Meanings of ROI

Meanings of ROI

The ROI is a business key figure for the return of a company. It is measured by the percentage ratio of capital employed and profit achieved and can be used to assess an investment, the performance of a branch of business or the entire company.

Short for ROI by abbreviationfinder, return on investment is a key figure calculated from the return on sales and capital turnover, from which the relationship between the capital invested and the profit achieved results. It can also be viewed as the profit target of a company or an individual business area, since it expresses the amount of the expected return flow of capital from an investment.

The ROI thus serves as a benchmark for the performance of companies or certain areas of the company in a certain period of time. Its development goes back to the American engineer Donaldson Brown, who defined it in 1919 while working for the chemical company Du Pont de Nemours. It is considered the key figure of the so-called Du Pont scheme. This oldest and most well-known key figure system, with which balance sheet analyzes can be created from several such figures and entrepreneurial decisions can be controlled, was also developed by the eponymous group. In the Du Pont scheme, the ROI is defined as the multiplication of return on sales and capital turnover.

The calculation of the ROI makes sense if it can be assumed that an investment will pay for itself within its expected useful life. In the IT sector, this useful life is set very low at around three years; it can be significantly longer for buildings and production facilities.

Calculate return on investment – ROI formula

To calculate the ROI, the total capital of a company, which is made up of equity and debt , is always used . However, according to a modernized variant of the ROI, individual investments can also be calculated. The prerequisite for this is that the returns from the individual investment are already known.

The ROI formula explains: This is behind the key figures for the calculation

Return on sales

The return on sales (also: Return of Sales (ROS) or net return on sales) is understood to be the relationship between profit and sales within an accounting period. It can be used to read what the percentage profit of a company is in relation to a certain turnover. For example, if the return on sales is 10%, this means that ten cents of profit were made for every euro wagered. If the return on sales increases, this is an indication of increased productivity, a falling ROS, on the other hand, means less productivity and thus increasing costs. The ROS can be calculated using the formula:

Return on sales = (profit / net sales) x 100

Capital turnover:

The capital turnover indicates the ratio of equity or total capital employed to sales. The reference values ​​for calculating the capital turnover are the average total capital and the sales revenue within a business period. By determining the capital turnover, it is possible to determine how much turnover was achieved with a certain amount of capital in a certain period. The formula for calculating the capital turnover is:

Capital turnover = net sales / total capital (or invested capital)

An example of calculating the ROI

A company is investing 50,000 euros in advertising in order to acquire new customers. For this measure, the company achieved a turnover of 60,000 euros.

The capital employed is therefore 50,000 euros, the generated sales 60,000 euros and the profit thus 10,000 euros (sales – costs = profit). Now just insert into the formula:

Return on Investment (ROI)

= Return on sales x capital turnover

= (Profit / sales) x (sales / invested capital)

= (10,000 / 60,000 x 100) x (60,000 / 50,000)

Return on Investment (ROI) = 2 = 20%

The calculated return on investment is therefore 2 or 20%, which means that with every euro invested, a profit of € 0.20 (and € 1.20 sales) was generated.

Analysis and interpretation of the ROI

For a correct analysis of the ROI, it is important to note that only monetary and internal company factors are recorded by it. Influences that have to do with the market situation, image values, customer satisfaction, risks and competitors as well as time factors are not included. For this reason, the return on investment should never be used as the only analysis tool for evaluating company performance.

As can be seen from the formula, the ROI is characterized by two important company-specific key figures and can therefore:

  • have the same result in different combinations,
  • be increased if the return on sales (profit: sales) decreases but the capital turnover (sales: capital) increases,
  • The independent analysis of return on sales and capital turnover are carefully examined for changes and their causes.

The results of the ROI calculation in percent can be compared with profit targets: A return on investment of 7.5 means that a certain amount of capital has brought in a return of 7.5%. Such a value can be quite satisfactory for traditional companies, whereas growth sectors will aim for values ​​between 15 and 25%.

What are the advantages of calculating the return on investment?

Even if the informative value of the ROI is limited by the mentioned limiting factors, there are some undeniable advantages. The ROI provides important data for:

  • the analysis and comparison of individual company areas and investment objects,
  • the determination and consideration of the overall performance of a company for a past period,
  • the planning and control of future investments

The importance of ROI in marketing

In marketing, the return on investment is particularly important in order to be able to plan in advance and finally evaluate the efficiency of an advertising campaign from a financial point of view. For this purpose, two units of measurement are used that are directly related to the ROI.

ROMI (Return on Marketing Investment, also: RoMI):

The ROMI measures – just like the ROI – the relationship between capital employed and profit achieved. However, it only relates to the marketing sub-area. For the calculation, the entire effort for a marketing measure, such as product costs, marketplace costs and pricing, is included. The formula for calculating the ROMI is:

ROMI = (net sales – product costs – advertising costs) / advertising costs

ROAS (Return on Advertising Spend):

The ROAS represents the profitability of an advertising measure. Among other things, it is used to implement measures that increase the quality of the measure and / or reduce the costs if the results of a campaign are negative.
The ROAS is calculated using the formula:

ROAS = (net profit / advertising costs) x 100

ROI

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