Return on investment, or ROI, compares what an investment produced against what it cost, and states the comparison as a percentage of the cost. The formula subtracts the cost from the return, divides by that same cost, and multiplies by 100.
ROI = (return - cost) / cost x 100A result of zero means the investment gave back exactly what went in. A positive result is the surplus, measured against the money committed rather than against revenue, and a negative result is the shortfall. The whole of the number’s meaning depends on two choices the formula does not make for you: which return, and which cost.
Which Return, and Which Cost
The formula is one line and the definitions underneath it are not standardised, which is why two people can compute two different ROIs from the same facts and both be arithmetically correct.
On the numerator, the question is whether “return” means the gross benefit or the benefit net of the costs already sitting in the denominator. Both conventions are in use, and they give different answers on the same investment, so the number is only comparable to another number computed the same way. The same choice sits behind gross versus net everywhere else in the accounts.
On the denominator, the question is what counts as invested. A purchase price is easy. Implementation time, training, and the internal supervision that continues after the thing is bought are the costs most often left out, and leaving them out inflates the ratio without any arithmetic error appearing anywhere.
The measure also has no rule about what may be excluded. That is the difference between ROI and a ratio like return on assets, whose numerator and denominator are both line items with a fixed meaning in the statements.
Worked on a single project, with the same facts read two ways:
Benefit produced over the period 60,000
Purchase price 40,000
Internal implementation and supervision 10,000
Denominator as purchase price only
ROI (60,000 - 40,000) / 40,000 x 100 50.0%
Denominator including the internal cost
ROI (60,000 - 50,000) / 50,000 x 100 20.0%Both lines apply the formula correctly. Only what counted as invested changed, which moves the cost in both halves of the ratio at once, and the answer fell by more than half. That is not a flaw in the arithmetic, it is the reason the inputs have to be stated whenever the output is.
The Formula Has No Time In It
ROI is a ratio of two amounts and neither of them is dated. A 30% return earned over three months and a 30% return earned over six years are the same number in this formula, which is why it cannot rank two investments of different lengths on its own.
Three other measures exist because of that gap, and each closes a different part of it.
Payback period answers how long the money is out rather than how much comes back. Net present value discounts the cash flows so that a dollar arriving later counts for less than a dollar arriving now. The accounting rate of return puts an average accounting profit over an investment base, which is a different question again.
Annualising an ROI is possible, and it is a separate calculation rather than a variant of that ratio, because compounding a period return over a number of periods is not the same operation as dividing a gain by a cost.
Where a Firm Meets the Ratio
ROI turns up in three places inside a practice, and only one of them is regulated.
The first is client advisory work, where the ratio is built from the client’s own facts and the argument is about the denominator. The second is a firm’s own buying decisions, and the cost benefit analysis frame is the same one. The third is a public company’s disclosure, where a self-defined performance ratio can fall inside a Commission rule.
An ROI figure quoted for an outsourcing or staffing arrangement is the first case with a particularly loaded denominator, and the model for it is worked through in ROI of accounting outsourcing.
When ROI Becomes a Disclosure Question
This is the part that catches people out, because the answer is usually no, and it is no for a reason worth knowing rather than by default.
A non-GAAP financial measure is a numerical measure of a registrant’s historical or future financial performance, financial position or cash flows that either excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows, or equivalent statements, of the issuer, or includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented (17 CFR 244.101(a)(1)).
Then comes the carve-out that decides most ratios. A non-GAAP financial measure does not include operating and other financial measures and ratios or statistical measures calculated using exclusively one or both of financial measures calculated in accordance with GAAP, and operating measures or other measures that are not non-GAAP financial measures (17 CFR 244.101(a)(2)).
Read the word “exclusively” carefully, because the whole test turns on it. A ratio assembled only out of GAAP figures, or only out of operating measures, or out of a mixture of those two, sits outside the definition. Put one adjusted figure into the numerator and the ratio no longer qualifies for the carve-out.
Item 10(e) of Regulation S-K carries the same carve-out in its own words. For purposes of that paragraph, non-GAAP financial measures exclude operating and other statistical measures, and ratios or statistical measures calculated using exclusively one or both of financial measures calculated in accordance with GAAP, and operating measures or other measures that are not non-GAAP financial measures (17 CFR 229.10(e)(4)).
Where a measure does fall inside the definition and appears in a filing, four things are required. The registrant must include a presentation, with equal or greater prominence, of the most directly comparable GAAP measure or measures; a reconciliation, by schedule or other clearly understandable method, of the differences between the two, quantitative for historical non-GAAP measures presented and quantitative to the extent available without unreasonable efforts for forward-looking information; a statement of why management believes the measure provides useful information to investors; and, to the extent material, a statement of the additional purposes for which management uses it (17 CFR 229.10(e)(1)(i)).
The last two of those four are relieved outside the annual report. If the filing is not an annual report on Form 10-K or Form 20-F, a registrant need not include the useful-information statement or the additional-purposes statement if that information was included in its most recent annual report on Form 10-K or Form 20-F, or a more recent filing, provided the required information is updated to the extent necessary to meet those requirements at the time of the current filing (17 CFR 229.10(e)(1)(iii)).
There is a list of prohibitions alongside those requirements, and one of them lands directly on a home-made ratio: a registrant must not use titles or descriptions of non-GAAP financial measures that are the same as, or confusingly similar to, titles or descriptions used for GAAP financial measures (17 CFR 229.10(e)(1)(ii)(E)).
Common Questions
Either, and the formula does not settle it. The numerator can be the gross benefit or the benefit net of the costs already in the denominator, and the two conventions produce different percentages from identical facts. A quoted ROI is only readable next to a statement of what went into each half of it.
That the surplus over the period was one fifth of the amount invested. It says nothing about how long the money was committed, because the formula holds no time term, so a 20% return is not comparable to another 20% return earned over a different span without a further calculation.
The formula cannot answer that. A percentage is only high or low against something else, usually the next best use of the same money or the cost of the money itself, and against the risk taken to earn it. A number quoted with no denominator definition and no period attached is not yet a fact about performance.
No. It has no definition in the accounting standards, which is exactly why the inputs have to be stated. In a Commission filing, a ratio built exclusively from GAAP measures, operating measures, or both, is carved out of the non-GAAP definition (17 CFR 244.101(a)(2)), and a ratio built partly from an adjusted figure is not.
Accountably places trained offshore accountants inside US CPA and EA firms, and a firm can run a block of its own management reporting and analysis work through a trial task before a client file depends on it.
