The ROI formula
Return on investment compares what you gained with what you put in. The calculator works out two versions:
- ROI % = (amount returned - amount invested) / amount invested x 100
- Annualized ROI % = ((amount returned / amount invested) ^ (1 / years) - 1) x 100
The first is the total return over the whole period. The second spreads it out into an equal yearly rate, compounded, so that a two-year project and a five-year project can be compared on the same footing.
A worked example
You spend $10,000 on a new machine for a workshop. Over two years it brings in $13,500 in extra profit. The gain is $3,500, so the total ROI is 35%.
Spread over two years, the annualized ROI is about 16.2%. That is the yearly rate which, compounded twice, turns $10,000 into $13,500. You can now set it against other uses for the same money, such as paying down a loan at 8% or putting it into savings.
Using ROI for marketing and projects
ROI is not only for stocks and property. You can use it to judge an ad campaign, a new hire, a software tool or a trade show. The rule is the same each time: count every cost that went in, and only the extra profit that came out because of it.
For ad campaigns, use profit rather than revenue as the amount returned. If you only have revenue numbers, the ROAS calculator is the better fit.
What ROI leaves out
- Risk. A safe 6% and a shaky 6% show the same ROI.
- Timing of cash. Money that comes back early is worth more than the same sum at the end. Annualized ROI helps, but a full cash flow model is better for large decisions.
- Hidden costs. Staff time, upkeep and the cost of the money itself are easy to forget and make a project look better than it is.
