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Return on Investment – ROI – A PMP’s View

Return on Investment (ROI) is one of the many metrics used to evaluate a Project or Investment.

Many people do get intimidated when faced with “complicated Return on Investment calculations” and many “professionals” scramble for their Excel sheets to figure out how ROI is calculated when presented with a ROI Calculation Request.

If you are wishing to determine how well your investment performed or is performing as part of your Portfolio of Investments, using a ROI calculation is a relatively simple. Return on Investment gives you a percentage value which is a relative measurement of an investments performance based on the amount of funds employed (invested).

The calculation itself is performed by determining the Investment Gain (Investment Revenue less the Investment Cost) divided by the Investment Cost (actual amount of funds used). The result is generally represented as a percentage but can also be presented as a ratio.

The Return on Investment Formula:

ROI Formula
It is important to note here that Investment Revenue less Investment Cost equals Investment Gain.

The Manual Calculation:

For those that want to do the calculation by hand or with a simple calculator it is suggested to use a clean piece of writing material to begin so you can see your work. Once you have this, follow these steps.

Step 1

Make a simple chart with the following headings:

Write “Amount of Investment” on the left side of the chart.

Step 2

Write “Investment Gain” to the right of “Amount of Investment”.

Step 3

Type “ROI” to the right of “Investment Gain”.

Step 4

Next, put the actual amount of investment and investment gain below the appropriate heading. What you should have should look like the below. For the purposes of this example, let us assume the following:

  • Amount of Investment = “$10,000”
  • Investment Gain = “$2,000”

This is how your table should look.

ROI Chart Reference

Step 5

Now for the actual calculation. If you are going to use a calculator, enter the following:

2000 ÷ 10000 =

ROI Calculator Return on Investment

 

This should render the answer 0.2 which converts to 20%.

ROI Calculator Return on Investment

Your numbers will undoubtedly render a different answer but if you wish to confirm your calculation mechanics are correct, use the numbers provided to ensure you come up with the same numbers as the example.

The Excel Calculation:

Return on Investment

Persons who wish to use an Excel Sheet to do the calculation should follow these steps once in Excel:

Step 1

Type “Amount of Investment” in the desired cell.  You will need to widen the cell to show all the text which you can do by clicking on the right hand side of the cell and dragging it to the right.

Step 2

Type “Investment Gain” into the cell to the right of the cell used in Step 1. You will need to widen the cell to show all the text which you can do by clicking on the right hand side of the cell and dragging it to the right.

Step 3

Type “ROI” into the cell to the right of the cell used in Step 2.

Step 4

Next, we are going to create a formula in the cell below the cell marked “ROI”.  Formulas are not difficult to create in Excel.  For the purpose of simplification and being able to give specific references, I am going to use the following values as a reference.  These numbers can be changed after the formula is created.

DO NOT TYPE THE “QUOTATION MARKS”, THEY ARE MEANT TO EMPHASIZE WHAT IS TO BE TYPED.

Let us assume the following:

  • We begin at cell A1 of the Excel Sheet
  • Amount of Investment = “$10,000”
  • Investment Gain = “$2,000”

Click in the cell to the right of the Investment Gain value of $2,000 and type the following:

ROI Table Values

This what is should look like:

ROI Table Return on Investment

 

When you press “enter” after inserting the formula as shown above, the Excel Sheet will do the calculation showing the following:

ROI Table Return on Investment

Now you can change the format of the ROI to percentage by clicking the “%” symbol just below the “FORMULAS” tab as show by the arrow.

ROI Table Return on Investment

Step 5

Now you can change the Amount of Investment and Investment Gain to whatever numbers you would like and it will calculate the amount automatically. Be sure to save your work to your computer so you will have it for later.

Why Use “Return on Investment – ROI”

Regardless if you do the calculation using Excel or by hand with a calculator, the answer will be the same.  If you have several investments to calculate, using Excel will be much less painful than having to do the calculation many times with a pencil and paper or even a calculator.

The “Investment Gain” refers to the proceeds or profit from the investment, whether that is in the form of interest or the sale of the investment make no difference. Because ROI is generally measured as a percentage, you can list your investments in a table to compare them objectively as the ROI gauges the profit relative to the amount of funds used to earn the profit.  It is not a static “number value”.

In the business world, Return on Investment is widely used because of the scalability and simplicity to compare single investments to multiple opportunities without having to take the bias of the investment amount into account.  While this metric should not be used alone as a sole determining factor of whether to enter and opportunity or not, you will be able to compare small investment to large investments using purely empirical data.

To better put this into perspective, let us assume John has invested $10,000 into two different opportunities available to him.  To objectively compare them based on the ROI, consider the following.

Investment A Investment B 
1 Year Investment
Fried Chicken Restaurant
3 Year Investment
Giant Big Box Store
John invested the $10,000 in 2010 and then twelve months later he sold the share for $12,000. In this case, John would calculate his ROI by firstly determining his profit which would be $12,000 – $10,000 = $2000. Then divide the profit over the investment amount of $10,000.John invested the $10,000 in 2010 and then thirty-six months later he sold the share for $14,000. In this case, John would calculate his ROI by firstly determining his profit which would be $14,000 – $10,000 = $4000. Then divide the profit over the investment amount of $10,000.
$12,000 – $10,000
$10,000
= 20%$14,000 – $10,000
$10,000
= 40%

Taking this information from a purely ROI perspective, it would appear that the Investment B is the better investment with a Return on Investment of 40%.

Limitations of “Return on Investment – ROI”

One of the lacking areas of the ROI calculation is its inability to take into account the time consideration. While John did make $4,000 on his $10,000 investment with Investment B, if you factor in the time the funds were employed into the calculation, it gives a much different viewpoint. Using an over simplistic calculation to illustrate this point, consider the following.

Investment AInvestment B
$12,000 – $10,000
$10,000
= 20%$14,000 – $10,000
$10,000
= 40%
Time Funds Exposed:1 yearTime Funds Exposed:3 years
ROI ÷ Time Funds Exposed20% ÷ 1 = 20%ROI ÷ Time Funds Exposed40% ÷ 3 = 13.3%

Now which is the better investment? This deficiency in the ROI calculation method demonstrates why this metric should not be the only metric used to evaluate investments but it does show that ROI along with other calculation methods such as Net Present Value, Annual Percentage Rate, Payback Period and the like should be employed as appropriate.

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