How is return on investment (ROI) generally calculated?

Return on investment (ROI) is a widely used financial metric that measures the profitability and efficiency of an investment. It is specifically calculated by taking the net profit generated from the investment and dividing it by the cost of that investment. This formula provides a clear percentage that indicates how effectively an investment has performed relative to its cost, enabling investors and stakeholders to evaluate the success of different ventures or projects.

The essence of ROI lies in its ability to present a straightforward ratio that highlights the return one would receive per dollar invested. A higher ROI indicates a more favorable return on the investment, which is a critical factor in decision-making for both individuals and businesses.

Other approaches, such as dividing total revenue by total expenses or calculating total assets divided by total liabilities, do not specifically address the profitability of an investment relative to its cost in the same manner, leading to different financial insights that are not focused on ROI. Similarly, subtracting costs from revenues provides gross profit, which does not account for the investment made, thus failing to convey the effectiveness or efficiency of an investment. Therefore, the calculation based on net profit divided by the cost of investment accurately represents the financial return being evaluated.