If you are an entrepreneur or an investor, this is not the first time that you are coming across or hearing this question. How to calculate the return on investment for your business? It is a known fact that everyone wants to have good returns for their investments. But calculating the ROI for your investment is not as easy as it sounds. It is not like you have a predefined method through which you can arrive at an answer. The fact is people use various methods to calculate the ROI for their company. For companies that are listed in the Fortune 500, it is an entirely different ball game. It is not just because of the huge numbers that they deal with. Even though these companies make huge profits, they have it practice of rotating the cash in their own company or in their sister concerns.
The ROI formula
The basic idea of ROI is to calculate money or value that you have additionally received from your investment in percentage.
The formula for ROI is (Return/initial investment) x 100
A simple example might help you get a clear picture. You are purchasing a small business for 200000 dollars. You later sell the business for 300000 dollars. So with the amount that you purchased and with the amount that you sold the business, you have made 100000 dollars. If you convert it into a percentage, it is fifty percent of the initial investment. So the ROI for your investment is fifty percent.
The above was very simple. But it is not this simple always. Let say you invest 200000 dollars and get a profit of 20000 dollars. If you again invest that 20000 profit in your business your investment becomes 220000 dollars. If you sell the business 300000 dollars, then the ROI becomes thirty-six percent.
Let us consider that the investment is 200000 dollars and you again invest 20000 dollars that you gained as profit and sold the business for 300000 dollars. But you have also made 50000 dollars in profit which you did not invest. So the returns have become 80000 dollars in addition with 50000 dollars. So that is a total of 130000 dollars. Then the ROI becomes fifty-nine percent.
If you think this is complicated. Think again. This is very basic. You will need the assistance of the professionals like auditors and lawyers to calculate and arrive at a perfect value.
This time we shall add the time factor which plays an important role. With the 220000 investment and 50000 as profit and the sale price is 300000 dollars after five years of accruing the business the ROI is fifty-nine percent which makes it 11.8 percent profit per year. You are investing in another business which gives forty percent ROI in two years. But you are not sure about its value after that. So this company gives twenty percent in one year, and the other business gives 11.8 percent on one year. The overall profit might be high but when you consider the time factor it is comparatively low.