What return on investment measures

Return on investment (ROI) sets the net profit a piece of spending earns against what that spending cost, and gives the result as a percentage. Business Queensland’s formula is net profit divided by the cost of the investment, multiplied by 100.

A guide published by Dotto. General information about a business’s own spending, not tax or financial advice. Business Queensland’s pages point to an accountant, bookkeeper or tax agent for help with planning figures.

The load: What the spending cost
The counterweight: The net profit it brings in
The reading: That profit as a share of the cost

Notch 1 of 6 on the steelyard.

Two descriptions of one sum

The glossary on business.gov.au describes ROI as a calculation of how efficiently a business makes profit from the money its owners and shareholders first put in. Its method matches Business Queensland’s: divide the investment’s net profit by its cost, then turn the answer into a percentage.

Applied to a single purchase rather than a whole business, the arithmetic asks a narrower question: for each dollar this spending took, how much net profit came back? That narrower use is this guide’s reading of the formula, and it is the one every later notch builds on.

An illustration in round numbers, not real prices: two outlays weighed with the same formula
Outlay	Cost	Net profit it brings in	Return on investment
A	$100	$20	20%
B	$400	$60	15%

Outlay A has the higher return on investment; outlay B brings back more dollars. Both readings are true at once, which is why a percentage is rarely the whole answer. (This guide’s arithmetic, using Business Queensland’s formula.)

What goes on each side

The counterweight: net profit

Business Queensland builds net profit in two steps. Gross profit is total revenue less the cost of goods sold. Net profit then takes away the business’s operating expenses, such as wages, supplies and materials, rent, utilities, advertising, taxes, interest and one-off costs.

Two of its reminders change an ROI figure directly. Operating expenses should include the wages or drawings an owner pays themselves; and an owner who pays themselves a salary should set it at what an employee doing the same work would earn, with superannuation. Leave the owner’s own time out of the sum and the return looks better than it is.

Spending rarely produces a profit line of its own. What belongs in the counterweight is the change in net profit the spending causes: the business with the outlay set against the same business without it. The Office of Impact Analysis calls this comparing “with” and “without” rather than “before” and “after”. Applying it to one business’s purchase is this guide’s reading.

The load: the cost

For an asset, the ATO counts the amount paid, plus the cost of transporting it, installing it and improving it. GST is left out of the cost when the business is registered for GST and can claim the full credit. The real cost of an asset goes through each part, and how the cost is spread over the years.

Three returns that are easy to confuse

Business Queensland publishes calculators for three ratios that share a numerator and differ in what they divide it by.

Three return ratios, from Business Queensland’s calculators
Ratio	Net profit divided by	Then
Return on investment	The cost of the investment	× 100
Return on assets	Total assets	× 100
Return on equity	Owner’s equity	× 100

Business Queensland adds a yardstick for the last of these: return on equity should at least match long-term bank interest rates on borrowed money, with a further return on top for the level of risk. It also notes that return on equity is often shown as a ratio, giving the example of $1.50 back for every dollar invested.

What one percentage does not show

How long it took A return of 25% earned in one year and 25% earned over five years print as the same number. The Office of Impact Analysis treats timing as central: because people prefer a dollar today to a dollar in the future, later costs and benefits are discounted to present values before they are compared. The method is in costs and benefits, the government’s way.
Whether the cash is there Business Queensland notes that profit is a gain on paper once expenses are paid, and is not the same as the money in the bank or total sales.
How many dollars came back A small outlay with a high percentage can return fewer dollars than a large outlay with a lower one, as the two outlays above show.
What else the money could have done The Office of Impact Analysis describes part of the cost of funds as the return given up by not putting them to their best other use. An ROI on one purchase shows that comparison only when it is set beside the alternatives.
The effects that are hard to price The same guidance warns against letting the effects that are easy to value in dollars crowd out the important ones that are not.

The next notch

ROI says how much came back for what went in. The break-even point answers an earlier question: how much a business has to sell before its costs are covered and any return begins. Business Queensland defines it as the point where total revenue equals total costs.