Return on Investment

The return on investment can be viewed as the following:

ROI = (gain from investment – cost of investment) / cost of investment

So, if you invested £15,000 and realised an increase in sales of £10,000, your ROI would work out at (10,000-15,000)/15,000, or -0.33.

This shows that the investment did not pay off – in fact, as the ROI is below zero, you would have been better off without making the investment.

But… hold on…

What if, in the example above, I spend £15,000 in year 1 to buy in a new ordering system, and again, I only gain £10,000 that year?

Sure, I lost £5,000. That year. What about the next year? Unless the outgoing is a recurring value, my investment in year 2 is zero, but I can still expect the additional £10,000 in sales.

So, at this point, my ROI now looks like this:

ROI = (20,000-15,000) / 15,000 = +0.33

All of a sudden, that investment looks like a better bet. So which answer is the correct one? Is it a bad investment, or a good investment?

Timing is everything

The answer is: It depends.

No two projects are the same, and nor are any two companies. One company may have a deadline set which states that the ROI over one year must be positive.

The company may be entering into an annual charge, in which case the costs will increase each year alongside the potential gains.

Other companies may not care so much about whether the ROI will be positive after one year, but will want to know how long the investment will take to pay for itself.

In order to work out how long the ROI period is, you can use the following formula:

ROI Period = cost of investment / additional monthly profit

So, an investment of £15,000 that results in an increase in monthly profit of £1,000 would take 15 months before a positive ROI was seen.