How to Calculate Your ROI (Return on Investment)

August 8, 2017
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Whenever I’m faced with a choice of whether or not to do something, I always find myself coming back to the same question. Is it worth it? Every choice we make, from our purchase decisions to reaching for that dessert, ultimately comes down to the question of worth. These, like most choices, are a game of give and take.

A purchase comes with a financial cost but has the potential to create benefits like enjoyment or utility. Similarly, going for a dessert might bring the immediate benefit of taste but comes at the possible cost of not fitting into your favorite jeans. The tradeoff between costs and benefits keep us constantly calculating the million dollar question: “is it worth it?”.

Return on Investment (ROI) answers the question of whether an investment is worth it or not

You see, worth is a small word but a very big idea. It combines the ideas of costs and benefits to arrive at an estimation of true value. While these “worth” calculations are important for individuals they’re absolutely essential for businesses. The decisions brands face on a daily basis impact the trajectory of the whole organization and can’t be undone by a few minutes on the treadmill. To manage the larger scale risks and rewards and figure out what decisions are worth making, today’s brands often turn to more a sophisticated metric: return on investment (ROI).

What is return on investment? How do you calculate it and most importantly how can you use it to choose between two or more opportunities? We’ve got the answers to all your ROI questions below so read on, it’s worth it!

 

How Do You Calculate Return on Investment?

Return on investment is actually a very straightforward calculation that only  requires two simple pieces of information. First, you’ll need the cost of the investment at hand or, in simpler terms, what did it take to make this investment happen? This could involve production, distribution, or any number of costs that go into an investment or campaign. Secondly, you’ll need the gain from the investment, or in other words what value did the investment create?

The benefit from an investment is the gain minus the cost. This will help calculate your return.

Once you’ve got these numbers just two quick operations separate you from your ROI. First, you’ll subtract your cost of the investment from the gain to give you an absolute measure of how much better (or worse) off you are for having taken the investment. We call this value the benefit from the investment. You’ll then divide that benefit by the initial cost of the investment to put things back in relative terms and express the benefit as a percentage of your initial costs. In the equation below we combine both steps to give you a streamlined ROI calculation.

ROI-Calculation equation.png

You’ve probably heard the saying “it takes money to make money”. Although there is truth in that statement, deciding between two business decisions is not always so black and white. How much money should an investment take? How much should an investment return? Are there better investments that you could be making? That’s where ROI comes in. When two opportunities have the same cost or the same expected return, comparing them is quite easy (choose the higher return if both costs are the same or the lower cost if the returns are matched). However, things get harder when we try to compare two opportunities that seem to be speaking different languages.

To illustrate this, let’s say you’re presented with two investments. One option (Investment A) costs $500 and makes $1000 while another strategy (Investment B) requires $300 and returns $700. The first option might make more money but it also comes with higher costs ($500 vs $300). Trying to figure out which option to pursue? A quick ROI calculation can help sort through these opportunities in no-time.

Return on investment (ROI) detailed example

As you can see when you factor in the costs and benefits for both investments the first option seems like a winner. After subtracting the costs, investment A leaves you $500 richer while investment B only leaves you $400 better off. However, we get a different picture when we look at their ROI values. Investment A has an ROI of 100% but investment B boasts a higher ROI of 133% and thus should be considered the better option.

 

How Can an Investment That Makes More Money Have a Lower ROI?

If investment A leaves us with more money at the end of the day, why does investment B have a higher ROI? To answer that question, allow me to expand on our example. Let’s suppose the costs and benefits of the investments stay the same but instead of choosing one investment you have $1500 to invest and you can choose either investment as many times as you’d like.

Sometimes an investment that makes more money have still have a lower return (ROI)

A couple quick calculations will show you that to spend all $1500 between the two investments you could either choose investment A three times or Investment B five times. Let’s see what happens in each of these cases.

ROI investable wealth calculation

Investment A has an initial cost of $500 so three rounds would have a total cost of $1500. With a return of $1000 each time you’d be left with $3000 at the end of the day which is $1500 more than you started with… not bad! On the other hand investment B has a lower starting cost of $300 which means you can afford 5 rounds at at total cost of $1500. Each of those 5 rounds makes $700 which would leave you with $3500 at the end of the day which is $2000 more than you started with.

Return on investment (ROI) total return comparison

The secret here is that even though it deals in smaller amounts, Investment B is actually the more efficient investment which means it does more with less. That’s what our ROI calculation was telling us before. You see, investment A essentially takes $1and turns it into $2 (100% return on investment), investment B however takes $1 and turns it into $2.33 (133% return on investment.) So when you have the same amount to put into both investments (like our second example with the $1500) you’d be better off choosing investment B.

The truth is, ROI is just one piece of the puzzle that is an investment decision. There may be times where choosing an investment with a lower ROI is actually the right decision because of intangible factors (decision variables that are hard to quantify or to attach a price tag to). For instance a campaign with a higher ROI might have negative effects on the environment or on employee morale. That being said, return on investment is far and away the most useful tool for getting a baseline comparison on the options in front of you.

ROI isn't the only metric you should be calculating, check out out guide for the rest!

Learning to Calculate ROI is an Investment Worth Making

Life is a series of mental ROI calculations, questions ranging from going on a run or buying the newest smartphone or even deciding between cooking dinner or dining out all boil down to costs and benefits. These costs and benefits can be monetary, effort, time or even emotions and they help us decide which opportunities are worth pursuing and which ones we should let go.

When it comes to deciding the trajectory of a business these decisions can have a lot more weight. Luckily we have tools and tricks like ROI to help us guide our strategy. While the calculation is simple, the insights gained from a return on investment calculation are invaluable and balance both costs and benefits to accurately assess the true efficiency of a given opportunity. So before you go jumping into a financial investment, invest in yourself first and learn to calculate your ROI, it’s an opportunity with great returns.