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Return on investment definition

Description

Return of investment is a measure which evaluates the efficiency of investment. This is very popular and often used ratio. Data to calculate this ratio is collected from the income statement.

This ratio can be calculated in many ways but mostly two of it is used in practice. ROI can be calculated to evaluate the whole activity of a company and of separate project as well. We describe only the most general ROI, used to evaluate the whole activity.

Norms and limitations

Negative value of ROI shows an unprofitable use of company’s assets.

While evaluating company’s activity it is important to realize that ROI is only one of many financial ratios and relying only on it would not be recommended.

Formula

Net income (net profit, net earnings), usually called “the bottom line”, is a measure which is calculated by taking revenues (sales and other incomes) and adjusting them to the cost of sales, operating cost, depreciation and amortization, interest, taxes and other expenses.

Equity (Shareholders’ equity) shows the equity stake currently held on company’s balance sheet. In other word it means total assets minus total liabilities.

Long - term debts mean loans and financial obligations lasting over the period of twelve months.