What is ROI

In finance, ROI (Return on Investment) is a powerful metric used to evaluate the profitability of different investments. Whether you’re analyzing stocks, real estate, or even a quirky sheep farm, this simple yet effective formula helps you weigh cost against potential gains. I’ve seen businessmen at a lunch table scribbling calculations on a napkin, excitedly exclaiming about high ROI opportunities—proof of how widely applied this quick-and-dirty method really is. These money-making schemes often involve quick mental math during casual discussions.

ROI Formula

The basic formula is straightforward:
ROI = (Gain from Investment – Cost of Investment) / Cost of Investment

For example, if Mark invested $50,000 at the beginning of his farming operation and his present profits sum to $70,000, his ROI would be 40%. Conversely, if he had a desired ROI of 40%, he could work backward from his initial cost to find the required gain.

Why ROI Matters in Real-Life Decisions

While intricate formulas like NPV, IRR, and payback period exist alongside ROI, it remains lauded for its simplicity. It’s undoubtedly one of the most frequently used methods for evaluating investments because it’s based on easily available data and provides clear value.

However, be careful not to confuse it with ROR (Rate of Return)—while sometimes used interchangeably, the key difference is that ROR denotes a specific period of time, like annually. As someone who’s helped several clients measure their investments, I always emphasize understanding this definition.

What makes ROI truly valuable is its universal application—from Invested Capital (ROIC) to Average returns to Equity and Earnings per Share, it’s commonly known as the most accessible measure. When making real-life decisions, always discuss the details carefully—it’s worth mentioning that precisely computed ROI can mean the difference between profit and loss.