Return on investment (ROI) | Glossary

Preparing financial graphs and charts for return on investment analysis
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What is Return on Investment (ROI)?

Return on investment (ROI) is a profitability metric that businesses use to determine whether or not an investment is worthwhile. The initial cost of the investment and the profit derived from that investment are used to calculate ROI. Return on investment can be expressed as either a ratio or percentage value. Most businesses default to using percentage values because they are easier for most people to interpret.

ROI is used to measure profitability both for the business"s operations as a whole and its individual departments, campaigns, and investments. This essential business calculation can be used to measure returns for

  • Marketing campaigns
  • Product development
  • New equipment
  • Store openings or renovations
  • Stock investments
  • Consultancy services
  • AI marketing tools and AI-driven business tools
  • Any other business cost directly tied to creating profit

Businesses use ROI measurements to determine both the strengths and weaknesses of their revenue-generating strategies. It"s a key business metric that can be used to show an organization"s stakeholders the value of different types of investments. It can also be used to demonstrate which of a company"s investments don"t make good fiscal sense.

Preparing to calculate ROI with a spreadsheet and calculator
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How to Calculate ROI

Calculating the baseline ROI for any investment is a relatively simple process that can be used for both personal and business investments. If you"re calculating the ROI of many different campaigns or investments, you can set up a spreadsheet that will automatically calculate ROI when you plug in data. Your current business or marketing software suite might also have a program specifically for ROI.

Regardless of how you plan to calculate ROI, you only need to gather two data points:

  1. Net profit
  2. Cost of the investment

Imagine that you spent $1,500 on an email marketing campaign. This is the cost of your investment. You also know that you sold $9,000 in merchandise thanks to that campaign. This is your net profit. To calculate the ROI of your email marketing campaign, you would use this formula:

ROI = (Net profit - Cost of investment) / Cost of investment

So, your ROI calculation looks like this:

ROI = (9000 - 1500) / 1500 = 5

$9,000 minus $1,500 is $7,500, so your net profit for the marketing campaign investment is $7,500. When you divide that by your initial investment of $1,500, you get 5.

ROI is usually represented as a percentage, so you simply move the decimal spot over two places to find that your final return on investment is 500%. You can also represent this ROI as the ratio 5:1. Whether you calculate a percentage or ratio, you can say that the campaign"s return was five times greater than its cost.

The above formula can help you calculate the base ROI of any investment. While the calculation is straightforward, be aware that assigning exact values to cost and profit may be tougher.

Should you calculate the ROI of a social media campaign strictly by the total sales those ads attracted? Or should you use the estimated lifetime value (LTV) for each of the customers who purchased something from one of the campaign links? Do you count only sales that were made after opening the link? Or do you also count sales that started with someone clicking that link but weren"t finalized until the customer was sent an automated shopping cart reminder via email?

There are no hard and fast rules here. You can use any of the figures mentioned above in your calculations. Just remember to apply the same rules to all similar ROI calculations. If you decide that you"re going to calculate the ROI of one social media campaign using the LTV for all new customers, you should use that same value when calculating the ROI of future social media campaigns.

How ROI is Used to Improve Business Investments

In the example above, your business saw a significant return on investment from an email marketing campaign. You can use the ROI calculation to prove that the investment was worthwhile and that your company should continue to invest in email marketing campaigns in the future. But not all investments yield a positive return.

Now imagine that you spent $1,500 on an email marketing campaign, but it only resulted in $1,000 in sales. The ROI calculation would be set up exactly the same:

ROI = (Net profit - Cost of investment) / Cost of investment

So, your ROI calculation looks like this:

ROI = (1000 - 1500) / 1500 = -0.333

Represented as a percentage, the total ROI of this marketing campaign is -33.3%. This figure would be used to demonstrate that an investment wasn"t worth the value and likely should not be repeated in the future.

Business leaders compare the ROIs of different investments to determine where a business should prioritize its spending and where it should pull back.

Limitation of ROI Calculations

ROI calculations rely on accurate data. Some calculations, like the basic return for a PPC marketing campaign, use baseline figures that are easy to find. At other times, you"ll need to account for a variety of costs that contributed to one investment. In our earlier example, we said that your business spent $1500 on an email marketing campaign.

That might not capture all the costs involved. Your business paid $1500 for an email marketing company to send out your email and track its engagement. Were there other campaign costs? Your calculation changes if you factor in

  • How much you paid a freelance writer to create your content
  • The cost of buying a targeted email list
  • The labor hours marketing employees spent solely on developing the campaign

You need to add all of these individual costs into your original "cost of investment" figure to get a truly accurate picture of value. Calculating the ROI for the investment of non-monetary assets like employee time can be tricky. Business leaders in different industries use a host of specialized ROI calculations to nail down hard-to-determine values.

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