Return on investment—how to calculate it?

Investment efficiency is a key factor for any investor who wants to maximize profits. One of the basic tools for assessing it is the ROI method, which is used to measure the profitability of an investment by calculating the ratio of net profit to costs incurred.

ROI allows you to calculate the return on investment and the profitability of an investment, expressing the result as a percentage. This makes it easier to compare different projects in terms of their profitability. Calculating the rate of return on investment gives investors the opportunity to understand how effectively their invested funds are working for their profit.

Investors often use various measures of investment profitability. For example, the average annual rate of return can be an indicator that allows you to assess how the value of an investment changed on average over the year, taking into account a longer period and capitalization.

In contrast, the ROI metric measures the overall return on investment as a single percentage figure, which is particularly useful when evaluating shorter projects or individual investment activities.

In this article, we will discuss step by step how to calculate ROI, what to look for when interpreting it, and what factors influence its value, so that you can make more informed investment decisions.

Table of contents:

• What is ROI?
• How to calculate ROI?
• Return on investment ratio
• Factors affecting ROI
• Investment profitability assessment
• Practical tips
• Examples of return on investment calculations
• Example 1: One-time investment in gold
• Example 2: Long-term investment taking inflation into account
• Example 3: Purchase and sale of gold with transaction costs
• Conclusions and recommendations

What is ROI?

ROI, or Return on Investment, is a measure of the return on an investment that helps assess how an investment generates profit in relation to the costs incurred. ROI is defined as the ratio of net profit to investment costs, expressed as a percentage, which allows for comparison of the profitability of different projects and financial instruments.

The ROI formula is: (return on investment - investment cost) / investment cost × 100%, which gives a percentage value that indicates how much profit each dollar invested in the project generates. For example, if the profit is $2,000 at a cost of $10,000, the ROI is 20%.

The ROI indicator has a wide range of applications, allowing you to calculate both the annual and monthly return on investment, and can be used to analyze the profitability of marketing campaigns, business projects, or capital investments.

It is a simple and intuitive indicator, but it is important to remember that it does not take into account factors such as the duration of the investment, risk, or the nominal rate of return adjusted for inflation. Therefore, ROI is often combined with other indicators to obtain a more complete picture of the profitability of an investment.

How to calculate ROI?

To calculate ROI, or return on investment, you can follow a few simple steps. ROI is expressed as a percentage and shows the return on a given investment in relation to the costs incurred. Here are the steps and formulas that will help you calculate this indicator.

1. Identify the profit and costs of the investment – the profit from the investment is the value that the investment has generated after deducting costs. Example: if you invested $10,000 in shares and after a year their value increased to $12,000, the profit is $2,000 ($12,000 - $10,000).
2. Apply the ROI formula – ROI can be calculated as the ratio of net profit to invested capital, expressed as a percentage according to the formula:

ROI = (net profit / capital) x 100%

• net profit is the amount obtained after deducting production and advertising costs from revenue;
• capital includes all costs incurred to generate that profit.

ROI expressed as a percentage makes it easy to compare the profitability of different investments, regardless of their size or nature. Thanks to this method, companies can accurately estimate whether a given investment was profitable.

3. Use an ROI calculator – if you have multiple investments or need quick calculations, an ROI calculator, which is available online, can automatically calculate ROI based on the data you enter. Tools such as Google Analytics and CRM systems also offer modules for monitoring ROI, which are particularly useful in marketing activities.
4. Interpretation of the result – a higher ROI value means a more profitable investment. However, it should be remembered that ROI does not take into account the time of investment or risk, so it is worth combining it with other indicators for a more complete analysis.

Return on investment ratio

The return on investment ratio is a tool that allows you to assess how effectively a given investment generates profit in relation to the costs incurred. As a profitability indicator, ROI is used to compare the profitability of different projects, regardless of their scale. The ROI is interpreted by analyzing its percentage value—the higher the ratio, the more profitable the investment.

How to interpret the profitability ratio?

• A high ROI indicates highly effective investments that generate significant profits compared to costs.
• A low or negative ROI indicates low profitability or losses, which may suggest that the investment was unprofitable.

Factors affecting ROI include initial costs, investment duration, market risk, and the impact of inflation. However, it should be noted that this indicator does not take into account all elements, such as payback period, which is important for long-term investments.

Thanks to the ROI indicator, investors can more accurately assess which investments are worth continuing and which require a change in strategy.

Factors affecting ROI

Many factors influence ROI, which can significantly alter the profitability of an investment. Understanding these variables is crucial to accurately estimating the profitability and risk of an investment.

• Investment duration – ROI may differ for short-term and long-term investments. Long-term investments, while often more profitable, may be more susceptible to economic changes such as inflation, which affects the final result.
• Inflation – inflationary changes can reduce the real value of profits, especially in long-term projects. Rising inflation reduces the purchasing power of profits, which in turn lowers the real ROI.
• Real estate market – ROI in the real estate market can vary depending on location, demand, and economic conditions (interest rates). Investments in real estate in developing locations may generate a higher ROI than those in stable but saturated markets.
• Gold and silver market – investments in precious metals such as gold and silver– are often seen as "safe havens" in times of uncertainty. The price of gold and silver can significantly affect ROI, especially during periods of high market volatility.
• Economic and political conditions – global economic events such as recessions, financial crises, or changes in tax policy can affect the profitability of investments in various sectors, which will translate into ROI.

