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ROI, or return on investment, is a common business term used to identify past and potential financial returns. Managers and executives look to the ROI of a project or endeavor because this measure indicates how successful a venture will be. Often expressed as a percentage or a ratio, this value describes anything from a financial return to increased efficiencies.
What is ROI?
Any expense a company has can be calculated in terms of ROI. While some expenses or activities – such as buying staples or repairing an employee bathroom – may not have a direct or financial ROI, each expense contributes to an overarching investment. For example, hiring a graphic designer to create ads, paying a photographer to take pictures of the company, and overhauling the company’s website can be considered a return on investment.
In many instances, ROI is used to calculate how much of a value an investment is. For example, an angel investor would want to know the potential ROI of an investment before committing any funds to a company. Calculating a company’s potential or actual financial ROI typically involves dividing the company’s annual income or profit by the amount of the original or current investment.
ROI is also used to describe “opportunity cost,” or a return the investor gave up to invest in the company. If a business owner were to invest their money in the stock market, they could expect to receive an annual return of at least 5%. By investing that same money in a company, an owner would expect to see a similar, if not higher, ROI for their money.
Companies even use ROI to measure the success of a specific project. If a business owner were to invest money in an advertising campaign, they’d analyze the sales generated by the ad and use that information to determine the ROI. If the money generated exceeded the amount spent, then a business could consider it an acceptable ROI.
When calculating your annualized ROI, you’re looking for the average yearly return on investment earned during the investment period. This shows you how profitable the venture is, which is helpful, because ROI doesn’t include the holding period of an investment within its formula. Annualized ROI can help you analyze and compare the performance of your investment during specific time periods
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