In any business organization, you need to know how to determine whether a given product, advertisement, or marketing campaign will be worth the money you spend on it. In other words, you need to know whether that ad or product will produce a good return on investment (ROI).
If you’re unfamiliar with ROI or how to use it, don’t fret. We’ll break down ROI in detail and go over situations in which you should use ROI to pick between one ad or product or another.
Return on investment is a performance metric you can use to determine the estimated profitability or efficiency of an investment.
For example, imagine you are a business owner and want to know whether investing money into an up-and-coming business is a good idea. You calculate ROI, then use the number to determine whether you’ll fork over any funds.
Return on investment tries to directly measure the return you’ll get on any specific investment relative to that investment’s initial cost. Calculating ROI is fairly simple, meaning you can use this formula for a variety of purposes, like:
Overall, ROI is an important metric to measure, whether you’re a business owner, marketer, or investor. It helps alongside other calculations like net profit, annualized ROI, cash flow, and more to optimize your business operations.
In addition to financial ROI, which is mainly used in financial calculations dealing with capital gains, social return on investment (SROI) was developed in the 1990s to account for broader impacts of projects beyond net income.
To calculate ROI, use the following formula:
The current value of investment means the proceeds you’ve obtained from the sale of the investment of interest.
Let’s take a look at an example so you can better understand this formula and how it works:
Say that you have an upcoming digital marketing goal you want to meet, and you have a $50,000 marketing budget. If you spend $50,000 on advertising and generate $750,000 in sales, you’ll see a whopping 1400% ROI based on your ad expenditure alone.
The ROI can be used to determine the total cost of an investment, as well, since it takes into account whether the investment will lead to a negative ROI or long-term losses on the balance sheet.
The best way to understand ROI is as a simple, versatile method of gauging the profitability of an investment or expenditure.
Suppose you’re a business owner and want to know whether pursuing one marketing campaign or another is smarter. In that case, you can use ROI to pick between them based on how much money they are likely to make you in terms of sales, customer acquisitions, etc.
When you get a metric or value out of the ROI formula, remember that if the ROI is net positive, it’s most likely worthwhile. You make more money from the action than you put into it. However, if the ROI is a net negative, you spend more money than you make in the long run.
You can also compare multiple ROI formulas for different actions or investments to determine which of the two is more worthwhile.
For example, if you have multiple different billboard advertisement spots, but one has a much higher ROI than another, you’ll be better off spending money on the higher ROI billboard location than many others.
There are plenty of times when it’s wise to use ROI metrics.
For example, if you want to pick between two business decisions and don’t know which of the two will be more profitable overall, return on investment can help you determine that. You can also use return on investment to learn whether making an investment in the first place is a wise idea.
Say that you aren’t sure whether you should expand your business into a new retail office or storefront. You can use information like your expected return or the current profits you make on your first retail location to calculate the ROI on a new retail location.
In the end, you’ll know whether expanding your business in that way is a smart idea or whether you should find some other way to scale your enterprise.
ROI is not a foolproof formula, nor should it be used in every situation regardless of other considerations. The limitations of ROI are numerous.
For example, ROI can be overly simple when calculating complex business operations or costs. Furthermore, ROI is not good at determining overall profitability over a long period unless you specifically calculate that variable into the formula.
For the best results, you should use ROI in conjunction with other formulas, like rate of return (RoR). You can also use equations like net present value (NPV), which tells you the differences in the value of your money over time because of inflation.
Bottom line: While ROI is a valuable tool, it should be used alongside other tools in many situations.
That depends on your industry and what you hope to gain from your investment.
However, an annual return on investment of 7% or greater is considered a good ROI for any investment in stocks. That’s because it’s the average annual return for the S&P 500 when accounting for inflation.
Still, your investments won’t always be in the stock market. Therefore, you can only determine whether an ROI is good for you and your purposes by asking yourself questions like:
Return on investment is a useful way to determine whether a given ad or marketing campaign will give you enough bang for your marketing buck. The ROI calculation can be used to determine the cost of the investment you wish to make, whether an initial investment is wise, or whether you should choose between different investments based on their bottom lines.
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