Return on investment is something that attracts every investor. Well! It should be as it tells the investors that how successful or unsuccessful an investment went and on the basis of this data, he can predict that whether he should invest more in future or not. In other words, this serves as quite a useful stepping stone, which an investor can use to point himself in the right direction.
What is Return on Investment?
Return on investment also known to be ROI, lets one to measure the success level of investment, both current and futuristic. In formal words, it can be defined as the measure that can be used to evaluate the efficiency as well as the performance of business investments. It can also be used to compare the returns of one investment to a number of others.
It is important to keep in mind that ROI is a percentage value and depends on, both profit and cost prices, calculated as “(profit * 100) / cost price”.
Dissecting the Return on Investment
Understanding ROI is of extreme importance for anyone who belongs to this field, as it can give the investor even greater control over his investments. Furthermore, thanks to its simplicity and versatility, it can be used to gauge the profitability of various kinds of investment and the data, retrieved from it, can be interpreted to one’s own cause. For example, if the ROI does not show positive results, then the investor can start looking for further options where he can get a higher ROI value.
Return on Investment Examples
Let’s say a person has $2000 and he wants to invest it in some kind of business. Fortunately, he gets two choices and he chooses to invest $1000 on each side. Now, after a particular time period, one side gives $1200 in return whereas, the other one gives the output of $1400. By calculations, the first one gives 20% ROI while the second one gives 40% ROI. Since the value of ROI for the second case is much higher than the first case. This means that his decision of investing the second one was wiser than for the first one. In this way, he will try to find out more options while sticking to the ones, which are giving him good outputs.
ROI Key Concepts
ROI (Return on investment) is just like the final output which we are expecting from our calculations, but in reality, it is based on quite a number of basic concepts. Some of those concepts are extremely important, just like Return On Investment itself, whereas, the contribution from some of them is that much low so that we can say them excluded from the list. The most important of such concepts are:
It’s just as its name suggests, this concept deals with the prices involved in the production of a particular product. This includes all types of products, i.e. physical, virtual, etc. For physical products, it can be energy costs, the costs of “ingredients”, employees’ wages, etc. In the case of virtual products, like software, it can involve the electricity bills, pays of the workers i.e. developers, designers, marketers, etc.
The investment involves each and every kind of costs like production costs, costs of media, time investment, and investment in the form of dedication. Generally, it is kept limited to just production costs but in some particular cases, it becomes important to implement all those facts and figures in calculations.
Revenue, actually, signifies the output from the campaigns. In most cases, when the investor is investing in more than one case, it becomes trickier to study the outcomes of each and every campaign, individually. The same goes for the case involving long sales process.
How to Calculate Return on Investment
- Establishing a threshold for ROI
The first and foremost step towards determining ROI and developing a successful investment strategy is to establish a particular threshold as your target. This target can be set for individual campaigns or an entire budget. This target will, actually, act as a goal which you would the particular subject to cover. With this, you become able to gain even more power and control over your budget.
It works as if a particular campaign is unable to make it up to the threshold, then obviously, you will have to stay away from it. Moreover, if a campaign, which is currently ongoing, can’t be made to cross the threshold, then it’s better to leave that option alone.
- Setting the budget
Having an ROI goal brings you closer to your ultimate goals and reasons. In this step, those ROI goals and profit goals are used to predict a particular amount of money that you wish to invest for a specific reason. If possible, then calculate it with the help of a few formulas. These will make you confident in the field that you are targeting.
- Calculating Return on investment
Once everything is up and running, i.e. you have established a goal, set up a fixed amount of budget, and then it’s time to calculate ROI in campaigns. This capability of calculation of ROI decreases as the complexity of the projects increases. Well! This can be averted if everything is done with commitment, dedication, and a functional reporting process.
All this helps in shaping up some solid measurements. Now, with the assistance of all these measurements, try to improve your campaigns. You can also test new ways to boost up the ROI.
Limitations to ROI
Just like every other concept and objects, the concept of “return on investment” also has its own set of limitation and disadvantages. Such as in the above example, if the time period for the second case is assumed to be three years. Then, the calculations which we made above are rendered useless. Since, the ROI for the first case is 20% but for the second case, the observation can limit to just one year, which means you are required to divide the ROI for the second case by three, this will give the actual value of ROI of the second case on the annual basis. This means it depends greatly on the situations and conditions.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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