Definition and How to Calculate Return on Investment (ROI)
As a businessperson, it’s important to understand how to measure Return on Investment (ROI), also known as investment return, for the business you’re running. ROI is considered the most accurate first barometer of business profitability.
All operational activities can be assessed by knowing the level of ROI. According to financial experts in Indonesia, ROI refers to the money or assets gained or lost during the investment process in a business.
The investment in question includes the purchase of capital, assets, and budget allocated for investment costs.
What is Return on Investment (ROI)?
ROI is a performance metric used to evaluate the efficiency of an investment or compare the efficiency of several investments. Its main function is to measure the exact return on a particular investment relative to its cost.
Another definition of ROI is “Current Investment Value” because it reflects the outcome from the sale or interest of the investment. Since ROI is measured as a percentage, it allows accountants to easily compare different types of investments.
Simply put, ROI helps assess the profitability of an investment. This applies whether it’s ROI from stocks, a company’s expansion project, or returns from selling real estate.
Calculating ROI is relatively simple. If the ROI result is positive, the investment is considered profitable. But if the opportunity cost of another investment is higher, it signals that investors should explore other options.
ROI calculation also helps investors avoid negative returns, which could lead to losses.
How to Calculate Return on Investment (ROI)
ROI is calculated by dividing the profit earned from the investment by the cost of the investment.
For example, if Investment A yields a profit of IDR 100 million and the investment cost is IDR 100 million, then the ROI is 1, or 100% expressed as a percentage.
Although ROI is the quickest and easiest method to calculate investment returns, it does have some limitations. For example, it doesn’t consider the time value of money and may not provide a detailed comparison if different investments require varied time periods to become profitable.
Return on Investment (ROI) Calculation Example
ROI Calculation Example – Case 1
In 2007, Ani invested IDR 1 billion in PT Bunga Cantik. A year later, she sold her shares for IDR 1.2 billion. Her ROI is calculated as follows:
Net Profit = Investment Return – Investment Cost = 1.2B – 1B = IDR 200 million
ROI = Net Profit / Investment Cost × 100%
ROI = 200M / 1B × 100% = 20%
This result helps Ani compare her investment in PT Bunga Cantik with other projects.
ROI Calculation Example – Case 2
In 2014, Ani invested IDR 2 billion in the Mall Garden project. Three years later, she sold her shares for IDR 2.8 billion.
ROI = (2.8B – 2B) / 2B × 100% = 40%
Even though the result is higher, ROI alone may not reflect the better investment, especially when comparing investments with different durations.
Limitations of Return on Investment (ROI)
ROI isn’t a perfect metric. As seen in Ani’s example, comparing the PT Bunga Cantik investment (sold in 1 year) and the Mall Garden project (sold in 3 years) doesn’t account for the time factor.
To better compare, Ani could calculate the annualized ROI. For example, a 40% ROI over three years equals 13.33% per year, which is lower than the 20% ROI from the first investment.
Therefore, even though the second investment yields a higher return, the first one is more profitable and efficient in terms of time.
Other metrics like Rate of Return (RoR) and Net Present Value (NPV) can complement ROI to account for time-based performance or changes in money value over time.
ROI Development: The Rise of Social ROI (SROI)
Recently, investors and businesses have been working to develop a more comprehensive ROI metric known as Social Return on Investment (SROI).
SROI was introduced in the early 2000s to measure broader impacts of projects using extra-financial metrics such as social and environmental value, which are not represented in conventional financial accounting.
The benefit of SROI is its ability to assess ESG (Environmental, Social, Governance) performance, allowing businesses to make socially responsible investment decisions.
For example, if a company recycles plastic in its factory to replace traditional building materials, it might harm the conventional building industry (lower traditional ROI), but it contributes positively to environmental sustainability, resulting in a strong positive SROI.
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