Return on Investment (ROI)

What is the definition of Return on Investment (ROI)?

Simply explained, ROI shows when and how a company's investments pay off. The ratio is measured as a percentage of the capital invested and the profit generated. ROI can be used to assess investments and the performance of a branch of business or even the entire company. 

General information

ROI helps to evaluate the success of a company and provides information on how useful an investment actually was. The return on investment is also an important key figure for online marketing, for example, as the success of marketing campaigns is regularly analyzed in this area. However, the result is only significant if it can be separated again into return on sales and capital turnover. Then it is possible to determine exact causes for changes in an ROI. If, for example, profit has increased while sales remain the same, the return on sales will also increase. If the same high ROI is to be achieved, the capital turnover must consequently decrease. The ratio of the capital invested and the profit generated provide information about the return on investment. 

ROI formula for calculation  

The following formula is used to calculate ROI:

ROI = (Profit/Sales) * (Sales/Invested Capital) * 100% = Return on Sales * Capital Turnover * 100%.

Example:

A company promotes one of its new products with a post on all social networks. It spends €2,000 on this. Several customers are acquired through the post, therefore a profit of €17,000 can be attributed to the advertised post. In the case of this example, this results in a return on investment of 8.5%. Consequently, the individual investment has contributed significantly to the financial success.  

At what point is an ROI considered "good"?

As of what percentage a return on investment is good can only be roughly defined. An ROI that lies between 7-10% is a good value for a company with a stable business development. For companies with higher investments and more risks, an ROI of 15-25% should be able to be proven. So there is no exact value that defines a good ROI. Rather, the ROI value depends on various factors of an individual company.

Other forms of return on investment

Since there are numerous variations for calculating success within an entire company, there are also return on investment ratios such as return on equity (ROE) or return on assets (ROA) in addition to ROI.

Return on Equity (ROE)

ROE puts a company's profit in relation to its capital, but this formula cannot be used to determine the company's total revenue. ROE is calculated by dividing profit by a company's equity.

Return on Assets (ROA)

ROA also indicates how profitably the capital employed has contributed to the overall profit. Unlike ROE, the type of financing does not play a role here. In simple terms, ROA is used to calculate how many euros of profit a company has generated with each euro of capital and can be used to weigh up how the result has turned out for the company.

History of the Return on Investment

The development of the ratio ROI is due to the former engineer of the company Du Pont de Numerours, Donaldson Brown. Within the proven Du Pont scheme, he defined return on investment as the key performance indicator. With Du-Pont's scheme, a great many correlations can be derived. Not only capital turnover and return on sales influence ROI, but also many other key figures. For example, if the return on investment is to be increased, the total capital can be reduced, which increases the capital turnover and thus also the return on investment.  

Advantages of the ROI 

• The return on investment is independent of the size of the company, thus a comparison between different types/and sizes of companies can be made.
• Simple, concise presentation
• Meaningful result in the shortest time

Disadvantages of the ROI

• Information is often lost.
• The return on investment only provides monetary information.
• Not suitable as the only instrument for decision making