Return on Investment: Formula, Meaning, and How to Calculate It

Every major financial choice begins with a simple question: Does this investment create value? Understanding ROI equips you to compare options, assess potential outcomes, and allocate capital with confidence.

In this guide, you’ll learn how to determine ROI by analyzing scenarios that account for initial cost, risk appetite, and an investment’s projected performance. Join over 2 million professionals who turn to CFI to build real-world skills in accounting, modeling, analysis, and more.

What is Return on Investment (ROI)?

Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will receive in relation to their investment cost. It is most commonly measured as net income divided by the original capital cost of the investment. The higher the ratio, the greater the benefit earned.

This guide breaks down the return on investment formula with clear explanations and real-world examples. You’ll learn how to calculate return rate on investment using proven methods across different scenarios. A downloadable ROI calculator is also included to help streamline your analysis.

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ROI Formula

There are several versions of the return on investment formula. The two most commonly used are:

ROI = Net Income / Cost of Investment

or

ROI = Investment Gain / Investment Base

The first version of the ROI formula (net income divided by the cost of an investment) is the most commonly used ratio.

The simplest way to think about the ROI formula is to take some type of “benefit” and divide it by the “cost.”  When someone says something has a good or bad ROI, it’s important to ask them to clarify exactly how they measure it.

What is a Good ROI?

A “good” return on investment depends entirely on your objective, the type of asset, and how long you plan to hold it. There’s no universal benchmark; for example, an 8% return might outperform expectations in fixed income, but underperform in high-growth business ventures. That’s why understanding how to estimate return on investment is key to making informed financial decisions.

Here are the most pertinent factors to consider:

• Risk Tolerance: Higher ROI potential usually involves greater volatility. Establish your tolerance levels before committing.
• Holding Period: A high return over a short timeline typically delivers better value than a similar return over several years.
• Expected ROI: Compare your projected results to relevant industry data or long-term historical averages.
• Opportunity Costs: Ask what other outcomes you could have pursued with the same capital.
• Asset Type: ROI expectations vary across categories. A rental property, a startup, or a blue-chip stock each carries different risk-reward profiles.

Rather than chasing an arbitrary number, define ROI success based on your goals, risk profile, and the tradeoffs involved.

Example of the ROI Formula Calculation

An investor purchases property A, which is valued at $500,000. Two years later, the investor sells the property for $1,000,000.

We use the investment gain formula in this case.

ROI = (1,000,000 – 500,000) / (500,000) = 1 or 100%

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The Use of the ROI Formula Calculation

ROI calculations are simple and help investors decide whether to take or skip an investment opportunity. The calculation can also indicate how an investment has performed to date. When an investment shows a positive or negative ROI, it can be an important indication to the investor about the value of their investment.

Using an ROI formula, investors can separate low-performing investments from high-performing investments. This approach allows investors and portfolio managers to attempt to optimize their investments.

There are many benefits to using the return on investment ratio that every analyst should be aware of.

#1 Simple and Easy to Calculate

The return on investment metric is frequently used because it’s so easy to calculate. Only two figures are required — the benefit and the cost. Because a “return” can mean different things to different people, the ROI formula is easy to use, as there is no strict definition of “return”.

#2 Universally Understood

Return on investment is a universally understood concept, so it’s almost guaranteed that if you use the metric in conversation, then people will know what you’re talking about.

Limitations of the ROI Formula

While the ratio is often very useful, the return on investment formula has some limitations that are important to know. Below are two key points that are worthy of note.

#1 The ROI Formula Disregards the Factor of Time

A higher ROI number does not always mean a better investment option. For example, two investments have the same ROI of 50%. However, the first investment is completed in three years, while the second investment needs five years to produce the same yield. The same ROI for both investments blurred the bigger picture, but when the factor of time was added, the investor easily saw the better option.

The investor needs to compare two instruments under the same time period and the same circumstances.

#2 The ROI Formula is Susceptible to Manipulation

An ROI calculation can vary between individuals depending on which return on investment formula they choose to apply. A marketing manager can use the property calculation explained in the example section without accounting for additional costs, such as maintenance costs, property taxes, sales fees, stamp duties, and legal costs.

An investor needs to consider the true ROI, which accounts for all possible costs incurred when an investment increases in value.

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Annualized ROI Formula

As mentioned above, one drawback of the traditional return on investment metric is that it doesn’t take into account time periods. For example, a return of 25% over 5 years is expressed the same way as a return of 25% over 5 days. But obviously, a return of 25% in 5 days is much better than 5 years!

To overcome this issue, we can calculate an annualized ROI formula.

ROI Formula:
= [(Ending Value / Beginning Value) ^ (1 / # of Years)] – 1

Where:

# of years = (Ending date – Starting Date) / 365

For example, an investor buys a stock on January 1st, 2017 for $12.50 and sells it on August 24, 2017, for $15.20. What is the regular and annualized return on investment?

Regular = ($15.20 – $12.50) / $12.50 = 21.6%

Annualized = [($15.20 / $12.50) ^ (1 / ((Aug 24 – Jan 1)/365) )] -1 = 35.5%

Leverage and ROI

Leverage increases your return on investment by letting you control a larger asset using less of your capital. Instead of funding the full purchase, you borrow money to complete the initial investment. This strategy can significantly increase your gains when the investment performs well. However, it can also amplify losses if the investment underperforms. 

In any ROI analysis involving leverage, comparing both scenarios, cash-only versus financed, is essential to fully understand how borrowed capital affects your returns.

