Return on Investment ROI) – what is it?
Return on Investment (ROI) is a financial indicator that measures the profit generated from a specific investment relative to its cost. ROI is one of the primary tools used by companies to evaluate the effectiveness of investments and to make business decisions about resource allocation. It is an easy-to-understand tool that quickly estimates whether an investment is generating a satisfactory return, which facilitates financial and strategic planning.
ROI is calculated by dividing the net profit on an investment by the total cost of the investment, and then multiplying the result by 100% to express the result as a percentage. For example, if a company invested PLN 100,000 and made a profit of PLN 120,000, the ROI would be 20%. This is a key indicator to help compare the profitability of different investment projects, and to identify those with the highest growth potential.
It is worth remembering that ROI does not take into account factors such as the duration of the investment or the risks involved, so sometimes it may not give a full picture of the effectiveness of the investment. In such cases, companies can turn to more advanced indicators, such as NPV (Net Present Value) or IRR (Internal Rate of Return), which allow a more accurate assessment of the profitability of the project, taking into account the aspect of time and risk.
Frequently asked questions
1. How to calculate ROI?
ROI can be calculated by dividing the net return on investment by the total cost of the investment, and then multiplying the result by 100% to express the result as a percentage. For example, if the investment yielded 20,000 zlotys of profit at a cost of 100,000 zlotys, the ROI would be 20%.
2. What are the limitations of ROI?
ROI does not take into account the time factor and the risk associated with the investment, which means that this indicator can be misleading for long-term or high-risk investments. Therefore, consider using more advanced financial tools, such as NPV or IRR.
3. Why is ROI important for companies?
ROI is an important indicator because it helps companies determine which investments are most profitable and which should be continued. It is also easy to understand and allows quick comparison of different investment opportunities.
4. Can ROI be negative?
Yes, ROI can be negative if the investment made a loss. For example, if the cost of the investment was PLN 100,000 and the loss was PLN 10,000, the ROI would be -10%, which means that the investment was unprofitable.
