ROI

What it means

ROI is the profit from a project over what went into it. It is quick and easy to grasp but ignores time: the same percentage over one year and five is not the same thing.

For larger investments it is therefore joined by NPV and IRR, which do account for the time value of money. ROI stays useful for comparing smaller decisions fast.

ROI assesses one project or one investment, not the whole company. For the company as a whole, profitability ratios such as return on equity or on assets are used; a company with several profitable projects can still show weak overall profitability if they carry expensive overheads that nobody put into any ROI.

How it works in practice

The calculation includes everything the project cost: not just invoices but your own people’s time and the cost of training. Those are the items left out, making the result look better than it is.

In marketing ROI is computed on margin, not revenue. On equipment it is computed on the saving delivered, including time freed up for billable work.

For an investment in automation or new software we suggest writing down the expected ROI before deciding and comparing it with actuals from the books a year later: how many hours and how much cost really went away. Without that look back the company never learns to estimate, and the next project is approved on equally optimistic numbers.

What to watch out for

ROI quoted without a period and without a list of costs included is a marketing number, not a management one. Always ask what sits in the denominator.

ROI computed once from profit after depreciation and once from cash savings before it gives completely different figures for the same project. When two projects are compared the calculation must be built the same way, including tax and period, or the winner is the one calculated more cleverly rather than the one that is actually better.