How to calculate your return on investment (ROI)

Return On Investment, or ROI, is a very important performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. The ROI measures your income returned to you based on how much money you are using to put into an effort. ROI is important to consider because if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken. This measure is used a lot to analyze income property, real estate, business performance, small business investments, and even to determine upgrades or equipment purchases to help add services or improve services performed by a business. Here is how you calculate ROI.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• piece of paper
• calculator
• considering an investment to improve a business or service or to earn passive income

1. To calculate ROI, the benefit (or return of money or income gained) of an investment is divided by the cost of the investment. ROI is usually shown as a percentage. This formula can also be used to suit a number of different situations. Here is the formula for ROI:
   
   (Income from Investment - Cost of Investment) / Total Cost of Investment = ROI

2. When I look at an investment property, I use my formula to determine if it is worth buying the property or not. In the case of an investment property, ROI is calculated by dividing the cash flow after taxes, insurance, and expenses by the total invested. So the formula to help you determine your ROI on an investment property is:
   
   (CFAT)+(insurance)+(expenses)/(Total Invested in property) = ROI
   
   When working with an investment property, it is best to determine each cost over the course of a year to find out the yearly ROI.

3. For example, if $50,000 were put down to purchase an investment property and I had to spend another $5,000 in property repairs then my total invested so far would be $55,000. We are assuming that I paid cash for this house, so I do not have a mortgage. Now let's say that I could rent the house out for $800 a month. I would earn a total of $9600 a year on the property. Now I have to take into consideration the cost after taxes on my cash flow. So lets say the taxes are $600 a year. I have to also add insurance and other expenses for the year. For the sake of the example, we will say my insurance cost $400 a year, and my other expenses are $300 a year.
   
   So my equation would look like:
   
   ($9,600)-($600 + $400 + $300)/($55,000) = ROI
   
   ($8300)/($55,000) = 0.15 or 15% ROI per Year on my investment property

4. Now ROI looks a little better when applied to a vending machine company or to capital equipment. For example, if I were to spend $5,000 to purchase a vending machine, and another $1000 for the product for the year, then my total invested so far would be $6,000. Now let's say that I made a profit of $200 a month from the machine. I would earn a total of $2,400 a year from the machine. Now I have to take into consideration the cost of my rent for the machine in a building and any repairs. So lets say my rent for the year is $300, and my repairs are only $100 for the year. Here is what my equation would look like for this scenario"
   
   ($2,400)-($300 + $100)/($6,000) = ROI
   
   ($2,000)/($6,000) = 0.333 or 33% ROI per Year on a vending machine

5. Calculating out ROI is the best way to see how fruitful your investments or passive income strategies are going to pan out. If the ROI on investment is lower than another equally interesting investment, then you have a solid baseline for rejecting the lower investment strategy.

Resources

• Real Estate Blog

[beatybass]

on 8/6/2008 Well laid out and easy to understand.

[Feather]

on 8/6/2008 Thanks for making this a simple lesson in easy to understand terms!