How do you calculate return on investment from financial statements?

Return on Investment (ROI) is a financial metric that measures the profitability of an investment relative to its cost. The formula for calculating ROI is:

$ROI = \left( \frac{\text{Net Profit}}{\text{Cost of Investment}} \right) \times 100$

Here's a breakdown of the key components in the formula:

1. Net Profit: This is the total revenue generated by the investment minus all associated costs, including operating expenses, taxes, and interest.

   $\text{Net Profit} = \text{Total Revenue} - \text{Total Costs}$

2. Cost of Investment: This includes all costs associated with acquiring and maintaining the investment. It may involve the initial purchase cost as well as ongoing expenses.

   $\text{Cost of Investment} = \text{Initial Investment} + \text{Ongoing Costs}$

The ROI is typically expressed as a percentage. To calculate ROI using financial statements:

1. Gather Financial Statements:

   • Obtain the income statement, which provides information on revenues, costs, and net profit.
   • Gather information on the initial investment and ongoing costs from the balance sheet or other financial records.

2. Calculate Net Profit:

   • Subtract total costs from total revenue to calculate net profit.

3. Calculate Cost of Investment:

   • Add the initial investment to any ongoing costs associated with the investment.

4. Plug the Values into the ROI Formula:

   • Substitute the values into the ROI formula and solve for the percentage.

   $ROI = \left( \frac{\text{Net Profit}}{\text{Cost of Investment}} \right) \times 100$

5. Interpret the Result:

   • A positive ROI indicates a profitable investment, while a negative ROI suggests a loss.
   • Compare the ROI to benchmarks or industry standards to assess performance.

It's important to note that ROI is a straightforward metric and has some limitations. It does not account for the time value of money, and it doesn't consider the risk associated with the investment. Therefore, it's often used in conjunction with other financial metrics for a more comprehensive analysis.