


the public sector

References[edit]

1.

^ a b "Return On Investment ROI",


Investopedia as accessed 8 January 2013

2.

^ Joshua M. Pearce. (2015) Return on


Investment for Open Source Hardware
Development. Science and Public Policy.
DOI :10.1093/scipol/scv034 open access

3.

^ a b c d e Farris, Paul W.; Neil T. Bendle;


Phillip E. Pfeifer; David J. Reibstein
(2010). Marketing Metrics: The Definitive
Guide to Measuring Marketing
Performance. Upper Saddle River, New
Jersey: Pearson Education, Inc. ISBN
0137058292. The Marketing Accountability
Standards Board (MASB) endorses the
definitions, purposes, and constructs of
classes of measures that appear
in Marketing Metrics as part of its
ongoing Common Language in Marketing
Project.

Categories:
Investment

Income

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This page was last modified on 21 April 2016, at 11:11.

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