In a nutshell: What is ROI?
The abbreviation ROI stands for return on investment. It provides companies with a practical key figure that they can use to determine whether an entrepreneurial activity or investment is worthwhile or not. For the calculation, you put the profit in relation to the capital invested.
Definition of ROI: What does the abbreviation mean?
ROI means "return on investment", which can be translated as "return on investment". ROI therefore describes as a calculation parameter or company key figure when an investment has paid off. In this way, companies can find out which investments are worthwhile and which are less profitable.
The key figure "ROI" is also often referred to as follows:
- Profitability
- Return on capital
- Return on capital
To calculate the ROI, the profit is set in relation to the capital employed . Just like ROAS, the return on investment is always calculated over a specific period of time.
Where does the ROI come from?
ROI is used as a key figure in many companies. But where does this approach actually come from? Return on investment has its origins in the development of return on capital by Donaldson Brown. The former engineer at Du Pont de Numerours defined the key figure.
An old and well-known system of key figures was used, which has often proven its worth: the Du Pont scheme. It can be used to determine numerous correlations. After all, ROI also describes a relationship - the relationship between investments and profits.
ROI formula: How the ROI calculation works
The ROI is usually expressed as a percentage . You obtain the value by multiplying the return on sales by the capital turnover. But how do you calculate these two figures?
- Return on sales = profit / net sales x 100
- Capital turnover = net sales / total capital
Sample calculation: How to determine the ROI
We have created a calculation example for you to determine the ROI. Let's assume your net turnover for a financial year is 100,000 euros. The total capital, which includes equity and borrowed capital, is 50,000 euros. Your profit is 10,000 euros.
Now you want to determine the ROI. You divide your profit by net sales and multiply the result by 100 to determine the return on sales:
10.000 / 100.000 x1 100 = 10
To determine the capital turnover, divide your net sales by the total capital:
100.000 / 50.000 = 2
Once you have determined both values, it's time to calculate the ROI. All you have to do is multiply the return on sales and capital turnover:
10 x 2 = 20
According to this example, your ROI (return on investment) is 20.
What are the benefits of determining the ROI?
You have now calculated the return on investment (ROI) figure. But what use is this insight to you?
The interpretation of ROI is usually based on the past. This is because you can only determine the key figure retrospectively, as you need past values for this. However, you can also interpret ROI from a forward-looking perspective. This can be helpful if you want to define a target.
In principle, a positive ROI always describes a profit. However, it depends on your individual goals as to whether the effort was worthwhile. The interpretation of the ROI therefore always depends on what you want to achieve.
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Benefits of the return on investment (ROI)
Companies have to make new decisions every day. Particularly when it comes to investments, careful consideration must be given. Is an expenditure worthwhile or not? This is where ROI comes into play.
The return on investment enables companies to determine the efficiency of a measure. They can also compare different investments with each other. When doing this, however, the same time period must be considered. After all, ROI only ever relates to a specific time period.
A word of caution here: even though companies can use the ROI formula to determine which investments have paid off and which have not, ROI is not a means of making forecasts. It cannot be used to predict how much profit will be made. After all, numerous factors play a role here.
The ROI serves as a practical indicator in the following areas, among others:
- Acquisition of a new system in production
- Expenditure of advertising costs or costs for SEO measures
Sometimes it is not possible to establish a causal link between an investment and a profit. This makes the assessment very difficult. For example, if new customers place orders as a result of an advertising measure, the ROI is initially positive. However, if many employees had to work overtime due to these measures or an increase in orders, high costs have been incurred in the background that are not included in the calculation.
The return on investment (ROI ) should therefore always be treated with caution. It is important to keep the big picture in mind.
The advantages and disadvantages of ROI at a glance
The advantages of ROI are obvious:
- Simple and concise presentation
- Quick calculation
Based on the ROI, companies can make decisions regarding their investments that can improve the company's performance. If the ROI is negative, the investment should no longer be made. If it was very positive, further work should be done on it.
Nevertheless, there are also some disadvantages in terms of return on investment:
- Loss of information: Only a few values are included in the ROI calculation, which means that the big picture may be lost.
- Exclusively monetary consideration: Only monetary key figures are used, which means that factors such as investment risks and external influencing factors fall by the wayside.
- Difficult to compare: As ROI always relates to a fixed time frame, investments cannot always be compared with each other in a meaningful way.
- No clearly defined target value: A positive ROI can also be negative. It always depends on your individual target, but this is not taken into account in the calculation.
Conclusion: What is ROI?
ROI (return on investment) compares profits with investments. The key figure was developed on the basis of the Du Pont scheme and is used in almost every company today. The ROI provides information on whether a capital investment has paid off over a certain period of time or not. This allows unprofitable expenditure to be reduced and investments to be increased with greater success.
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