What is return on investment (ROI)?

ROI or return on investment is one of the most common buzzwords on banking ads and business magazines these days. So what really is this ROI? ROI is the most common profitability ratio evaluating the performance of a business by dividing net profit by net worth. Therefore, if your net profit is 50,000 bucks while you’re total assets amount to 25,000 bucks, your ROI would be 2 or 200 percent.

Comparison with ordinary profit
Keep this in mind that ROI however isn’t the same as your normal profit. Return on investment is calculated on the money which you might have invested in one or more companies and the return which you receive on that same amount based on the net profit of the business.

This ROI is different from profit in the sense that profit only measures the performance of business. Also, you must not mix up ROI with the return on the owner’s equity. The latter is a completely separate concept. Only in the case of sole proprietorships will equity equal the total investment or assets of the business.

Again, ROI could be used in multifarious ways to understand the profit-making in your business enterprise. Say, you could gauge the performance of your pricing policies, capital investment and so forth on the basis of ROI. In fact, ROI could also be used within the company by dividing net income, interest and taxes by total liability that will give you an idea of the rate of earnings of total capital under employment.
Hence, as a measure of the company’s performance, return on investment could be effectively used to understand the efficiency of different investments which are undertaken. In purely economic sense, this is the way you consider your profits in relation to the investment of your capital.