How is the return on investment (ROI) calculated?

Return on investment (ROI) is an essential metric used to evaluate the efficiency of an investment or to compare the efficiency of several different investments. The formula for ROI involves calculating the net profit generated by an investment relative to its cost, providing a clear picture of profitability.

The correct approach begins with subtracting the total costs from total revenues to determine the net profit. This step reflects the actual financial gain generated by the investment. After obtaining the net profit, dividing this figure by the total costs provides a ratio that reflects the return on investment as a percentage. This calculation allows investors to assess how effectively their capital is being utilized and aids in comparing the effectiveness of various investment strategies.

Understanding this formula is crucial for financial management, as it helps stakeholders make informed decisions about resource allocation and investment opportunities.