Finance⏱ 5 min read
How to Calculate Return on Investment (ROI)
ROI is the simplest way to compare whether any investment was worthwhile — but the basic formula hides important nuances. Here's how to calculate it correctly and avoid the common traps.
Return on Investment (ROI) is the most widely used performance metric in business and investing. Its simplicity is a strength — and a weakness, because that simplicity can obscure things that matter. Here's how to use it correctly.
The Basic Formula
ROI % = (Net Profit ÷ Cost of Investment) × 100
Net Profit = Final Value − Initial Cost
Example: Buy shares for £5,000, sell for £6,500
Net profit: £6,500 − £5,000 = £1,500
ROI: (£1,500 ÷ £5,000) × 100 = 30%
Including Income Returns
For investments that generate income (dividends, rent, interest), include income received in the net profit calculation:
Net Profit = (Final Value − Initial Cost) + Income received
Buy-to-let property: £150,000 purchase price
Sell after 5 years for £170,000
Rental income after costs: £3,000/year × 5 = £15,000
Net profit: (170,000 − 150,000) + 15,000 = £35,000
ROI: (35,000 ÷ 150,000) × 100 = 23.3% total over 5 years
Annualised ROI
Raw ROI ignores how long the investment was held. A 30% ROI over 10 years is much less impressive than 30% over 1 year. Annualised ROI (CAGR) allows fair comparison:
Annualised ROI = (1 + ROI/100)^(1/years) − 1
Example: £5,000 grows to £6,500 over 3 years
Raw ROI: 30%
Annualised: (1.30)^(1/3) − 1 = 1.0914 − 1 = 9.14%/year
Example: £5,000 grows to £6,500 over 8 years
Annualised: (1.30)^(1/8) − 1 = 1.0336 − 1 = 3.36%/year
Very different outcome from the same raw ROI.
ROI for Business Decisions
Marketing ROI:
ROI = (Revenue generated − Marketing cost) ÷ Marketing cost × 100
Spent £2,000 on advertising, generated £8,000 in sales:
Net: £8,000 − £2,000 = £6,000
ROI: £6,000 ÷ £2,000 × 100 = 300%
Training ROI:
Training cost: £1,500
Productivity gain (est.): £600/month = £7,200/year
ROI (year 1): (7,200 − 1,500) ÷ 1,500 × 100 = 380%
What ROI Doesn't Tell You
Time: Addressed with annualised ROI, but the basic formula ignores it completely.
Risk: A 15% ROI with near-zero risk (e.g. a fixed savings bond) is very different from 15% ROI from a startup investment. ROI doesn't capture the probability of loss.
Costs of capital: If you borrowed money to make the investment, the cost of borrowing must be deducted from the net profit.
Inflation: A 5% ROI during 4% inflation is a 1% real return. Real ROI = Nominal ROI − Inflation rate.
Real ROI vs Nominal ROI
Real ROI = ((1 + Nominal ROI) ÷ (1 + Inflation rate)) − 1
Example: 8% nominal return, 3% inflation
Real ROI = (1.08 ÷ 1.03) − 1 = 1.0485 − 1 = 4.85% real return
This is the return in terms of actual purchasing power gained.