Understanding Return on Investment (ROI)

The concept of return on investment (ROI) is a simple one. It is a tool used to evaluate the effectiveness of a particular investment in comparison with others. In the most global sense possible it is a way to measure what you will get back in comparison to what you put in. The formula used to determine the ROI is as follows:

ROI =(Your gain from Investment – Cost of your investment)/Cost of the investment

The gain from your investment relates to what you expect to obtain when you sell the investment involved.

Return on investment is a particularly popular tool for investors because it is simple and easy to apply. If you are looking at a potential investment and the ROI isn’t positive, you simple don’t put your money down. Alternatively, you search for the options that offer the highest potential ROI and put your money there.

The catch when using ROI as your major tool when investing is that the calculation can be manipulated in order to provide an inaccurate, and rosier, picture of a particular situation. Different investors account for the ROI differently; one may look at gross profit while another will prefer total value of resources. How the equation is manipulated is designed to suit the user’s needs.

If you choose to use return on investment as a one of your benchmarks then make sure you understand which figures are being used to generate the numbers. The Return on Investment (ROI) numbers are only valuable to you if you know how they were reached.

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