Return on Investment: What is ROI analysis?
Return on Investment (ROI) analysis is one of several approaches to evaluating and comparing investments. With ROI, decision makers evaluate investments by comparing the magnitude and timing of expected gains to the magnitude and timing of investment costs. A good ROI means that investment returns compare favorably to investment costs.
ROI compares returns and costs by constructing a ratio, or percentage. In most ROI methods, an ROI ratio greater than 0.00 (or an ROI percentage greater than 0%) means the investment returns more than its cost. Other things being equal, the investment—or action, or business case scenario—with the higher ROI is considered the better choice, or the better business decision.
One serious problem with using ROI as the sole basis for decision making, is that ROI by itself says nothing about the likelihood that expected returns and costs will appear as predicted. ROI by itself, that is, says nothing about the risk of an investment. ROI simply shows how returns compare to costs if the action or investment brings the results hoped for. (The same is also true of other financial metrics, such as Net Present Value, or Internal Rate of Return). For that reason, a good business case or a good investment analysis will also measure the probabilities of different ROI outcomes, and wise decision makers will consider both the ROI magnitude and the risks that go with it.
Decision makers will also expect practical suggestions from the ROI analyst, on ways to improve ROI by reducing costs, increasing gains, or accelerating gains (see the figure above).
In the last few decades, this approach has been applied to asset purchase decisions (computer systems or a fleet of vehicles, for example), "go/no-go" decisions for projects and programs of all kinds (including marketing programs, recruiting programs, and training programs), and to more traditional investment decisions (such as the management of stock portfolios or the use of venture capital).
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