Return on investment (ROI) is a metric used to denote how much profit has been generated from an investment that’s been made. Knowing how to calculate ROI can benefit you in several ways, including helping you make the case for a project, providing greater insight into your team’s performance, and making it easier to identify which efforts should be greenlit.
Anticipated vs. Actual ROI
Return on investment comes in two primary forms, depending on when it’s calculated: anticipated ROI and actual ROI. Anticipated ROI, or expected ROI, is calculated before a project kicks off and often used to determine if that project makes sense to pursue. Anticipated ROI uses estimated costs, revenues, and other assumptions to determine how much profit a project is likely to generate. This figure will often be run through several different scenarios to determine the range of possible outcomes. These numbers are then used to understand risk and, ultimately, decide whether an initiative should move forward. Actual ROI is the true return on investment generated from a project. This number is typically calculated after a project has concluded and uses final costs and revenues to determine how much profit was made compared to what was estimated.
Positive vs. Negative ROI
When a project yields a positive return on investment, it can be considered profitable because it produced more in
revenue than it cost to pursue. If it yields a negative return on investment, it means the project cost more to pursue than it generated in revenue. If the project breaks even, it means the total revenue matched the project’s expenses.
The ROI Formula Return on investment is typically calculated by taking the actual or estimated income from a project and subtracting the actual or estimated costs. That number is the total profit a project has generated, or is expected to generate, divided by the costs. The formula for ROI is typically written as:
ROI = (NET PROFIT / COST OF INVESTMENT) X 100
In project management, the formula is written similarly but
with slightly different terms:
ROI = [(FINANCIAL VALUE – PROJECT COST) / PROJECT COST] X 100
Calculating the ROI of a Project: An Example
Imagine you have the opportunity to purchase 1,000 chocolate bars for £2 apiece. You would then sell the chocolate to a grocery store for £3 per piece. In addition to purchasing the chocolate, you need to pay £100 in transportation costs.To decide whether this would be profitable, you would tally your total expenses and your total expected revenues.
EXPECTED REVENUES = 1,000 X £3 = £3,000
TOTAL EXPENSES = (1,000 X £2) + £100 = £2,100
You would then subtract the expenses from your expected revenue to determine the net profit.
NET PROFIT = £3,000 – £2,100 = £900
To calculate the expected return on investment, you would divide the net profit by the cost of the investment, and multiply that number by 100.
ROI = (£900 / £2,100) X 100 = 42.9%
By running this calculation, you can see the project will yield a nearly 43 percent positive return on investment, so long as factors remain as predicted. Therefore, it’s a sound financial decision. If the endeavour yielded a negative ROI, or an ROI that was so low it didn’t justify the amount of work involved, you would know to avoid it.
