What is return on investment (ROI) and how to calculate it?

Por: Equipe OpServices em 29.05.2017

Return on investment (ROI) for IT projects

Return on investment is one of the simplest measures to calculate if it pays to invest your money in a business. In this article we shall learn what ROI is, how to calculate it and understand why this metric is so relevant to entrepreneurs. Keep following!

 

return on investment - ROI

 

What is return on investment?

Return on investment is a financial concept that measures profitability through financial resources injected into a company. Although we always hear about ROI in the corporate context, this business term could be applied even to a simple savings account. ROI is the ratio of what you have earned or lost and the amount invested.

When your company invests in a particular asset, it expects to receive return in profits. ROI of such investment — be it done in equipment, marketing actions or inventory — is the measure that determines the benefit obtained. Likewise, the resource you dedicate to a venture can also be gauged. Good ROI means that the money you have put into a particular company is generating return.

In IT projects, whether in software or hardware acquisition investments, the definition of future expectation or calculation and how much you get in ROI can be quite complicated. This is because the costs involved (TCO, Total Cost of Ownership) can be quite nebulous.

 

How to calculate ROI?

There are several methods for calculating ROI. The most used one is very simple. To figure out the ROI, all you have to do is subtract your initial investment from profits and divide it all by the same initial investment.

From there, simply multiply by 100 to get the same percentage value. It looks something like this:

ROI = (profit – investment/investment) x 100.

Let’s say at the beginning of your company you invested BRL 2000. Over the course of six months, the business yielded to you BRL 3000. Your ROI in the period was then 50%. But what does it mean?

That means that your business share offered a 50% profit. What sometimes complicates the calculation of ROI in some investments, such as in IT, is the difficulty of obtaining accurate figures. But there are methods that can minimize this type of doubt and facilitate the calculation of this return.

 

Should ROI be the only metric to consider?

Nope. Although ROI is a measure of success, business is more complex than that. At the beginning of our conversation, we used the purchase of equipment and goods as an example of one of the investments in which ROI can be calculated.

However, this type of investment involves other variables that are as important in decision-making as returns are. When you buy equipment, it shall probably be used to produce value. Whether it is a computer or a machine, its acquisition is conditional on generating profits. However, goods like these suffer an effect known as depreciation. In addition, they are subject to other details that affect your income, such as maintenance or even obsolescence.

Therefore, even if ROI is a relevant measure, it should not be the only one to consider by entrepreneurs. What ROI does very well is to calculate profitability.

For other needs, as in this example of purchasing equipment, TCA (Total Cost of Acquisition) may be a better metric. Especially if ROI is also considered during its calculation. In the IT area, another metric is the cost of ownership, as it involves all costs related to a given investment (training, salary of the team involved, hours spent, cost per position, etc.).

Understanding what a return on investment is and how to calculate it is critical for entrepreneurs but there are several other financial performance indicators relevant in decision making.

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