Return On Investment (ROI)

If anyone is getting into business without having no clue what the ROI is, they are in some serious trouble. When one owns a company, it is absolutely vital for that person to know if the investments he/she has made led to gains or to losses.

This is the most basic definition of ROI: it is the figure that allows you to gauge how much money you’ve earned relative to the money that you’ve invested in your company (or in some other company, in the form of shares or stocks).

How do I Calculate It?

Let’s imagine this: you’re an investor and you’ve purchased $2.000 worth of stocks. Obviously, you’ll need to wait around to sell those stocks until the moment you are guaranteed to make a profit.

So, a couple of years have passed, and you sold those stocks you’ve purchased for $2400. This is how you calculate the ROI (although you’ve kind of gotten the drift of it already): you divide the net profit which is, in this case, $400, by 1000.

The result is 0.4. Now multiply that by 100% and you get your ROI percentage, 40% to be more precise. Nothing easier.

Why Would I Need to Know This?

Why would you not? – that’s the right question. There is a very simple reason why you should be familiar with the ROI and how to calculate it on your own: to avoid being tricked into believing that you’ve earned more than you did. Third parties will sometimes do that, especially when it’s working in their benefit.

There’s also another major downside when it comes to the ROI: it doesn’t really matter when you’re expecting a bigger profit in a shorter period of time. Calculating the ROI gives you the opportunity to gauge a profit only within a specific period.

This calculus won’t really do you much good when you’re trying to figure out how much you’ll be making in profits over 4-5 years, for instance. If this is what you want, you should calculate the Rate of Return (RoR), but that’s an entirely different topic.

Obviously, all business owners want huge ROIs, but that doesn’t happen overnight. It doesn’t happen when they get into investments that seem too good to be true and then turn out to be as such. There’s really no point in investing into something if that’s not going to bring a profit about.

Conclusion

In spite of its evident limitations, the ROI percentage is helpful in manifold ways, but primarily for seeing whether or not an investment will be as profitable as one thinks. The Rate of Return is the tool you should use if you’re trying to figure out how much money you’ll be making in two years as opposed to one (to give you just one example).

While the ROI metric isn’t endemic to the HR Department and pertains more to Finances, it still has applicability in HR, and that’s why it is, to this day, a tool used by them.