How is return on investment (ROI) calculated?

Return on investment (ROI) is a key performance metric that evaluates the efficiency of an investment or compares the efficiency of several different investments. The correct method to calculate ROI is using net profit divided by the cost of the investment. This formula provides a clear view of how much profit is generated for each dollar invested, which is crucial for decision-making and assessing the profitability of various investments.

By focusing on net profit, you capture the actual earnings after all expenses have been deducted, ensuring that the ROI reflects true profitability. The effective cost of the investment ensures that the calculation is based on the amount of resources put into the investment, making this a comprehensive measure of the return achieved relative to the initial investment cost.

This contrasts with other options that either reflect different concepts (such as gross profit margins or operating performance) or utilize differing financial metrics that do not provide a direct measure of return in relation to the investment cost. Understanding ROI in this manner is critical for decision-making, as it helps individuals and businesses evaluate which investments yield the best returns.