Return on Investment (ROI) is a performance metric meant to evaluate the effectiveness of an investment or for the comparison of several investments. The final result is indicated as a percentage or a ratio.
Return on investment, abbreviated ROI, is the financial metric that evaluates forecasted profitability on different investments.
Although the ROI is easy to calculate for everyone and is a term globally understood, there are some limitations to it as the ROI formula does not take into consideration the factor of time and can be susceptible to manipulation.
There are several versions of the ROI formula, but the most commonly used is:
ROI = Net Profit / Total Investment * 100
Example: a person buys a house worth $100.000, invests another $20.000 into renovations and then sells the house for $150.000. In this case, the net profit will be the selling price ($150.000) minus the investment in the house ($100.000 + $20.000), so $30.000. The total investment is the price the house was brought with ($100.000) plus the money paid on the renovation ($20.000), so $120.000.
Then according to the ROI formula, in this particular case:
ROI = 30.000 / 120.000 *100
ROI = 0,25*100
ROI = 25%
The person in this example gained a 25% return on investment, but it must be mentioned that the ROI can also be a negative number.
In marketing, the return of investment is calculated for a better understanding of how the marketing budget should be planned, as it helps determine and compare the marketing campaigns' efficiency.
For the marketing ROI, the formula above does not apply, as there are different factors to take into consideration when establishing. Marketers must decide depending on the context, what elements will eventually constitute the final formula for calculating the ROI (net revenue, gross revenue, average sale price, customer lifetime value, etc).