What ROI (Return On Investment) Is And How To Calculate It

Investment introduces us to the profit and loss system. There are times when the capital you invest in a company will experience a decline in value, on the other hand there is also an opportunity to make a profit. ROI is a term often used to describe the situation.

Some of you may be familiar with the acronym ROI or Return on Investment. However, it is undeniable that there are still many people who question the definition and how to calculate the actual ROI. Let’s find out more through the following Actively Share’s article!

Definition of ROI

Return on Investment or ROI is the percentage of profit that can be obtained from the total number of investment assets. From its definition, it can also be said that ROI is a calculation that can show the level of how effective a person or company is at risking funds in the form of investments.

ROI or Return on Investment is a return on investment that shows the ratio of profits to business / invested capital to achieve business goals.

This ratio shows the results of all assets controlled regardless of the source of funding, this ratio is usually measured by a percentage. Not infrequently, the calculation of ROI also includes the duration or time needed to achieve a target.

If you are a beginner in the business world, you should understand how to calculate ROI. Proper ROI calculations can be useful for almost any decision you will make for your business. In addition to calculating investments, buying assets, and investing, ROI is also useful for calculating if you want to recruit workers to help you run your business.

There are two stages that can help companies determine investment sustainability through ROI figures. When the ROI formula produces a number on a positive scale, it is better for the investment to continue. On the other hand, if the percentage obtained shows a negative number, then you should immediately withdraw the investment because it will cause losses.

Also read Understanding Return on Assets (ROA), Functions, & Calculations

Why Do You Need to Calculate ROI?

There are many reasons why a business actor needs to know what the rate of return on investment is owned by the business they run. By calculating the rate of return on business, a business actor can easily convince potential new investors to invest in developing their business; especially if the rate of return on investment is high.

In addition, Return on Investment can also be a tool to measure the success ratio of a business strategy; particularly related to marketing and sales activities of the business being run.

If from the ROI calculation it is known that the rate of return on investment is low or even in a minus position, business actors can adjust their business model quickly to cope with these losses instead of continuing the same and unprofitable business model. Its growth can also be monitored from period to period because the calculation of ROI is generally carried out per investment period as a periodic analysis.

Without a ROI calculation, a business actor will find it difficult to determine the progress of his business development, so he will be stuck in the same way continuously without being able to rise and increase his business income.

If this situation continues, of course the business will lose money or find it difficult to develop. This is why ROI is important in the profit and loss analysis of a business.

With these two reasons alone, of course there is an idea why it is necessary to calculate ROI in each period, especially for business actors who really want to continue to develop their business to be more advanced and bigger. From this calculation, it is not uncommon for business operations to be adjusted to get maximum results.

ROI formula

ROI is the result of income obtained from investments involving state companies. In another sense, there must be the involvement of paying taxes in it. In general stock transactions, the tax imposed is 0.1% of the gross sale of shares. Then the ROI formula is as follows:

ROI = Net Profit after Tax : Total Assets x 100%

Example of ROI

As a technique to understand how to calculate ROI in the formula above, here are some examples of ROI for you to learn. Look and pay close attention according to each situation.

  1. You are an individual investor who will invest in a fast-food fried chicken restaurant. It is estimated that the net profit that will be obtained in November is $ 40k. While the total asset of the funds you provide is $ 800k rupiah. Then the ROI figures obtained are:ROI = Net Profit : Total Assets x 100%= 40,000 : 800,000 x 100%= 0.05 x 100%= 5%From the results of how to calculate ROI above, it can be seen that the percentage result reaches 5%. This means that the investment you make is likely to generate profit and increase your income by 5% or equivalent to $ 40k. So, it is better if the investment is still carried out for the future period.
  2. An audio visual content production company “ABCD Production” provided a number of funds to a well-known entertainment agency in New York, namely “EFGH Agency.” This investment was made to build future cooperation, so that the shares of EFGH Agency were purchased by ABCD Production at a price of 160K. However, due to internal problems, EFGH Agency’s income was forced to decrease by $. 200K. Then the ROI obtained is:ROI = Net Profit : Total Assets x 100%= -40,000,000 : 160,000,000 x 100%= -0.25 x 100%= -25%Unlike the first profitable example, a drop in revenue could result in a minus on the old calculation. In another sense, ABCD Production suffers a loss. So that the ROI is -25%, there is no need to maintain the investment made.

Factors Affecting ROI

After knowing how the ROI example is based on the two different cases above, it is now clearer that the Return on Investment formula can generate a surplus or minus in your company’s cash. This phenomenon does not just happen, there are several factors that affect ROI, namely:

  1. Operating asset turnover cycle or often referred to as operational assets. Some examples are buildings, money, tools, company patents, and other items that are useful in running the company’s wheels. This factor can be seen how well the company’s management of its operational assets is.
  2. Profit margin or the ratio of profit and sales. The greater the profit margin calculation results, the profits obtained in ROI will also increase.

Advantages and Disadvantages of Return on Investment (ROI)

There are several advantages that make it easier for you to calculate assets if you use ROI, such as:

  • Makes it easier for you to make decisions to buy assets, provide funding for certain projects or programs, or when you decide to invest.
  • Can measure the efficiency of the use of capital, production, and sales.
  • You can compare your business with competitors’ businesses. However, this can only be achieved if you have industry data so that you can calculate industry ratios first.
  • Can be used to do business planning.

However, ROI also still has some uncontrollable drawbacks, namely:

  • Does not include the element of cost of capital into the formula so that a high ROI value cannot be called effective if it has not been compared to the cost of capital.
  • The percentage obtained from calculating ROI cannot always be compared with competitors, because each business has different accounting and management practices.

Also read What is ROE (Return on Equity)? This is Definition & How to Calculate

Great Conclusion

When running a business or want to make an investment, don’t just focus on the nominal profit that you will get. But make sure you have calculated accurately so that you can ensure and convince yourself that the business you are running can grow in the future. For that, the use of ROI is one way.

Pay attention to the amount of funds you have to invest in achieving the sales target, the amount of profit earned, and the part of the profit that will be used again to develop the business.

If the investment or business that you want to do only produces a small profit, chances are that the business will have difficulty growing in the future.

Therefore, consider also making your business known to internet users. Even though you may not get the target you are aiming for at the same time, at least some people with  the same niche as your business will be interested and find out more about your business.

In conclusion, for entrepreneurs, ROI is a very important thing to know. By applying the method of calculating ROI, you can predict in advance the sustainability of the investment made.

Then you can also make a more mature plan about how to invest or the asset. Hope it is useful!

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