“ROI” in French means king. It may be more than just a coincidence that the Return on Investment ratio is considered by some to be the King of the investor ratios!
Return on Investment or ROI is an important financial ratio in the investor’s armory. It helps express the total profit or loss on an investment as a percentage of the total value of funds invested. The basic Return on Investment ratio formula is particularly valuable when it is compared to similar ROIs of other investments.
What is the Formula to Calculate the ROI Ratio?
This ROI king measure of profitability is calculated as:
Return On Investment (ROI) = ((Net profit) / (Total Funds Invested)) x 100
Investors and analysts will quote the ROI ratio as a percentage.
What makes the Best Return On Investment (ROI) ratio?
The best ROI ratio is simplistically the highest positive percentage. It is important however for investors to look at other investment ratios to gain a fuller understanding of the potential investment. This is because a high ROI percentage implies that a company is profitable.
Why is Return On Investment (ROI) Considered an Important Calculation of Profitability?
ROI is considered important since it helps the investor compare the inputs (Total Funds Invested) with the outputs (Net Profit generated by the investment).
An alternative ROI calculation is the Du Pont formula:
Return On Investment using Du Pont formula = ((Net profit after taxes) / (Total Assets)) x 100
This can also be defined as:
Return On Investment using Du Pont formula = ((Net profit after taxes /Sales) x (Sales / Total Assets)) x 100
The Du Pont calculation will be quoted by investors and analysts as a percentage.
ROI calculations Frequently Used by Securities Investors
Return On Investment (ROI) = ((Net Income) / (Shares and preference share equity plus long-term debt)) x 100
Again the securities investors and securities analysts will quote this ratio as a percentage.
What are the Issues with Return On Investment Ratio Analysis of a Company?
The 3 key problems with the Return On Investment (ROI) percentage are often considered to be:
- As with most financial ratios, many investors & analysts put too much importance on the ROI ratio without carrying out detailed analysis of other profitability ratios.
- Analysts find it difficult to define Total Assets when an investment is made within an organization. Furthermore it is critical for the investor to understand what constitutes the investment.
- It is critical to be clear if the Net Profit figure is before or after tax.
See more financial ratios.