ROI stands for Return on Investment but what actually it tells us about our investment? ROI is one of the simplest and easiest way to summarize the return rate. Being simple it is easier to compare with different investment instruments, countries, currencies etc. It focuses to the financial gain so there is some caveats for analysing ROI. First of all it doesn't covers risks. So you need to interpret it yourself. Comparing an investment tool with 40% in 5 years and 20% in 2 years might be misleading. Think of an investment which has a exponentially growth rate. 2 year 20% ROI of that instrument might seem very low comparing to another instrument with linear growth of lets say 40%. That is why we also have the Annualised ROI. This will at least take period into account.
Despite the limitations with the simplicity it is one of the key metrics for business analysis to evaluate and rank returns, intuitive metric of profitability when used with other cash flow measures like IRR and/or NPV.
It is actually the ratio of our profits to investment costs. Calculations are as simple as a division but in real life scenarios are most of the time more complex, especially deciding what to include in costs. If you somehow now your all costs and add them up, you can subtract your end of period balance to calculate the pure profit. Than you divide this to the period of investment. Last step is multiply by 100 and get the ROI percentage. To formulate this:
ROI = (Net Return on Investment / Cost of Investment) ×100%or if you dont know net return:
ROI = ((Final Value of Investment − Initial Value of Investment) / Cost of Investment) ×100%Another metric here is the Annualised ROI. This is actually equal to CAGR. You can use our CAGR (Compound Annual Growth Rate) Calculator to calculate it. It gives a yearly basis return rate needed for the amount we expected.