Return on Investment (ROI): Definition and How to Calculate
Profit and loss is a common occurrence in many types of investments. There are times when the capital you invest in a company will decrease in value, on the other hand there are also opportunities for profit generation. ROI is a term that is often used to describe the situation.
Some of you may be familiar with the abbreviation ROI or Return on Investment. However, it cannot be denied that there are still many people who question how to define and calculate ROI. Let's find out more through this Prospeku article!
Definition of ROI
Return on Investment or ROI is the percentage of profit that can be obtained from the total amount of investment assets. From its definition, it can also be said that ROI is a calculation that can show the level of how effectively a person or company risks funds in capital investment in the form of investment.
There are two stages that can help companies determine investment sustainability through ROI figures. When the ROI formula produces a number on a positive scale, it is better for the investment to continue. Conversely, if the percent obtained shows a negative number, it is better to immediately revoke the investment because it will cause losses.
Definition of Return on Investment According to Experts
When viewed in terms of theory, the definition of ROI is a concept that is often found in the field of economics. ROI is used to calculate the percentage of one's net profit in investing. There are also several definitions of return on investment according to experts such as the following three points.
Rahardjo (2009) states that ROI is a ratio used to measure the company's ability to generate profits in the investments they make.
Syamsudin (2011) defines the abbreviation ROI or Return on Investment as a comparison scale between net profit after tax and total assets.
Cashmere (2015) defines the ROI formula as the ratio of return or return on assets used by a party in the company. In addition, ROI is a scale measuring the effectiveness of management of an investment transaction.
ROI is the result of income obtained from investment or capital investment involving state companies. In other words, there must be an involvement of paying taxes in it. In general stock transactions, the tax imposed is 0.1% of gross stock sales. Then the ROI formula is as follows:
ROI = Net Profit after Tax : Total Assets x 100%
Also read: Definition of Property Investment and How to Make a Profit!
As a technique to understand how to calculate ROI in the formula above, here are some ROI examples for you to learn. Look and pay attention carefully according to each situation.
You are an individual investor who will invest in a fast food fried chicken restaurant. It is estimated that the net profit that will be obtained in November is 40 million rupiah. While the total assets of the funds you provide are 500 million rupiah. Then the ROI figure obtained is:
ROI = Net Profit : Total Assets x 100%
\= 40.000.000 : 500.000.000 x 100%
\= 0,08 x 100%
From the results of how to calculate ROI above, it can be seen that the percentage result reaches 8%. This means that the investment you make is likely to make a profit and increase your income by 8% or the equivalent of Rp40,000,000. So, it is better to keep the capital investment for the next period.
An audio-visual content production company "B Production" provided some funds to a well-known entertainment agency in Indonesia, "H Agency." This investment was made to build future cooperation, so the shares of H Agency were purchased by B Production at Rp150,000,000. However, due to internal problems, H Agency's revenue was forced to decrease by Rp200,000,000. Then the ROI obtained is:
ROI = Net Income : Total Assets x 100%
\= -50.000.000 : 150.000.000 x 100%
\= -0,33 x 100%
Unlike the first example that got a profit, a decrease in revenue can result in a minus in the old calculation. In other words, B Production suffered a loss. Hence, with an ROI of -33%, there is no need to maintain the investment made.
After knowing how ROI examples based on two different cases above, it is now clear that the Return on Investment formula can produce a surplus or minus in your company's cash. This phenomenon does not just happen, there are several factors that affect ROI, namely:
- Operating assets turnover cycle or often referred to as operational assets. Some examples include buildings, money, tools, company patents, and other items that are useful in running the company's wheels. In this factor, it can be seen how good the company's management of its operational assets is.
- Profit margin or the ratio of profit and sales. The greater the result of calculating the profit margin, the profit obtained in ROI will also increase.
In conclusion, for entrepreneurs, ROI is a very important thing to know. By applying how to calculate ROI, you can estimate in advance the sustainability of the investment made. Then you can also plan more carefully how to invest the capital or assets. Hope you find it useful!