Return on investments or ROI is a calculation ratio between capital invested and the net income from the total assets invested. A high ROI simply means that the profits of the investment more than its investment cost (the operating costs). As an economic performance indicator, ROI is employed to compare the efficacies of an individual investment to those of other investments or to assess the profitability of the whole venture. Return on investments can also be calculated on the basis of the amount of initial investment.
There are many ways to calculate ROI. One of the simplest and most popular ways to calculate it is to calculate it on the basis of current sales and recurring operations. Sales per annum, or sales per day, is a standard sales measure that can be used to calculate this. The sales per day value is then divided by the number of days in a year. This gives the annualized ROI of the venture.
Another way to calculate ROI would be to use the present value of future cash inflows. The present value is the net present value of all future cash inflows, less any initial capital expenses. This is calculated by multiplying the present value of future cash inflows by the total cost of the invested capital. The result of this calculation is the current value of the investment.
Present value of ROI calculation does not take into consideration the effect of changes in stock prices on profitability. Thus, it may not be appropriate for certain investments such as oil and gas or other commodities whose prices change frequently. It may be difficult to determine the profitability of a venture in a volatile market, if one method of calculation is the total cost of capital and another the net present value of ROI.
Return on investment (ROI) is not a simple ratio like the measure of profitability. The meaning of ROI, “the amount that can be earned back from an investment” is not the same as “the amount that can be made from the investment”. The meaning of both phrases is different.
Return on investment is the profit that can be made from the investment, and the word “profit” in it simply refers to the amount that can be earned from the investment. Return on investment is the sum of net profits from the total amount of investment made over time. Net profit is equal to the gross profit, less the net profit. Return on investment is measured over time, not an interval of time like the term “reinvestment”.