As the name suggests, return on investment, or ROI, is the amount of money a business or individual gets back from an investment. It is expressed as a percentage. Returns vary by industry or investment product.
To calculate ROI, you subtract the investment in the business or activity from the returns generated. Next, divide the difference by the investment. If you put $150,000 in start-up costs and $50,000 in additional expenses into the first-year operations of a company, your total investment is $200,000. If the business generated returns of $300,000, subtract $200,000 from that amount and you get $100,000. Then, divide $100,000 by the investment of $200,000, and you get a ROI of 0.50, or 50 percent.
Positive vs. Negative ROI
While a positive ROI is desired, it is possible to have a negative ROI on an investment. This is especially true during the first year of a business or project with high upfront expenses. An example of a negative ROI is a company generating $200,000 in returns on a $250,000 investment. The difference is minus-$50,000, which when divided by the $250,000 investment reveals an ROI of negative 20 percent.
Return on equity is a business version for ROI that refers specifically to the profit generated relative to average shareholder equity for a given period. A December 2013 Forbes article, citing a Sageworks study, reported that the average ROE for all industries was 39.10 percent. The highest ROEs, 101.1 percent, were reported by dentist offices. The legal services industry had the next highest ROE at 80.5 percent, followed by accounting services at 78.3 percent. Ten to 12 percent returns are more typical for public companies, according to Forbes.
Predicting and Monitoring ROI
Before getting into an investment, individuals and groups should project its ROI. Financial services firms typically publish anticipated return rates for investment products such as savings accounts, money market accounts, certificate of deposits and certain brokerage funds. Knowing that one fund has an historical ROI of 6.7 percent, for example, makes it look favorable relative to another fund with an ROI of 2.6 percent during the same period. Companies and investors monitor ROI for stability and trends. When returns decline, the company must look for ways to boost them back up, whether it is finding new customer markets or diversifying its product line.