What is ROI - formulas and examples of Return on Investment calculation

ROI stands for "Return on Investment" and refers to the profitability of invested funds. This indicator is most often used in business and financial reporting: marketing, advertising, cryptocurrency and stock markets, investments.

Terminology

Before we get into calculating ROI, let's define the terminology. I think this is important because definitions are often confused. This causes misunderstanding of statements and complicates interaction with colleagues.

In my explanation, I adhere to the following terms:

• Income — all cash flows that increase equity.
  • Gross Income - the difference between revenue and cost of goods and services.
  • Net Income - final profit after deducting all possible expenses from revenue.
• Revenue — cash receipts from sales of goods and services.
• Cost, Expenses — all costs that reduce capital.
• Earnings - is a general term for business income after expenses, but without specifying which expenses have been recognized.
• Profit - the difference between all income and all expenses. The final result, which shows how much money is left after all taxes, costs, salaries and other mandatory expenses have been paid
• Gains - additional profits received not from the core business activities. For example, profits from the sale of equipment, exchange rate differences, and won lawsuits.

In advertising, as a rule, income is equal to revenue, but there are special cases when income comes from sources other than goods and services - for example, in the form of bonuses or compensation from external sources. Therefore, income can be greater than or equal to revenue, but not less.

If you see "Revenue" or "Income" - most likely meaning the same thing, based on the formula quantity * price.

As for earnings, in calculating the return on investment, it is more logical to use just net income - revenue minus all possible costs.

ROI calculation

The indicator is calculated as the ratio of profit received to all costs. Profit is equal to the difference between income and costs:

(income - costs) / costs * 100%

Or shortened:

profit / costs * 100% 

For example, the investment in the advertising campaign amounted to $300,000. Expenses, including cost of goods sold, taxes, employee salaries, other expenses and marketing costs, amounted to $700,000. The revenue of the goods sold was $1,000,000. Then the ROI will be equal to:

(1.000.000 - 300.000 - 700.000) / (300.000 + 700.000) * 100% = 0%

If you cut marketing costs to $200,000 while maintaining current sales levels, then:

(1.000.000 - 200.000 - 700.000) / (200.000 + 700.000) * 100% = 11.11%

When analyzing an investment portfolio:

(Cost + Dividends - Investments) / Investments

Normal ROI

If we talk about the break-even point, the normal value is considered to be greater than 0% - it means that we have received some profit. At 0%, the profit is 0, meaning that for every dollar invested, 1 dollar of income has been returned.

The level of “normality” will be different for different valuation objects.

For an investment portfolio, the interest should not be lower than the inflation rate, so that money at least retains its purchasing power. When the inflation rate and the key rate change, this parameter also changes.

In “hot” advertising with the purpose of direct sales, for example, contextual advertising in Google- it is considered normal ROI more than 30-40%. But it very much depends on the product and channel.

In media advertising aimed at maximizing coverage, there may well be a negative indicator.

At the same time, the above-mentioned “hot” advertising may allow negative values, for example, if the campaign strategy - capture market share, or attracted customers have a large LTV (lifetime value, that is, the client will bring more money in the future).

To summarize - the target ROI value is determined individually, depending on the object of evaluation, strategy and conjuncture. It should preferably be greater than 0%.

Differences between ROI and ROMI and ROAS

ROMI and ROAS include only marketing data, while ROI includes all revenues and expenses, so it is a more comprehensive indicator.

In general, ROMI and ROAS are designed to solve 2 problems: to hide information about the company's profit and to simplify calculations. If there are no such tasks, it is better to use ROI. It will allow to estimate the real profitability of the object of evaluation.

As an alternative to ROMI and ROAS you can use ACOS - advertising cost of sales. In essence, it is the same ROAS, but in reverse:

ROAS = advertising revenues / advertising costs * 100%

ACOS = advertising costs / advertising revenues * 100%

That is, ROAS can be conventionally called “advertising sales of cost”. If we know that the margin of the product is about 30%, then ACOS must be below 30% for advertising to work profitably. ROAS is more difficult to perceive in this respect, because it should be 333% for the same arrangement. Agreed, in a quick analysis it is easier to compare 30% and 30% than 30% and 333%, although the information is identical.

I hope the article was useful for you and you will get answers to your questions from it. Thank you for your attention!