If you landed on this page, it’s because you’re looking for an answer to the question: What is ROI? Keep on reading to get a definition, plus a formula to calculate ROI.
What is ROI?
ROI, an acronym for return on investment, is a financial metric we use to measure the efficiency and profitability of an investment. To put it simply, it’s a calculation to find out whether your initial investment has paid off when compared to the profit earned.
Before investing capital in anything, you should use this metric to determine whether a particular investment is worth your time, effort and money.
What is ROI in marketing?
You might have seen the term ROI when reading about Google Ads, creating a campaign for Google Performance Max or simply scrolling through entrepreneurs giving their two cents on TikTok.
When we say marketing ROI, we’re referring to how much money a company spends on marketing campaigns compared to how much revenue those campaigns yield.
Calculating your ROI in marketing is important because it helps you figure out whether your marketing investment is paying off or you need to make adjustments to your strategy.
Why is calculating ROI important?
Calculating ROI can help you, as an investor of your own business or someone else’s, evaluate the profitability of different investments and determine whether to invest in a particular asset.
Imagine you have two different companies you can invest in. One of the metrics you can use to make a decision is each companies’ return on investment, which will allow you to compare your potential net profits.
Now picture the following scenario: you have put some money into both email marketing and affiliate marketing, but you want to know which marketing program you should keep investing in. ROI can help you track the performance of your investments over time and determine which modality is worth the marketing cost.
It's important to note that ROI is just one metric for evaluating investments. You should not just calculate ROI and use it isolatedly; instead, you need to combine this information with other financial metrics such as net present value (NPV), internal rate of return (IRR) and payback period.
How to calculate ROI
ROI is calculated as the ratio of net profit to the cost of investment. Okay, that was too complicated (at least for us!), so let’s break it down for you.
The formula for calculating ROI is:
ROI = (net profit ÷ investment cost) x 100
We’re big fans of examples here at Shoplazza, so let’s use one to explain the ROI formula calculation.
Let’s say you invested $500 in paid traffic sources like Instagram Ads and Google Ads and, at the end of the campaigns, you earned $1,500 as a direct result of that first investment. To calculate the return on investment relative to these campaigns, you’ll need to subtract the total cost of your investment from your total revenue to obtain your net profit. Then, you’ll divide your net profits by the cost of investment.
($1,500 – $500) ÷ $500 =
$1,000 ÷ $500=
Then, to turn it into a percentage:
2 x 100 = 200%
Now let’s have a closer look at each component of the ROI formula so you can nail your ROI calculation:
This is how much revenue you have left if you discount your initial investment.
In the example above, if you invest $500 in a social media campaign and make $1,500 in return, your net profit or net income is $1,000.
Cost of investment
This refers to the total amount of money you invested, including any fees, maintenance costs or expenses incurred during the investment process.
For example, if you put $200 into a TikTok for Business campaign and spend another $300 to hire a person to run the campaign for you, your total cost of investment is $500.
Return on investment: conclusion
In conclusion, ROI is a simple yet powerful financial metric that can help you assess the profitability of an investment. When you measure ROI, you’re in a much better position to make investments and get healthy net profits.