Return On Investment, or ROI, is a crucial metric used to measure the performance of an investment. It calculates the amount of return generated from an investment, expressed as a percentage of the original investment. Understanding ROI is crucial for making informed investment decisions and can help you maximize your returns while minimizing your risk.
In this comprehensive guide, we’ll walk you through everything you need to know about ROI, including:
- What is Return On Investment?
- How to calculate Return On Investment?
- Why calculate your Return On Investment?
- Limitations of Return On Investment metric
- What is a good Return On Investment?
- How to increase Return On Investment?
Let’s dive right in!
What is Return On Investment (ROI)?
Your business investments are the time and money you devote to enhancing your enterprise. And the profit you earn from your investments is the return.
So, technically, the ratio of your net profit to the entire investment cost defines your Return On Investment (ROI).
When ROI is used to determine your investment’s benefits and monetary returns, it is most helpful to your goals when it relates to something specific and measurable. The most common technique of analyzing investments is in terms of their monetary cost because it is the simplest to measure. However, it is also possible to compute ROI considering time as an investment.
The ROI statistic, often known as the ROI figure, is used in a variety of investments and industries, including return on equity (ROE), return on ad spend (ROAS), return on assets, return on social investment, etc.
How to calculate Return On Investment (ROI)?
Return On Investment (ROI) is calculated by dividing the net profit of an investment by the cost needed for that investment. Simply put, here’s a simple formula to calculate ROI:
Formula: ROI (%) = [(Current Value Of Investment – Cost Of Investment) / Cost Of Investment] *100%
Why calculate your Return On Investment (ROI)?
By calculating your ROI, you can have a better understanding of whether an investment directly is efficient and valuable to your business or not. You can use ROI to compare different investment opportunities to decide which one is more worth investing in.
If a particular type of investment returns a high net profit, you can allocate more budget and time to similar investments. Whereas, if some investments cannot generate enough profit for you to cover the costs, then you can eliminate them from your list and invest in more profitable areas of your business.
For instance, you have three upcoming projects – a Google ad campaign, an affiliate program with a Youtube influencer, and a Facebook ad campaign to promote your newly-launched T-shirts.
- You invest $10,000 in the Google ads campaign and get $17,000 in net profit after a year. Then your ROI for the Google ad campaign is [($17,000 – $10,000) / $10,000] * 100% = 70%.
- You paid the Youtube influencer $3,000 and get $6,000 in net profit after 2 years. Then your ROI for the affiliate campaign is [($6,000 – $3,000) / $3,000] * 100% = 100%.
- You invest $5,000 in the Facebook ads campaign and get $2,500 in net profit after 6 months. Then your ROI for the Facebook ad campaign is [($2500 – $5,000)/ $5,000] * 100% = -50%.
Limitations of Return On Investment (ROI) metric
Though ROI is a widely-used, good metric to measure how efficient an investment is, the indicator itself has several limitations.
Clearly, the Facebook ad campaign above has a negative ROI – which makes it a bad investment. But is the Youtube influencer (100% ROI) better than the Google ad campaign (70% ROI)?
That’s it! The basic ROI firstly doesn’t take into account the time of the investment. The Google ad campaign has a 70% ROI but it only takes one year while the Youtube influencer campaign takes double the time despite a 30% higher ROI.
Additionally, ROI is expressed as (%), so it also doesn’t take into account the value of the investment. Though the influencer campaign has 100% ROI, it’s only worth $3,000 while the 70% ROI Google ad campaign is worth $7,000 net profit.
? Therefore, to overcome this limitation, a solution is to calculate the annual return on investment rate or net present value (NPV) instead.
What is a good Return On Investment (ROI)?
The ideal ROI for eCommerce businesses can vary greatly depending on various factors such as the industry, target market, marketing strategies, etc. However, a common benchmark for a good ROI in eCommerce is between 20-30%. This means that for every dollar invested in the business, the return should be between 20-30 cents.
Keep in mind that ROI is not the only measure of success for an eCommerce business and there may be other factors that contribute to its overall success, such as customer satisfaction, brand reputation, and market share.
Therefore, it’s important to regularly evaluate your business’ performance and adjust strategies accordingly to achieve a good balance of growth, profitability, and sustainability.
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How to increase Return On Investment (ROI)?
Although each business will have its own way of making a profit, here are some universal strategies you may want to adopt to boost your return on investment.
#1. Closely monitor your store important’s metrics
As mentioned above, the stand-alone ROI doesn’t factor in the investment’s value in money and time. So to improve your business’s overall ROI or ROI for a specific project, you have to keep close track of your ROI together with other important metrics.
To name a few, remember that many of your customers will come back and make other purchases in the future. So it’s important that you count in the customer lifetime value, repeat purchases, etc.
#2. Focus on your target audience
One of the best methods to increase your return on investment is to effectively engage with your target audience. Since these are those who are most likely to purchase from you, investments that improve engagement with your target audience are likely to yield greater returns.
For instance, you can deliver tailored ad campaigns to your target market to increase your conversions.
#3. Don’t be afraid of experimenting with new investments
Don’t be hesitant to try something that lacks a proven track record because the market will be the genuine judge of an idea’s value.
Begin small with more experimental tactics—you may evaluate whether an investment is worthwhile worth scaling and expanding by measuring its ROI over a shorter period of time.
Wrapping up!
In conclusion, Return on Investment (ROI) is a crucial metric for evaluating the efficiency and profitability of an investment. It provides a clear understanding of how much money has been generated from an investment compared to the others.
Whether you’re an investor, business owner, or financial analyst, understanding ROI is essential for making informed investment decisions and maximizing returns.
And in order to do so, you need a good tracking solution to keep a close record of your ROI and other important metrics. If you host your website using Shopify, TrueProfit might be the exact tool you’ve been looking for.
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