Return on investment is a crucial analytical tool used by both businesses and investors. In this lesson, you’ll learn the basic formula, a variant used for shareholders, and be provided examples.
ROI Defined
Return on investment (ROI) is the ratio of a profit or loss made in a fiscal year expressed in terms of an investment. It is expressed in terms of a percentage of increase or decrease in the value of the investment during the year in question. For example, if you invested $100 in share of stock and its value rises to $110 by the end of the fiscal year, the return on the investment is a healthy 10%, assuming no dividends were paid.
Basic ROI Formula and Example
The basic ROI formula is: Net Profit / Total Investment * 100 = ROI. Let’s apply the formula with the help of an example.
You are a house flipper. You purchased a house at the courthouse auction for $75,000 and spent $35,000 in renovations. After sales, expenses, and commission, you netted $160,000 on the sale of the renovated house. What is the ROI?
Your net profit is going to be what you netted ($160,000) minus what you spent ($75,000 + $35,000), so it is $50,000. Your total investment is also what you spent ($75,000 + $35,000), which is $110,000.
ROI = Net Profit / Total Investment * 100
ROI = 50,000 / 110,000 * 100
ROI = .45 * 100
ROI = 45%
Source: Study
