# What Is Return on Investment (ROI) for Small Businesses?

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Definition

For small businesses, the return on investment (ROI) ratio (sometimes known as the "return on assets" ratio) is a profitability measure that evaluates the performance or potential return from a business project. The ROI formula looks at the benefit received from an investment divided by the investment's original cost.

### Key Takeaways

• In a small business context, return on investment (ROI) calculates the return on a particular project or purchase.
• You can calculate ROI for a project at your business by dividing its net income or return by net assets or investment.
• The ROI calculation can be nuanced for multiple different small business situations.

## How the Return on Investment (ROI) Ratio Works

ROI serves as a returns ratio that's typically expressed as a percentage, allowing a business owner to calculate how efficiently the company uses its total asset base to generate sales. Total assets include all current assets such as cash, inventory, and accounts receivable in addition to fixed assets such as the plant buildings and equipment.

If an investment doesn't have a good ROI, or if an investor or business owner has other opportunities available with a higher ROI, then calculating the ROI values on the different opportunities can instruct them as to which investments to choose for the best return.

Many analysts and investors like to use the ROI metric because of its versatility and simplicity. Essentially, it works as a quick gauge of an investment’s profitability, and it's very easy to calculate and interpret for a wide variety of investment types.

### Note

You can determine ROI in different ways, but the most frequently used method involves dividing net profit buy total assets. In some cases, return on investment ratio is also called the "return on assets" ratio because that investment refers to the firm's investment in its assets.

For investments in a company, you can find net income on the company's income state and total assets from the company's balance sheet. Here's what that equation looks like:

Investment gain (Net Income) / Cost of Investment (Total Assets) = ROI (%)

If you're investing in a security such as a company's stock, you can use a slightly different ROI calculation that's based on the buy and sell prices:

Investment's Price When You Sold It-Investment When You Bought It/ Investment Price When You Bought It = ROI (%)

### Examples of ROI

Say that Joe invested \$1,000 in his start-up, Joe's Super Computer Repair. He has a buyer for the business for \$1,200. The ROI for this equals Joe's profit or \$200 divided by his initial investment, \$1000, for a 20% ROI.

Joe also invested \$1,000 in Sam's New Computer Sales, and a buyer is looking to pay \$1,800. The ROI for this equals the \$800 profit divided by his investment of \$1,000, or 40%. From this comparison, selling Sam's New Computer Sales appears to be the wiser move because the return on investment is double what you'd get from Joe's Super Computer Repair.

Instead of buying a company, say you bought a company's stock: 100 shares at \$1 per share. Your initial investment was \$100. Soon after buying the stock, the company's CEO is arrested for fraud. The stock drops to 50 cents a share and you sell all your shares. Your ROI is -50%: (50-100)/100.

## Interpreting ROI Results

To interpret the ROI percent results, collect appropriate, comparative data such as trend (time series) or industry data on ROI. The business owner can look at the company's ROI across time and also at industry data to see where the company's return on investment ratio lies.

### Note

The higher the return on investment ratio, the more efficiently the company is using its asset base to generate sales.

## ROI and the Time Factor

What the ROI formula doesn't tell you, and one of the short-comings of the ROI ratio, is the time involved. This metric can be used in conjunction with the rate of return on an asset or project, which does consider the period of time.

You can also incorporate the net present value (NPV), which accounts for differences in the value of money over time due to inflation, for even more precise ROI calculations. The application of NPV when calculating the rate of return is often called the real rate of return.

## How do you calculate return on investment?

The ROI calculation has several nuances but, in general, you get ROI by dividing the amount of money you get back from an investment by the amount of money or assets you put into it. Small businesses can use ROI to decide if investing in a new software platform, for example, would be worth it.

## What is ROI and why is it important?

ROI is a measurement of the return you can get from an investment. Your investment could be in a business project or security such as a stock or fund. It's an important metric because it can help you decide if it's worth putting your money into a particular project your business wants to do is worth it.