It is denoted as a percentage value with the total profit—or loss—in the numerator divided by the initial cost of investment in the denominator multiplied by to calculate the ROI percentage. Although this is one way to calculate ROI, there are two common ways of calculating it for similar results. You can calculate ROI in multiple ways. Here we will review the two methods used most often to determine your ROI. Since most methods use real estate as a passive income vehicle, we will look at an example around investing in real estate.
One effective way to calculate ROI is by using this formula:. Here are the steps to follow when using this formula:. There may be other costs incurred during the purchase and sale of the property, but to keep the example simple, we will say that these were all the costs you incurred.
Let's look at the calculation with the information provided:. Here you are taking the purchase price and subtracting it from the sale value of the home, after which you need to subtract out any other costs you incurred to obtain or sell the property. This would include any commissions to the agents, escrow fees and capital gains tax.
Another effective method of calculating your ROI is:. This formula can be achieved by following these steps:. Going back to our example from Method 1, we want to identify the initial value of the investment.
Now we must identify the final value of the investment. This is essentially your sale price less any costs you incurred during the sale. Next, we'll subtract the final value of the investment by the initial value before we divide by the cost of the investment:. You should get a decimal that reads 0.
The final step is to take the 0. You'll notice that this figure is the same as our result from the first calculation since we did not add any other costs to the mix. This shows you 2 different ways to get to the same ROI result, so use whichever you feel the most comfortable with. Here is how we can calculate an annualized ROI for the real estate investment example we used above. If you were to use the straight-line method of calculating your Annualized ROI, the formula will be as simple as:.
However, due to the straight-line method ignoring the effects of compounding over time, which can make an investment significantly more or less valuable depending on how you leverage the purchase, we will use the initial formula discussed above. Since this was a home you lived in, there were no additional income sources to increase your ROI.
If you decided to rent the home out for 5 years instead, then your ROI would include the rental income received each year, making your ROI value a much bigger percentage, thus increasing your Annualized ROI accordingly. You can use ROI to:. You can then use the formula to identify your margin to figure out how much more you can put into the businesses to expand and make the value of your businesses even more profitable.
If any of the factors affecting expenses or revenue were to change during implementation, your actual ROI could be different. The result is a reduced net profit and a reduced actual ROI. Circumstances are rarely as straightforward as this example. There are typically additional costs that should be accounted for, such as overhead and taxes.
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Tim Stobierski Author Contributors. Anticipated vs. Perhaps they find you through a PPC ad, then they follow you on social media and sign up for your email list, and then they buy. The question is, which led to the sale? You could argue the PPC did because it introduced the prospect to you, but it's possible a social media post or email led to the actual sale. If you engage in a free promotional activity that results in increased sales, the denominator in your ROI calculation would be zero, which results in a mathematical error.
Normally, a zero ROI is bad, but in this case, it's good. You made money without spending money. Free marketing often involves the personal investment of time, which does have a financial value, and you can use that to determine ROI.
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