Return on Investment (ROI) is an important financial metric. It tells you how successful or profitable an investment is relative to the money spent on it. This article will cover everything you need to know about Return on Investment (ROI). You will discover what return on investment is, how to calculate ROI, how to increase ROI and practical returns on investment example. Let’s get into it.
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What is Return on Investment?
Imagine investing ten thousand naira (#10,000) to buy a company’s shares. After a year, the value of your shares has increased to twelve thousand naira (₦12,000). This value increment means you have made a profit of two thousand naira (₦2000). The two thousand naira profit is your return for your ten thousand naira investment.
Mathematically, your two thousand naira profit represents a 20% increase. This means that you have made 20% of your initial investment. In simpler terms, your investment has a return in investment (ROI) of 20%.
Using that same logic, if you had invested a return on investment capital of ₦1000, you would have earned ₦200. Also, if you had invested ₦1, you would have made a profit of ₦0.2. In each case, you will always make a 20% return on investment.
In essence, ROI is how much you get for every unit of currency you invest. It helps you know how much profit or loss you get on an investment and it is usually calculated in percentage.
Return on Investment: How to Calculate it
Calculating your ROI is a straightforward process. The first step is to determine how much you invested. This initial cost of the investment can be any expenses, fees, or return on investment capital.
The next step is to find out the current value of your investment after a specific period. It could be the current value of a stock you invested in, or the selling price of a property you bought. It could also be the revenue from a project or business venture you invested in.
You then have to subtract your initial cost from the current value of your investment. That is, Net Profit or Loss = Final Value – Initial Investment.
Your net profit or loss shows how much money you made or lost on an investment or business transaction. In other words, it is the return or value you get on that business or investment. This value is what you use to calculate your actual ROI in percentage.
You can determine your ROI in percentage by dividing your net profit or loss by the initial cost of investment and multiplying it by 100. That is ROI = Net Gain or Loss ÷ Initial Investment X 100. Let’s consider a simple return on investment example:
Let’s say you bought a piece of land for five hundred thousand naira ten years ago. Due to inflation, and drastic development in that land area, the price of your land is expected to have gone up. Imagine the value of the land is now worth five million naira, you will make a substantial profit selling it. You can determine your ROI on this ten year investment following the steps below:
Initial land cost (investment) = ₦500,000
Current land cost (Value) = ₦5,000,000
Net Gain or Loss = ₦5,000,000 – ₦500,000 = ₦4,500,000
ROI = ₦4,500,000 ÷ ₦500,000 X 100 = 900%
From the calculation in this return on investment example, your ROI is 900%. In other words, you are getting a whooping 900% return for every unit of currency you invest.
How to Increase ROI
As shown in the return on investment example above, we have established that ROI is a way to measure how profitable an investment is. Every business owner or investor is always seeking a way to increase their ROI. Although there is no one-size-fits-all formula, there are certain strategies you can employ.
Here are some strategic approaches that can help you increase your ROI.
Research and data-driven decision making
There are certain market dynamics that influence the profitability of an investment. Some of these market dynamics include market trends, customer behaviour, cost of operations, operational efficiency, etc.
Adequate research and analysis helps you understand these important factors and how they relate to your investment. This will help you make informed investment decisions, which lay the foundation for positive returns.
It wouldn’t be wrong to go all in on one investment, especially if it is backed by thorough research and analysis. However, it is safer to diversify. There’s a wise saying: don’t put all your eggs in one basket. The same thing applies in the investment world. Rather than putting all your return on investment capital on one investment, it is safer to diversify.
Spreading your investments strategically across different markets or assets gives you insurance against heavy loss in the event that one investment fails. In the long run, diversifying your investment portfolio also helps enhance your returns.
There are certain unnecessary expenses that you can do without. Find out these expenses and minimise them or remove them completely. Find a way to optimise operations, negotiate better deals, and implement cost-effective technologies. The goal is to achieve the best quality with minimum cost.
Innovations and technology
Technology is constantly developing. And it is creating an advantage for those who can leverage it, whether in the business world or any other facet.
Therefore, technology is a tool you should pay attention to. It could be artificial intelligence, blockchain, data analytics, or automation. Leveraging relevant technological innovations within your field gives you an advantage. It helps you enhance productivity and uncover new avenues for returns.
Regular assessments and adjustment
Regularly assess the performance of your investments. These regular assessments will help you determine if your investments are meeting your established goals and benchmarks. You will then be able to make necessary adjustments that will impact your ROI.
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Throughout this article, we have explained return on investment meaning in detail, how to increase it and calculate it. We have also seen a practical return on investment example to explain its meaning better.
Knowing how to calculate your ROI is important for you as a business or investor. You should also consciously seek to increase your ROI. Employing key strategies like diversification, informed decision-making, cost reduction, adopting technology, and regular assessments will help you navigate market changes and maximise your returns.
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