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How do I Calculate Return on Investment?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 25 August 2016
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The need to calculate return on investment (ROI) is very important to anyone who wishes to make the most of the assets in an investment portfolio. This is true for any type of asset, from shares of stock to real estate. Even as it relates to the resources that are put into a business, there is a need to determine what type of return on the investment is taking place, and if that return is sufficient. Depending on the circumstances, the process of making that calculation can be straightforward or somewhat complicated.

One basic formula used to calculate return on investment is to take the actual return or benefit of the investment and divide that amount by the total cost associated with the asset. The result of this approach yields a percentage that can makes it easier to measure that return and decide if the benefits are worth the effort. For example, if the goal is to calculate return on investment as it relates to a manufacturing operation, the resulting percentage will provide the company with a measurable percentage that makes it clear whether the work and resources put into the production process is generating enough returns to merit continuing the operation.

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While the formula used to calculate return on investment is simple at first glance, it is actually the information behind those elements that can sometimes make the process somewhat difficult. In order to arrive at an accurate ROI, it is necessary to identify and account for all the costs that go into the production effort. This includes the cash used to fund the operation, but it also involves accounting for labor costs, management costs, machine upkeep, and a range of other tangible and intangible costs. One of the most common errors made in determining the return on investment is a failure to identify all the costs and allow for them when making the calculation. When this happens, the resulting percentage is skewed and can provide a very false snapshot of what is really happening with the business.

It is important to note that a company can generate a profit margin and still post a relatively low ROI. When this is the case, the business can take this information and begin to explore ways to lower costs while still maintaining the same level of quality and holding onto its market share. Doing so increases the profit margin and ultimately makes it possible to enjoy a higher return on investment. Many companies will calculate return on investment on a monthly basis, as a means of identifying forward movement in the returns, or as a way to identify issues that may be adversely affecting returns and take steps to correct those issues before they can have a significant impact on returns.

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