Return on investment (ROI) is one of the simplest and most common calculations to determine a given investment's potential for gain. To find ROI, subtract the cost of the investment from the total gain, then divide the result by the cost of the investment. Several factors can influence ROI, so be sure to evaluate all of them before choosing an investment.
Profit may seem straightforward, but there are a few complications to keep in mind. For example, if you want to figure an ROI for a real estate investment, you have to account for any income you receive from rent, any increased profits and future property appreciation. It's important to account for all of the potential gains you will receive from the investment, because a higher ratio of gains to losses will result in a better ROI.
How you calculate your costs for the ROI formula is also a very important step in obtaining an accurate figure. As noted by Investopedia, calculating the costs for real estate, stocks and leveraged investments can be a tricky business, because there are many costs that add up. If you forget to account for all the costs associated with a given investment, your ROI calculation will be exaggerated. Common costs that factor into ROI calculations include upfront costs, management fees, maintenance costs, insurance fees and taxes.
There's one important factor that is not accounted for in ROI calculations: time. A simple ROI formula does not account for changes and fluctuations in time, which is an important factor in more complicated business settings. For this reason, as noted by Solution Matrix, simple ROI is the best way to calculate returns if you have a simple investment with straightforward costs and gains. A more complex ROI calculation, known as discounted ROI, is useful for calculations that account for the future performance. Discounted ROI can be found by dividing the net present value of all the investment benefits by the total present value of costs.
As with any investment formula, ROI only goes so far. As noted by Investopedia, a company may have a very impressive ROI during its initial periods of growth, only to decline as it matures. Even projected ROI calculations have to be taken with a grain of salt, since they are entirely based on previous performance. Always consider other investment figures, such as compound annual growth rate (CAGR), internal rate of return (IRR), and debt to equity, before you decide to make an investment.
- Jupiterimages/Polka Dot/Getty Images