How Leverage Impacts ROI

Let’s walk through an example leveraged ROI equation:

Property Value: $200,000

Sale Price After One Year: $220,000

Total Profit: $20,000

Without Leverage (100% Cash Investment)

• You invest $200,000 of your own capital.
• ROI = $20,000 ÷ $200,000 = 10%

With Leverage (80% Financing)

• You invest only $40,000 and finance the remaining $160,000 with a loan.
• ROI = $20,000 ÷ $40,000 = 50%

The asset’s current value and total profits remain the same in both cases. What changes is the ROI, because you committed less personal capital in the leveraged scenario. This example shows how leverage can multiply your investment’s net profit by evaluating results against a smaller personal contribution instead of the full asset price.

Benefits of Leverage

• Greater ROI Potential: A smaller capital outlay can produce a much higher return percentage.
• Access to Higher-Value Investments: Borrowed funds allow you to invest in assets that might otherwise be out of reach.
• Improved Capital Efficiency: Less personal capital allows you to pursue additional opportunities or diversify your portfolio.

Risks of Leverage

• Losses Can Multiply Quickly: If the property falls to $180,000, you still face a $20,000 loss. In a leveraged scenario, that becomes –50% ROI because your return is measured against only $40,000 of invested capital.
• Reduced Net Return: Interest charges, fees, and loan-related expenses reduce your net return, even if the investment makes money.
• Greater Sensitivity to Market Shifts: Leverage increases volatility. Even small changes in asset value can have an outsized effect on performance, which demands careful attention to your risk tolerance.

Using Leverage Strategically

Model Worst-Case Scenarios

Before leveraging an investment, estimate the potential consequences if the asset declines in value. Include interest costs, transaction fees, and possible exit penalties in your calculation.

Match Leverage to Your Risk Profile

Leverage is not suitable for every investor. Make sure it fits your goals and timeline.

Use Planning Tools to Make Informed Decisions

CFI’s ROI Calculator helps you explore the impact of different assumptions. You can adjust factors like debt ratio, resale value, and holding period to see how your ROI changes across scenarios.

Leverage is a tool. Applying carefully can boost your expected ROI and help you locate a better investment. But if used recklessly, it can wipe out capital with impunity.

ROI Formula Calculator in Excel

Download CFI’s free ROI Formula Calculator in Excel to perform your own analysis.  The calculator uses the examples explained above and is designed so that you can easily input your own numbers and see what the output is under different scenarios.

The calculator covers four different ROI formula methods: net income, capital gain, total return, and annualized return.

The best way to learn the difference between each of the four approaches is to input different numbers and scenarios, and see what happens to the results.

Download CFI’s Free ROI Calculator Template

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Video Explanation of Return on Investment/ROI Formula

Below is a video explanation of what return on investment is, how to calculate it, and why it matters. You’ll learn a lot in just a couple of minutes!

Alternatives to the ROI Formula

There are many alternatives to the very generic return on investment ratio.

The most detailed measure of return is known as the Internal Rate of Return (IRR). This is a measure of all the cash flow received over the life of an investment, expressed as an annual percentage (%) growth rate. This metric takes into account the timing of cash flows, which is a preferred measure of return in sophisticated industries like private equity and venture capital.

Other alternatives to ROI include Return on Equity (ROE) and Return on Assets (ROA). These two ratios don’t consider the timing of cash flows and represent only an annual rate of return (as opposed to a lifetime rate of return like IRR). However, they are more specific than the generic return on investment since the denominator is more clearly specified. Equity and Assets have a specific meaning, while “investment” can mean different things

Read More About Rates of Return

Thank you for reading this CFI guide to calculating return on investment. To continue learning and advancing your career, these additional CFI resources on rates of return will be helpful:

• Return on Equity (ROE)
• Return on Assets (ROA)
• Internal Rate of Return (IRR)
• DCF Modeling
• See all accounting resources
• See all capital markets resources

Frequently Asked Questions

A strong understanding of ROI helps you make confident, informed financial choices. Below are answers to common questions that will support your ability to apply the return on investment formula.

What is a realistic ROI?

Realistic ROI expectations vary by asset type, holding period, and your personal risk profile. For example, long-term portfolios of index funds may return 7% to 10% annually, while higher-risk categories like real estate or startups may promise more, but with greater volatility. Context and consistency are more important than chasing high numbers.

Is there an Excel formula for ROI?

Yes. In Excel, you can calculate ROI by dividing your net return by the original investment amount. For instance, if you invest $1,000 and your final value is $1,250, your gain is $250. ROI equals 250 divided by 1,000, which gives you 25%.

Here is the basic Excel formula for ROI:

ROI =(Final_Value – Initial_Investment) / Initial_Investment X 100%

To simplify the process, download our ROI Formula Calculator. It includes built-in models for annualized returns, capital gains, and more.

What is the ROI percentage?

ROI percentage shows how much you earned compared to how much you invested, expressed as a percentage. If you invest $1,000 and sell for $1,200, the gain is $200. Dividing 200 by 1,000 gives you an ROI of 20%.

What is ROI in Business?

ROI in business works the same as calculating ROI on any type of investment. Measuring ROI is critical for setting goals, measuring performance, and making organizational decisions. 

What is a simple ROI calculation?

You calculate ROI by subtracting the original cost from the final value, then dividing that result by the original cost. Let’s say you invest $500 and it grows to $600. That’s a $100 gain; 100 divided by 500 gives you a 20% ROI.

What is the best way to calculate ROI?

The right method depends on what you’re measuring. For quick snapshots, use the basic ROI calculation. An annualized ROI offers a more accurate reflection of performance over time for comparing investments with different timelines. In detailed scenarios, like property, product launches, or portfolio analysis, factor in every cost to determine the most accurate return.