There are many different metrics businesses use to gauge profitability and overall financial strength. One of the most common and most effective is ROI. In this article, we’ll cover all the basics you need to know about ROI, along with some tactics you can use to increase your ROI.
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What is return on investment?
Return On Investment (ROI) is an index of the rate of return in business activities. The determination of this index is for the purpose of predicting – measuring the efficiency of investment capital.
Return on investment measures the ability to generate a return on a dollar invested in the business, irrespective of the source of that investment capital, indicating that a dollar invested in the business creates. how much profit.
It is the most objective indicator reflecting the efficiency of capital use because it does not depend on the level of debt use and the corporate income tax policy. Therefore, ROI can be used to compare the return on investment in different firms.
ROI= (Net income/Cost of Investment) ×100%
Essentially, an ROI is a means of comparing the money earned by a company with the profits earned elsewhere. In general, the ROI should be reasonably high – more than a company would expect from investing in something else, such as in government bonds.
Let’s say a new 1,000,000 PHP computer-controlled machine you’re considering could save the company 180,000 per year over the life of the machine, which is an estimated seven years. .
Total savings would be $ 1,260,000 (i.e. $ 180,000 x 7), giving an actual return benefit of PHP 260,000 (i.e. PHP 1,260,000 – PHP 1,000,000). Applying this formula ( PHP 260,000 divided by PHP 1,000,000), we get an ROI of 26%.
Meaning of ROI
ROI is the basis for assessing the ability to pay interests of the business on the basis of operating profit.
ROI is the basis for business managers to evaluate the impact of financial leverage and make decisions on capital mobilization.
Using ROI to evaluate the efficiency in using loans of businesses
The ROI can be used to tell us whether the firm is using loans effectively or not, through the ROI – i
A business has ROI = 15% and interest rate i = 10%.
From the data above, we can calculate
ROI – i = 15% – 5% = 5%
This means that for every 100 peso of loan, the company has 5 dong of profit before tax.
On the contrary, if it means that the use of debt reduces the pre-tax profit of the enterprise, the enterprise will not use the loan effectively.
Advantages of ROI
- Objectively show the efficiency from investment, help define business goals, compare profitability between projects.
- Can calculate quickly based on two factors that are easy to collect from financial data.
- Suitable for use in short term investment.
- Easy to calculate.
Dis advantages of ROI
- The ROI index only contributes a part in the overall “picture” of the investment, it cannot be completely based on that to make a decision. Also should refer to other indicators such as NPV, IRR or PP, ..
- Only suitable for short term calculation. For long-term investments, which take a long time to generate revenue, often results in deviation from the nature.
- No reason reflected why ROI is low / high.
- It takes the support of many tools to produce more specific results.
What is a good ROI?
Depending on the cost structure and the current business situation, each business will have a different ROI. However, generally ideal ROI will fall between 5: 1 and 10: 1. If more than 10: 1 plan or project is selected for investment certainly not feasible.
The reason why ROI should be in the range of 5: 1 – 10: 1 is because the production cost of the goods accounts for 50% of the selling price on a product. Thus, if the company spends $ 100 on marketing to get $ 200 in revenue, it will lose $ 100 more revenue to offset the cost of producing the product. That means, 2: 1 ROI only helps businesses return to the breakeven level, but has not really generated any co-profits.
A Marketing plan is considered perfect when it has the most accurate metrics. Because after all, the ultimate goal is still the real profit increase of the company. Then, ROI will be an important indicator to help businesses assess the feasibility of the plan.
See also: ROI from Wikipedia