What is ROI?
Return on Investment (ROI) is a Key Performance Indicator (KPI) used to evaluate the performance of an investment, or to compare the efficiency of a number of different investments within a portfolio.
Why is ROI important?
ROI is a very useful performance measure for assessing the level of profitability in relation to capital invested over time, enabling business owners to make more accurate future business decisions.
How is ROI different to Profit Margin?
Both Profit Margin and ROI calculations can help business owners to measure the profitability of their business. However, there are a few fundamental differences between the two metrics.
A business’s Profit Margin shows the amount by which revenue from sales exceeds costs, whereas ROI gives the investment value of a product.
Return on Investment is usually a longer term measurement which includes more costs than simple Profit Margin calculations.
Another key difference is that Profit Margin can never exceed 100%, whereas ROI can.
When to calculate Return on Investment
A company may calculate ROI to compare the expected profitability of different potential investments. It is useful to calculate ROI as part of the market research process, when considering whether to launch a new product or service. It is also a vital calculation to make when deciding whether to purchase a new business asset, or before launching any new marketing campaign.
What is the formula for ROI?
How is ROI measured?
Let’s use a (very) simplified example. Lucy is a shoe designer and she has decided to make her own shoe collection. She makes 10 pairs of shoes which costs her £900 (£90 each) to make.
She decides to sell the shoes online. To help promote her shoe collection she decides to invest £100 into AdWords to advertise them. Lucy’s total cost of investment is now £1000.
Lucy sells all 10 pairs of shoes for £300 each, which makes her £3000.
As maths isn’t her strongest asset, Lucy uses an online ROI calculator to determine whether her investment was worthwhile.
The calculation shows that Lucy’s return on investment is 200%, which assures her that her investment was worthwhile and has benefited her business.
ROI can also be expressed as a revenue-to-cost ratio by calculating how much money is generated for every £ spent.
What is a good ROI?
Many business experts seem to suggest that a revenue-to-cost ratio more than 5:1 is considered a strong ROI for most businesses, whereas a 10:1 ratio is considered to be exceptional.
In percentage terms, anything over 15% is generally considered to be a good ROI.
How can ROI be improved?
To improve their ROI, businesses will usually need to either reduce costs or increase sales. They should also look at their business model to determine how they might increase the efficiency of their business operations.
Please bear in mind that the above is a broad and simplified explanation of how to conduct a return on investment analysis in order to measure the profitability of an investment. If you’re a business, knowing your ROI is crucial but it is important to remember there are many more factors to consider when making business decisions. Marketers should always understand the position of their company, and this includes being fully aware of the returns expected.