lead to management of a company towards satisfactory results that guarantee results aligned with the established goals is, without a doubt, the great challenge of any leadership, and this includes the ROI.
After all, there are several strategies for leveraging business performance, so that even the most experienced manager can be faced with doubts about which ones to adopt – especially when the investment required to adopt these measures raises the value of the bet.
Therefore, before a certain investment is made, it is necessary to carry out a strategic and precise assessment of the issue, anticipating its potential return through a Return on Investment indicator.
Precisely for this reason, we have prepared this content for you. Throughout this article, we will detail the whole concept behind this metric, in addition to explaining everything about how to correctly perform one of the most important calculations relevant to a company's strategies, enhancing the multiplication of your company's results. Good reading!
What is ROI?
ROI is undoubtedly one of the most valuable financial indicators of a business. The term, coming from the English language, is an acronym for the expression “Return On Investment” – or, as we would say in Portuguese, “Retorno Sobre Investimento”.
This is a somewhat self-explanatory concept, if we consider that ROI is nothing more than an indicator of the relationship between expenses and earnings involved in each investment made by the company.
Therefore, it would be correct to state that, at a strategic level, each and every initiative carried out aiming at profitable results must be included in the ROI before being presented to the higher spheres of the organization: this applies both to training and software acquisition, as well as hiring, campaigns marketing, actions aimed at customer retention and much more.
Precisely because it encompasses the entire company strategy, ROI can (and should) be calculated in absolutely all of your areas and departments. In this way, it becomes possible to assess the viability of launching new projects of any nature, from the point of view of the financial return on invested resources.
This measure is vital not only for assessing the profit potential of new investments, but also for improving and optimizing the performance of those that are already in progress. This is because the ROI calculation is carried out in real time, which allows adjustments to be made throughout the development of a campaign, without having to wait for its conclusion.
How to calculate ROI
The ROI calculation is based on two formulas. One for standard ROI and one for annualized ROI. Check both below.
standard ROI
The basis for calculating the standard ROI is in the following formula:
ROI = [(Revenue – Expense)/Expense] x 100%
At first, it may seem complicated, but if we put it in practical terms, we will see that it is a very simple calculation.
Imagine, for example, a company that carried out a certain action whose investment was BRL 10.000,00, and which generated BRL 15.000,00 in revenue:
[(R$15.000–R$10.000)/R$10.000] x 100% = 50%
In this example, we noticed that the investment of the company in question presented an ROI of 50%.
annualized ROI
However, the calculation described above does not consider how long a given project or investment was maintained – and this is information capable of making a lot of difference to the company's management.
For this variable to enter into the account, it is necessary to calculate the annualized ROI. It is a tool for measuring not only the ROI, but also the annual ROI of projects or investments. In this case, the formula to follow is:
Annualized ROI = [(1+ROI)1/N–1] x 100%
Here, N refers to the number of years over which the investment or project has been held. To better understand the importance of calculating annualized ROI, let's analyze the same calculation presented above, but using an example of calculating annualized ROI.
Let's say a particular company achieved a baseline ROI of 50%, but that return was realized at the end of a five-year period.
We might assume that the annualized ROI would be 50%/5 or 10%, but that would be a miscalculation, disregarding compounding effects.
In fact, by the annualized ROI calculation formula, we would have the following:
[(1+0,5)1/5–1] x 100% = 8,45%.
From the calculation above, we can assess that the same gain, if it had occurred over a period of two and a half years, would represent an annualized ROI of 17,61%. If that return were to be given in six months, the annualized ROI would be 125%.
The annualized ROI, therefore, proves to be very useful for evaluating long-term investments, as it allows investments made in different retention periods to be compared more precisely.
However, it is also important to remember that choosing an investment should not be made solely on the basis of a high annualized ROI. Potential risks are also valuable data – and in some cases, a lower ROI but offering significantly lower risks may represent a wiser choice.
Interpreting the ROI
It is already clear that ROI provides a powerful tool for evaluating different investments and comparing their potentials. However, it takes a good deal of insight to interpret it correctly, as we will see in the following example:
Imagine, for example, that a company decides to invest R$100.000 to generate revenue of R$400.000.
(R$400.000 – R$100.000) / R$100.000 x 100% = 300%
The calculation points to an ROI of 300%, which, in principle, can be considered a good return – until the manager discovers that the revenue could have been 400%.
It is also worth considering that, with regard to evaluating the effectiveness of a company's revenue, there are other relevant variables to be considered, such as:
- competitors' prices;
- the user experience;
- the results generated by advertising;
- the quality of your product or service;
- plus a multitude of factors that also influence your potential ROI.
Likewise, for this comparison, it is also important to understand the potential ROI of other investments.
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What makes a good ROI?
As you can see, the ROI calculation is a key element for the manager to obtain a good understanding of the return brought by the company's investments.
After all, it is this metric that will define whether, in fact, there is a satisfactory return on invested capital; whether some strategies will need to be reconsidered; or, as a last resort, whether it will be necessary close the company's doors. But when can this calculation be considered positive?
In summary, we can say that the result of the ROI formula is positive when its value is above zero, as this would be the indicator that the investment did not show a loss. A result less than zero, on the other hand, indicates that the amount invested was greater than the revenue generated – which indicates damage to the company's coffers.
However, it is important to remember that, although the ROI is an important instrument for measuring the efficiency of investments, there are other evaluation indicators that must be applied jointly, since other aspects of an intangible nature need to be determined so that the assertiveness of the application of resources is parameterized in a really appropriate way.
In this sense, as mentioned above, external factors must be considered, such as competition, the period of time within which the investment generated a return, and others.
Indeed, time represents a crucial factor in this equation, as a really satisfactory ROI offers a significant financial return in a short period of time. After all, if the investment takes too long to generate results, there is no doubt that the project's productivity will be less than ideal – and, therefore, it will be necessary to consider this delay.
We conclude, therefore, that the measurement of this indicator cannot be given from a solely central point of view: it is necessary to have a broad understanding of what to expect from the project, its performance and the investments necessary for its development.
Why is ROI important for companies?
ROI consolidates itself as one of the most traditional performance indicators in the corporate world, being widely used by organizations of all types – from large multinationals to small business.
And, contrary to what it may seem at first glance, its effectiveness is not just for the simple assessment of the financial return of a project: here we have a powerful instrument for comparing the performance of different projects, strategies and activities.
In fact, ROI proves to be a valuable guidance tool for assertive decision-making. After all, the prior view of the enterprise's operations makes it possible to anticipate and discard unfeasible alternatives.
Finally, it is worth mentioning that the return on investment proves to be extremely useful when communicating with customers, investors, partners and other stakeholders in the business, as it is an easy-to-understand practice that is already extremely widespread in the market.
If you liked this content, we invite you to continue our conversation with our special article on crisis management, which you can check out by clicking here!
