What is a good ROI
Does an investment increase the company's profitability? This is a question that concerns many established companies, company founders and start-ups who are investing in promising projects. One speaks here of Return on Investment (ROI). You use the ROI as a benchmark to assess the performance of your company and investments.
Check out our post to learn how to use the Return on investment calculate and what advantages it brings for your company.
What is the Return on investment?
The Return on investment(ROI) describes a business key figure that indicates profit in relation to expenditure. Companies use the ROI to assess their investment or profitability. Literally translated, return on investment means the return on investment, i.e. the extent to which the invested capital is profitable.
The term return on investment originated in 1919 when the American engineer Donaldson Brown worked for the chemical company "DuPont de Nemours".
When performing calculations to determine the return on capital investments, he first used the term "return on investment" and thus referred to the Return on total capital. So that's that Du Pont key figure system the oldest key figure system in the world.
Calculate the return on investment
With the ROI let the Profitability of a company as well as calculate its investments. As already mentioned, this entrepreneurial key figure tells you whether an investment has paid off or is profitable at all.
The formula for calculating the Return on Investment (ROI) as follows:
(Profit / Sales) * (Sales / Invested Capital) * 100%
= Return on sales * Capital turnover * 100%
Briefly to explain the individual terms:
- As Profit is the remainder of the amount that remains after deducting all expenses.
- The sales however, includes all income of a company while invested capital represents the cost of the investment.
- The Return on sales is therefore the ratio between profit to sales and a good measure of how economically the sales work.
- The Capital turnover describes the relationship between sales and invested capital.
The ROI in sales
Employees often work in sales ROI metrics. You want to know whether a sales investment will pay off:
New software is being introduced in the sales department of a company to help sales write visit reports faster. Instead, employees should use the time saved to spend more time with customers.
Let's say the software costs 100,000 euros. After a year, sales have decreased by exactly 20 % and the increase can clearly be attributed to the new software. The ROI can be calculated using the following formula:
(Profit / sales) * (sales / invested capital)
= (20,000 euros / 20,000 euros) * (20,000 euros / 100,000 euros) * 100%
= 20 %
The ROI is in this case 20 %. That means the company with every euro invested 20 cents profit earned.
If there is no additional revenue, the ROI is zero. The investment has therefore made no profit. If sales even decline despite the investment, one speaks of one negative ROI.
What are the practical benefits of the ROI?
The ROI is used in sales to analyze investments in order to assess the overall performance of sales. This enables a company to plan and manage new investments better.
In marketing return on investment is used to plan the efficiency of an advertising campaign in advance. The ROI is the ratio between the advertising budget used and the profit achieved through the advertising placed - in other words: the Profit in proportion to the effort.
In summary, the ROI means:
- It helps in deciding whether to get one Investment is worth it.
- He shows, how profitable the investment is.
When is the ROI used?
Whenever it comes to investing in a company, division, sales or marketing, the decision-makers want to know how efficient the capital investment is within a certain period. In short: how good is it profitability of a business?
For a traditional company with stable business development, an ROI of 7 to 10% is a good value.
A company in a growing industry with higher investments and more risks should have an ROI between 15 to 25% can have.
So there is no specific metric that means more success.
The Return on investment is not a universal measuring instrument, because it does not provide any information about the absolute amount of profit. Further impairments of the ROI must also be taken into account when making a calculation:
He doesn't take that into account Risk of investment or corporate values like image or employee satisfaction, although these affect the profitability of the company.
In addition, the ROI always relates to you specific observation period and is difficult to compare with investments with different maturities.
The significance of the return on investment
When it comes to investing in business, this is it Return on investment an important metric to help make this decision. In retrospect, the ROI can be calculated very precisely.
However: for the evaluation of future investment projects is the ROI only suitable to a limited extent, as it does not take external influencing factors such as investment risks or economic and market risks into account. In spite of everything, the return on investment is a sensible measure and helps to better check an investment for its effectiveness.
Header image: Pinkypills / iStock / Getty Images Plus
Originally published March 11, 2020, updated 11 March 2020
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