Return on Investment Calculation

Return On Investment Calculation ROI

Return on Investment. A widely used measure of business success that relates net income to invested capital (total assets). ROI provides a standard for evaluating how efficiently management uses the average dollar (or unit of currency) invested in assets, whether the investment came from owners or creditors. A higher ROI may also result in a higher return on stockholder's equity (ROE).

There are two ways of calculating ROI: the traditional formula and the DuPont formula. The traditional approach presents a single, static measure of a company's past performance. In contrast, the approach developed by the DuPont Corporation uses two factors, net profit margin and total asset turnover, to measure success — in recognition of the fact that excessive funds tied up in assets can be just as much of a drag on profitability as excessive expenses.

Traditional Formula:

ROI = Net Profit After Taxes ÷ Total Assets

DuPont Formula:

ROI = (Net Profit Margin) x (Total Asset Turnover)
ROI = (Net Profit After Taxes ÷ Sales) x (Sales ÷ Total Assets)

For example, using the traditional formula, a company with $100,000 in total assets and $18,000 in net profit after taxes would have an ROI of 18%. The DuPont formula takes the analysis one step further by factoring in sales. Using the previous example, if sales are $200,000, then the net profit margin is only 9% and the total asset turnover is 2. This still yields an ROI of 18% but provides more insight into how the company was managed and what might be changed to improve profitability. The breakdown of ROI into its two components reveals that a number of combinations of net profit margin (M) and total asset turnover (T) can produce the same return on investment. For example:

ROI = M x T
18% = 9% x 2
18% = 6% x 3
18% = 3% x 6
18% = 2% x 9

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