What is Return on Investment (ROI)?

Published by Thomas Herold in Accounting, Corporate Finance, Economics, Investments

'Return on Investment (ROI)' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

ROI is the acronym for return on investment. This return on investment is among the most often utilized methods of determining the financial results that will arise from business decisions, investments, and actions. ROI analysis is used to compare and contrast both the timing and amount of investment gains directly with the timing and amount of investment costs. Higher returns on investment signify that the results from investments are positive when you compare them against the costs of such investments.

Over the past couple of decades, this return on investment number has evolved into one of the main measurements in the decision making process of what types of assets and equipment to buy. This includes everything from factory equipment, to service vehicles, to computers. ROI is similarly utilized to determine which budget items, programs, and projects should be both approved and allocated funds. These cover every type of activity from recruiting, to training, to marketing. Finally, return on investment is often employed in choosing which financial investments are performing up to expectations, as with venture capital investments and stock investment portfolios.

Return on investment analysis is actually used for ranking investment returns against their costs. This is done by setting up a percentage or ratio number. With the vast majority of return on investment calculation methods, ROI’s that are higher than zero signify that the returns on the investment are higher than the associated expenses with it. As a greater number of investments and business decisions compete for funding anymore, hard choices are increasingly made using the comparison of higher returns on investment. Many companies believe that this yields the better business decision in the end.

There is a downside to relying too heavily on the return on investment as the only consideration for making such business and investment decisions. Return on investment does not tell you anything regarding the anticipated costs and returns and if they will actually work out as forecast. Used alone, return on investment also does not explain the potential elements of risk for a given investment. All that it does is demonstrate how the investment or project returns will compare against the costs, assuming that the investment or project delivers the results that are anticipated or expected. This limitation is not unique to return on investment, but similarly plagues other financial measurements. Because this is the case, intelligent investment and business analysis also relies on the likely results of other return on investment eventualities. Other measurements should also be used along side the return on investment to help measure the risks that accompany the project or investment.

Wise decision makers will demand more from return on investment figures than simply a number. They will require effective suggestions from the person making the return on investment analysis. Among these inputs that they will desire are the means of increasing an ROI’s gains, or alternatively the means for improving the ROI through decreasing costs.

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The term 'Return on Investment (ROI)' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.