What is ROI (Return on Investment)?
Return on Investment (ROI) Definition
Return on Investment (ROI) is a core financial performance measure used to evaluate the efficiency of an investment and to compare the efficiency to other investments. Most financial and business concepts build upon ROI because its purpose is to tell investors how much money they stand to make in the future if they make an investment right now.
ROI is expressed as a percentage or ratio and is calculated as follows:
Uses of the ROI Metric
ROI’s are very useful for short term investments, but can be misleading for long term investments because they do not factor in the time value of money. Time value of money is based on the principle that a dollar today is worth more than a dollar paid at a later date.
The ROI is still a useful metric because it is both versatile and simple, allowing investors to estimate the profitability of their investments. ROI is applicable across a variety of investments such as real estate investments, stock market investments, or investments in updating factory tools and machinery.
Return on Investment & Net Present Value
The net present value of a company, which is the current value of all future cash outflows, is similar to ROI but is stated as a dollar amount and includes any discounts in the investment. When the net present value of an investment is net positive, then it is most likely a profitable investment. Investors should analyze the profitability of their investments using both ROI and NPV, and should avoid investments when negative ROIs are calculated.