The formula for calculating return on investment (ROI) using financial statements is:
ROI = (Net Income / Investment Cost) x 100
This formula helps you understand the profitability of an investment by comparing the net income generated from the investment to the initial cost. Here's a breakdown:
- Net Income: This represents the profit earned from the investment after deducting all expenses. You can find this information on the income statement.
- Investment Cost: This is the initial amount invested in the project or asset. You can find this information on the balance sheet under the assets section.
Example:
Let's say you invested $10,000 in a new piece of equipment. After one year, the equipment generated $2,000 in net income.
- ROI = ($2,000 / $10,000) x 100 = 20%
This means your investment yielded a 20% return.
Practical Insights:
- Higher ROI is generally better: A higher ROI indicates a more profitable investment.
- Compare ROI across investments: You can compare the ROI of different investments to make informed decisions.
- Consider the time horizon: ROI calculations often consider a specific time period, so it's essential to compare investments over the same timeframe.