Analyzing these factors allows investors to better predict potential changes in ROI and adjust their strategies accordingly.

Investment profitability assessment

The assessment of investment profitability is based on several key indicators that help investors understand whether a given investment has generated satisfactory returns in relation to the costs incurred. The ROI indicator is a basic tool that allows the profitability of an investment to be expressed as a percentage return on the capital invested. The resulting percentage makes it easier to compare the effectiveness of different investments.

Other profitability indicators:

• NPV (Net Present Value) – Net Present Value (NPV) takes into account cash flows over time and changes in the value of money, which is particularly important for long-term investments. NPV helps predict future financial benefits and determines whether an investment generates a surplus over the cost of capital. A positive NPV indicates that a project is profitable, while a negative NPV suggests that it is not.
• IRR (Internal Rate of Return) – Internal Rate of Return (IRR) is another indicator that determines the interest rate at which the NPV of an investment is zero. IRR allows you to compare the profitability of investments with different levels of risk, helping you to make decisions about the allocation of funds.
• Market factors – When assessing the profitability of an investment, investors should consider broader economic factors such as inflation, market volatility, and global political and economic developments. For example, investments in real estate, gold, silver, and other precious metals may have different rates of return depending on economic conditions and market circumstances.

Practical tips

It is worth using automation tools such as ROI calculators and CRM systems, which help monitor profits and costs and regularly review profitability indicators. By combining ROI with additional indicators, investors can create a more balanced and long-term portfolio, maximizing profits and reducing the risk associated with investment decisions.

Examples of return on investment calculations

Here are some examples of practical ROI (Return on Investment) calculations for investments in gold. Using the formulas below, you can easily calculate the ROI for various scenarios in which investors want to estimate the profitability of their gold purchases.

Example 1: One-time investment in gold

Let's assume that an investor bought a gold bar for PLN 10,000. After a year, its value increased to PLN 12,000.

Formula: ROI = [(return on investment - investment cost) / investment cost] * 100%

Calculation:

ROI = [(12,000 - 10,000) / 10,000] * 100%
ROI = [2,000 / 10,000] * 100%
ROI = 0.2 * 100%
ROI = 20%

Interpretation: Investing in gold yielded a 20% return over the course of a year.

Example 2: Long-term investment taking inflation into account

An investor bought gold for PLN 15,000 five years ago. Currently, the value of gold has risen to PLN 20,000. We want to calculate the ROI, taking into account an annual inflation rate of 3%.

Formula: ROI with inflation = [(return on investment - adjusted cost of investment) / adjusted cost of investment] * 100%.

1. We calculate the adjusted investment cost:

Adjusted cost = 15,000 * (1 + 0.03) ^5
Adjusted cost = 15,000 * 1.15927
Adjusted cost = $17,389.05

2. We substitute into the formula: ROI = [(20,000 - 17,389.05) / 17,389.05] * 100%

ROI ≈ [2,610.95 / 17,389.05] * 100%
ROI ≈ 0.15 * 100%
ROI ≈ 15%

Interpretation: After taking inflation into account, the investment yielded a 15% return over a five-year period.

Example 3: Purchase and sale of gold with transaction costs

The investor purchased gold for PLN 30,000, incurring additional transaction costs of PLN 500. After two years, he sells the gold for PLN 35,000.

Formula: ROI = [(return on investment - total costs) / total costs] * 100%.

1. We calculate the total costs: total costs = 30,000 + 500

Total costs = 30,500

2. We substitute into the formula: ROI = [(35,000 - 30,500) / 30,500] * 100%

ROI ≈ [4,500 / 30,500] * 100%
ROI ≈ 0.1475 * 100%
ROI ≈ 14.75%

Interpretation: After taking transaction costs into account, the investment yielded a return of approximately 14.75% over two years.

Each example illustrates how ROI calculations can be adjusted to account for specific costs or long-term variables such as inflation. This allows for a more accurate assessment of the profitability of investing in gold.

Conclusions and recommendations 

ROI, or return on investment, is a fundamental tool for investors, allowing them to quickly assess the profitability of various projects and assets, regardless of their scale. A good return on investment, expressed as a high ROI, suggests greater profitability and indicates that the investment was effective and profitable. However, for a more accurate assessment of ROI, it is worth combining it with other indicators, such as IRR or NPV, which take into account time and risk factors.

Recommendations for investors:

1. Cost optimization – to achieve a higher ROI, it is worth constantly analyzing and optimizing investment-related costs. Examples include reducing transaction costs or choosing more effective sources of financing.
2. Diversification of investments – investing in different asset classes, such as gold, real estate, and stocks, allows you to reduce risk and increase investment returns, as different assets can generate profits in different market conditions.
3. Regular analysis of indicators – monitoring ROI in conjunction with other financial indicators allows for better portfolio management. Regular analysis enables quick responses to market changes, which can translate into higher profits and investment stability.
4. Consider inflation and investment duration – for investors seeking higher ROI on long-term investments, it is important to consider the impact of inflation on real returns and net present value. Taking these factors into account allows for a more comprehensive assessment of profitability.

ROI is a simple but very useful metric that supports investors in making informed decisions and helps maximize profits. However, investment success requires a strategic approach that combines the benefits of high ROI investments with an analysis of risk and market conditions.