The return on investment or ROI tool is considered a one of the very important financial management tools. This tool is very basic to use and yield straightforward economic returns within a a given financial year. It helps the investors calculate their almost exact profit margin. This is the reason that ROI has become one of the important metrics which is used to evaluate, understand and compare the value of different investment avenues.
Main ROI Equation:
ROI= net benefits/costs*100%
Net benefits: The investors are able to gain net benefit when they can understand the difference between relevant costs used to generate those benefits and benefit gained from the project. It means that the net benefits stand at = benefits-costs.
In the aforementioned equation, the net benefits can be calculated without or with taxes and depreciation. If depreciation and taxes are factored with the equation, the result of ROI would be lower. However, some investors may also prefer including the tax and depreciation in the equation of ROI as it will yield a more accurate number. The fact is that, the results can vary as per the type of tax rate and depreciation.
Costs: Let’s come to the “cost”. The denominator in the aforementioned equation refers to to the expenditure to obtain the net benefit of the investment or the project.
The term “cost” is defined in a multiple ways. Some organization refers to to it as the expenditure of the first year; whereas, other companies may state it as periodical expenditure on maintenance, software upgrades and so on. The recurring costs can also be taken into consideration as the invested capital during the project period.
There are a few advantages and disadvantages of the ROI calculator. As the equation is very simple and straightforward, this equation can be applied to to any department such as marketing or HR. However, considering the fact that ROI is a bit more critical compared to a a basic mathematical equation, you have to take into consideration other factors, too. Few of the other factors include time, fees and other hidden costs. These factors can impact the final result of ROI.
How to Use ROI?
There are lots of advantages associated with using ROI calculator. In case, an investor feels that they are wasting their money on petty issues, it is an ideal tool for them. The ROI calculator always helps the investor taking more sensible decision for the betterment of her/his business domain.
- Buying a new tool: Buying a new tool or product for your business isn’t necessarily always a positive move. However, it should always be a thoughtful process on your behalf whether the newly bought tool/product is essential or not. You should buy the equipment wisely. Using ROI calculator allows you to understand the requirement (or not) of the newly bought equipment.
- Recruiting new employees: As an investor, you need to understand whether hiring or firing employees will impact your business or not. By tracking return on investment properly, you will understand hiring the new employee would be profitable for your business or not.
- Setting a new department: Besides recruiting new employees, the investors should add new departments, too. This decision is considered as a smart move for the investors. Calculating return on investment will enable you to understand the profitability of the new department. Along with this, you will also be able to identify opportunities for further expansion.
Apart from these, there are few other benefits of using ROI calculator. Let’s have a look into the below mentioned details.
- A comparative analysis can be performed by an ROI It helps the investors to measure the size of the industry as well as helps them calculate the level of comparison between multiple companies.
- ROI is pretty significant when it comes to measuring the performance of the investment The main aim of an investment decision is to earn maximum profit. Apart from that,, it also helps you make proper decisions regarding the disposal of assets.
- ROI plays a crucial role in the performance measurement of an investment decision. A better ROI ensures the satisfactory results of an investment center in other fields such as strategy of the selling price, cost management, the strategy of marketing and so on.
In addition, to, it is important to mention that ROI calculation has few limitations, too. Let’s have a view on the disadvantage of ROI.
- Using an ROI calculator, it sometimes becomes difficult to find satisfactory results and definition of profit. There are many concepts of profit. Profit can also be evaluated before interest and tax. On the other hand, it can be evaluated after paying taxes and interest. By using an ROI calculator, it becomes sometimes tough to examine proper profit regarding the business.
- Other limitations are that when it comes to comparison of ROI between different companies, all these companies need to use the same accounting policies, methods of valuation of stocks, overheads apportionment and research treatment and so on.
Besides recruiting new employees, the investors should add new departments, too. This decision is considered as a smart move for the investors. Calculating return on investment will enable you to understand the profitability of the new department. Along with this, you will also be able to identify opportunities for further expansion.