return on investment

Fin

a ratio of the profit made in a financial year as a percentage of an investment

Abbr. ROI

EXAMPLE

The most basic expression of ROI can be found by dividing a company’s net profit (also called net earnings) by the total investment (total debt plus total equity), then multiplying by 100 to arrive at a percentage:

Net profit/Total investment × 100 = ROI

If, say, net profit is $30 and total investment is $250, the ROI is:

30/250 = 0.12 × 100 = 12%

A more complex variation of ROI is an equation known as the Du Pont formula:

(Net profit after taxes/ Total assets) = (Net profit after taxes/ Sales) × Sales/Total assets

If, for example, net profit after taxes is $30, total assets are $250, and sales are $500, then:

30/ 250 = 30/ 500 × 500/250 =12% = 6% × 2 = 12%

Champions of this formula, which was developed by the Du Pont Company in the 1920s, say that it helps reveal how a company has both deployed its assets and controlled its costs, and how it can achieve the same percentage return in different ways.

     For shareholders, the variation of the basic ROI formula used by investors is:

Net income + (current value – original value) /original value × 100 = ROI

If, for example, somebody invests $5,000 in a company and a year later has earned $100 in dividends, while the value of the shares is $5,200, the return on investment would be:

100 + (5,200 – 5,000)/ 5,000 × 100 (100 + 200)/ 5,000 × 100 = 300/ 5,000 = 0.06 × 100 = 6% ROI

     It is vital to understand exactly what a return on investment measures, for example assets, equity, or sales. Without this understanding, comparisons may be misleading. It is also important to establish whether the net profit figure used is before or after provision for taxes.