QFINANCE Topics
• Balance Sheets and Cash Flow
• Financial Markets
• Financial Regulation and Compliance
• Funding and Investment
• Governance and Ethics
• Mergers and Acquisitions
• Operations and Performance
QFINANCE Reference
• Research Data
• Financial Reference

Home > QFINANCE Dictionary > Definition of return on investment

Definition of

# return on investment

Finance

profit as percentage of investment a ratio of the profit made in a financial year as a percentage of an investment.

The most basic expression of ROI can be found by dividing a company's net profit (also called net earnings) by the total investment (total debt plus total equity), then multiplying by 100 to arrive at a percentage:

ROI = Net profit ÷ Total investment

If, say, net profit is \$30 and total investment is \$250, the ROI is:

30 ÷ 250 = 0.12 × 100% = 12%

A more complex variation of ROI is an equation known as the Du Pont formula:

Net profit after taxes ÷ Total assets = (Net profit after taxes ÷ Sales) × Sales ÷ Total assets

If, for example, net profit after taxes is \$30, total assets are \$250, and sales are \$500, then:

30 ÷ 250 = 30 ÷ 500 × 500 ÷ 250 =12% = 6% × 2 = 12%

Champions of this formula, which was developed by the Du Pont Company in the 1920s, say that it helps reveal how a company has both deployed its assets and controlled its costs, and how it can achieve the same percentage return in different ways.

For shareholders, the variation of the basic ROI formula used by investors is:

ROI = (Net income + Current value − Original value) ÷ Original value

If, for example, somebody invests \$5,000 in a company and a year later has earned \$100 in dividends, while the value of the shares is \$5,200, the return on investment would be:

(100 + 5,200 − 5,000) ÷ 5,000 = 300 ÷ 5,000 = 0.06 × 100% = 6%

It is vital to understand exactly what a return on investment measures, for example, assets, equity, or sales. Without this understanding, comparisons may be misleading. It is also important to establish whether the net profit figure used is before or after provision for taxes.

#### Related definitions of "return on investment"

• Hedging Credit Risk—Case Studies and Strategies
This checklist examines credit risk and the instruments that may be used as hedges to reduce exposure.
• Calculating Return on Investment in Human Resources
This checklist looks at how to calculate return on investment in human resources and the benefits of such an assessment for a company.
• Improving Corporate Profitability Through Accountability

Improved governance requires the right employees, the right culture and values, and the right systems, information, and decision-making. Unfortunately, most organizations are attempting to steer their information-age businesses using industrial-age measurements. Managers have struggled for decades with accounting systems that fail to measure many of the variables that drive long-term value. The historical lagging indicators of performance that...
• Navigating a Liquidity Crisis Effectively

Until 2007, debt had become very cheap and accessible. Most companies sharply increased their leverage. In Germany, for example, the net-debt-to-EBITDA ratio extremes moved from around 3 in 2002 to around 7 in early 2008. However, a downturn in company performance or an external financial crisis—where lending becomes scarce and borrowing expensive—can make this approach risky.

Definitions of ’return on investment’ and meaning of ’return on investment’ are from the book publication, QFINANCE – The Ultimate Resource, © 2009 Bloomsbury Information Ltd. Find definitions for ’return on investment’ and other financial terms with our online QFINANCE Financial Dictionary.