What is ROI and how is it calculated

Everyone talks about it so much because it’s one of the most important metrics of your business. We’re obviously talking about ROI (Return on Investment). The return on investment is surely one of the most significant KPI’s that a businessman must keep in mind when deciding which business activities to pursue and which to set aside.

However, the simple definition “return on investment” is not enough to explain what ROI really is and exactly why it’s so important.

In this article you will learn how ROI is calculated and how you can use some advanced tools and instruments to instantly identify this performance indicator!

How is ROI calculated?

In simple terms, ROI is the ratio between net income and investment. Defined as such, the return on investment is an essential parameter for indicating the profitability of the capital invested in a company, or in a production line, measuring the return obtained per each euro invested therein, whether it be equity capital or debt capital.

As for net income, it’s simply the difference between the revenues and the typical costs of a business project, without considering – therefore – other elements that are unrelated to the typical margin like financial expenses and taxes. The investment, instead, is the sum of the equity capital and third-party capital.

Let’s make an example!

Example of ROI calculation

Let’s imagine to have closed 2019 with a net income of 100.000 euros, and that the investment was equal to 600.000 euros for the same period. Using the formula for calculating the ROI illustrated before, we find that:

ROI = (100.000 / 600.000) * 100 = 16,67%

But what information can we obtain from this result?

Given that the ROI allows you to get an idea of the profitability of the investment you are making, and that, all other factors being equal, the higher the ROI and the higher the efficiency of the investment, an initial basis of comparison for whether or not ROI is satisfactory will be a comparison with interest rates.

In fact, if the ROI is higher than the rates you would pay on any debt, it makes sense to take on debt in order to make business investments, because the returns will pay you back for the costs you need to incur to be able to sustain them.

You can also evaluate the ROI of one production unit with respect to those of other units if you have to make choices about which products to keep and which products to “thin out,” favoring projects that can provide you with more satisfactory returns.

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ROI: what does it mean… and what not!

Unfortunately though, things aren’t as easy as they seem.

Firstly, it’s not always easy to keep a close eye on the income generated by an investment in a business or in a production line, because:

• it’s not always simple to attribute the “credit” for revenue to a specific channel / investment;
• the purchases made by one’s customers are often the result of a lengthy decision-making process, and thus are not characterized by an immediate response to a given investment;
• many products and services are bought cyclically by customers, and therefore, revenues are multiple for a single initial investment.

It’s also for this reason that the invested capital (that is, the denominator in the above formula) is often calculated as the average of the last 2-3 fiscal years, rather than as point in time figure for the year.

Anyways, notwithstanding these operational difficulties, the calculation of the ROI still remains one of the most important operations for measuring performance, that we strongly recommend all entrepreneurs keep in mind.

What are the tools for calculating ROI?

Our advice is to assess the evolution of the ROI together with the other KPI’s that are fundamental to your business and to your investments, like revenues, profits and margin. We will be dealing with a few of these topics in our next insight articles, so stay tuned on our blog to not miss any of them!

In ZonWizard we have implemented our software to give you daily updates of ROI and other performance indicators, such as Real Profit, that take into consideration all your business costs.

If you want to take control of your Business using a suite of advanced tools you can register on our website and take advantage of the 14-day free trial dedicated to new members.

Thank you for reading this article. We hope it has shed some light on what ROI is and why it is so useful to Amazon sellers.

We encourage you not to miss the insights and latest news about the Amazon world on this blog.

By the way, if you haven’t already done so, take a look at our live demo to see how it works and how ZonWizard can become your best Amazon sales ally.

Happy sales from ZonWizard!