Return of investment, commonly abbreviated as ROI, can in the most simple way be defined as a measure used in business to evaluate the profit progress of a business enterprise against the investment capital ventured. More specifically, it can be defined as the amount of profit returns or benefits that an investment from a single business or a number of them generate. It is the measure of the financial consequences of a business based on the magnitude and timing of the investment. Where the profit favorably compares to the cost of investments, it is referred to high return of investment. However, return of investments does not account on time value of the capital as it is of little harm.
Therefore, in other words, it is a ratio and actually it is presented mathematically as a ratio. Return of investments is the ratio of the difference between the gain from investments and the cost of investment to the cost of investment. It is usually presented as a per cent and mostly used by personal evaluation.
ROI has grown to become a very essential business metric over the past decade. It has found use especially in the determination of the viability of a certain investment to prevent losses. It enables close examination of the total efforts in terms of capital investments against the returns from them in a business entity so as to figure out if it is safe to undertake the business or not. By so doing, many small scale business people and the large business owners can greatly save themselves from the impact of unforeseen loss that would have hit them. ROI is also applied in comparing the different components of a portfolio in a project.
As profit refer to the measure of the performance of the business, it should not be confuse with the ROI which deals with the money invested in a business and the returns realized from it. There are many ways of calculating ROI. First it can be calculated in other terms as social returns on investment (SROI). It is a means based on principles used to measure extra financial value such as environment and social, in relation to all the resources invested. This method is especially used to evaluate the impact of the stake holders in a business environment.
It must be further known that the figure from the ROI alone may not be sufficient enough for the business man or woman to result into a decision over another. The found result of the ROI, does not necessarily indicates that the pattern of the profits to come will have the same outcome as before. This means that uncertainty of the business require more other objects incorporated to approve it.
Many specialists finally prefer to come up with a better decision of using the discounted cash flow stream together with the return of investments. The discounted cash flow is the inflow and outflow of the present values. Whenever extensive capital comes early and extensive profit comes later, the return of investments becomes lower than the earlier calculated one.
Many of the various financial metrics give the investment perspective of the required action or the necessary decision. This shows that every metric brings a comparison between the timing of the returns to the timing of the cost. But, the major metrics of cash flow such as return of investments , the IRR, NVP, and payback period, deals with the comparison differently portraying different messages.
But, how can one choose on which type of business to apply the return of investments? Most financial specialists always will look forward to project an estimated value of the cost and the profits or benefit obtained from two or even more scenarios. However, only the pattern that presents an incremental behavior will allow the specialist to construct the idea using the return of investments. That of which the difference between the profit and the corresponding cost portray the incremental pattern will be easily analyzed using the return of investments. This means that only the incremental figures of the cash flow statements are most appropriate for the return of investments. These statements directly represent the cash inflows and cash outflows attributing to the action taken.