What is Return on Investment (ROI)?
The Return on Investment (ROI) indicates how profitable an investment was or could be. It is a key figure that puts the profit in relation to the capital invested. The ROI shows when an investment has paid for itself and is also referred to as return on capital, return on investment or profitability. The ROI is calculated from the profit achieved and the capital investment required for this over a certain period of time. Not to be confused with ROAS.
ROI - explained by example:
Example: A tax consultant decides to purchase special software to automate tax returns. This software costs €3,000. By using the software, the tax consultant can look after 20 additional clients per month, which brings him an additional profit of €150 per client. This means that he increases his profit by €3,000 per month (20 clients x €150). Within one year, this results in an additional profit of €36,000.
The investment in the software was fully amortized after just one month. This means that the money that the tax advisor spent on the software has “returned” in full after one month, and the additional profit is clearly attributable to the use of the new software.
Calculation of ROI - Return on Investment
ROI = profit share divided by capital invested (over one year), ROI = €36,000 divided by €3,000, ROI = 12
As the investment (software) and the profit (€150 per additional client) are clearly linked in this case, the return on investment is easy to calculate. This also allows the tax advisor to compare different software solutions in order to choose the most profitable option. The software that generates a higher profit in a shorter period of time is the more profitable investment with a higher ROI.
Complexity of the ROI calculation
In practice, the relationship between investment and profit is not always as easy to determine as in our example. With more complex investments, it is more difficult to directly link costs and benefits. For example, general administrative costs often cannot be clearly allocated to a specific investment. The more indirect or difficult to allocate costs there are, the more difficult it becomes to use ROI as a reliable indicator of profitability.
The return on investment therefore shows the relationship between investment and profit and can be used both for individual projects and for assessing the profitability of an entire company.
