Return on Investment, also known as ROI, is simply a measuring tool used in determining how well a company is doing. Investors use this tool a lot to find out if their investment in a company is moving well or not. This goes to inform them when it is best to sell their stocks (especially if they are losing value), or to stay back with the company (and make more returns). This is one way the value of return on investment can be of benefit to an investor. Another good way of using the RIO is before making an investment for the first time. Potential investors use it when trying to make decisions on what company to invest in.
ROI is expressed as a percentage, but that is not enough information for anyone looking for how return on investment is calculated. There are different ways of calculating it; all of which include comparisons of income to assets. The two most common methods for calculating ROI are
1. NET INCOME ÷ AVERAGE TOTAL ASSETS:
This is what is left after all business expenses, losses from all revenue, and gain for the same financial periods has been deducted. When a company has a clear definition of all the assets at their disposal, they can then divide their net income with it to get the value of the ROI. For instance, if the net income of a company is $100 000, and the average total asset is worth $2,700,000, then the ROI of such company will be
ROI = 100 000 ÷ 2 700 000 = 3.7%
2. OPERATING INCOME ÷ AVERAGE OPERATING ASSETS:
With this method, you will first have to start with income before income taxes and interest, which is divided by average operating long lived assets. For a company whose operating income is $8,200, and the average operating asset is worth $120,000 the
ROI = 8,200 / 120,000 = 6.83%
Why should an investor or a potential investor care about the ROI of a company he or she has invested in or is considering investing in? It is for the simple need for transparency.
People want to see how well a company management manages the assets of a company. This will go a long way to inform one on the competency of that management of the company, and also make some financial analysis on what will become of whatever extra money that is put into the business.
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.