How is return on investment roi calculated

Return on investment from an accounting point is easy. It represents a way of measuring performance that determines the efficiency of an investment. The money invested in a business is so that it can yield profit but how much it will eventually yield will depend on the overall efficiency of the different component. The return on investment attempts to give a standard measure of the returns on the investment considering the cost. What an investor benefit from an investment he made is the return on investment.

IMPORTANCE

The purpose or importance of return on investment cannot be exhausted. Because money or capital is in short supply and  investment opportunities are many, the average investor often have to ask the question, what is the yield of one investment when compared to another with the same risk exposure?

And the answer have practical importance in his decision of which investment to put his money into, so here are some reasons why return on investment must be known.

- IT USED TO ATTRACT INVESTORS

The major attraction for investors in any field is the return on investors, so without calculating it, you cannot sell an investment opportunity as viable. The money needed to start a business or expand an old one will flow in once it can be established that the return on investment is substantial.

- IT IS USED TO OBTAIN LOANS

This is one important fact that the bankers will want to see before lending out money for investment. It is a prove that it is worth the effort, for besides testing  feasibility, it must be known that after the business has kicked off, it will return enough benefit to have worth the stress of starting it.

TYPES OF RETURN ON INVESTMENT

The purpose of setting up business is different. For example a social entrepreneur may put up a firm not to make profit but to help the less privileged. For such a firm, there is still need to calculate the return on investment since there are many social ventures that the money can be spent on. But in this case, the return on investment won’t be in terms of profit as we understand it, but rather, the social benefit, this is called social return on investment. There are other values that are measured depending on the interest for setting up the venture, all these are considered extra- financial value and they are all based on the investment.

RISK

Return on investment is simple to understand and easy to calculate, but here lies a danger. It flexibility permit different variables to be used when calculating ‘benefits from investment’ for example and this may not really have a bearing on what should be considered ‘benefit of investment’ and in the end, the ROI may not be a true representation of what it should be and because so many decisions will be based on it, there will be wider implications. For example, it is often used to prioritize investments, so before this is done car must be taken to ensure that return on investment was properly done

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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