Return on Investment. Different approaches to R.O.I.
Return on Investment, also known as ROI, is one of several approaches to building a strong financial portfolio. Return on investment means that decision makers evaluate the investment potential by comparing the magnitude and timing of expected gains to the investment costs. In the last few decades, this approach has been applied to asset purchase decisions, "go/no-go" decisions for programs of all kinds, and to more traditional investment decisions.
Return on investment is frequently derived as the return from an action divided by the cost of that action. For example, what is the return on investment for a new marketing program that is expected to cost $1,000,000 over the next five years and deliver an additional $500,000 in increased profits during the same time? To calculate this return on investment you take the gains ($500,000) subtract the investment cost ($1,000,000) and divide by the investment cost. This will give you a percentage which if the return on investment.
Simple return on investment works well in situations where both the gains and the costs of an investment are easily known and where they clearly result from the action. Other things being equal, the investment with the higher return on investment is the better investment. The return on investment metric itself, however, says nothing about the magnitude of returns or risks in the investment. In complex business settings, however, it is not always easy to match specific returns (such as increased profits) with the specific costs that bring them, and this makes return on investment less trustworthy as a guide for decision support.
In brief, several different return on investment metrics are in common use and the term itself does not have a single, universally understood definition. Therefore, when reviewing ROI figures, or when asked to produce one, it is a good idea to be sure that everyone involved: defines return on investment the same way and understands the limits of the concept when used to support business decisions.
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