What Is Return on Investment (ROI)?
Formula, a worked example, and the limits of ROI.
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| Used for | Comparing investments and judging divisional performance |
|---|---|
| Limitation | Ignores the time value of money and risk |
| Topic | Management accounting · Performance measurement |
ROI in plain English
ROI answers: “For every 100 I put in, how much profit did I get back?” The higher the percentage, the better the return, all else being equal.
Worked example
A business invests 50,000 in new equipment and earns an extra net profit of 8,000 a year from it.
ROI = 8,000 ÷ 50,000 × 100 = 16%.
- Comparing projects with very different time spans using ROI alone.
- Using revenue instead of profit in the formula.
Frequently asked questions
What is a good ROI?
It depends on the industry and risk. Compare the ROI with the cost of financing and with alternative investments.
What are the limitations of ROI?
It ignores how long the money is tied up, the timing of cash flows and the risk involved.
How is ROI used in divisions?
Divisional ROI divides a division’s profit by the capital invested in it, to compare performance across divisions.
Keep learning
This page is for general learning. Accounting rules vary by country and standard.