# Return on Investment (ROI)
ROI is the percentage return earned on the funds invested in a business. In plain terms, it tells the owner whether the effort and money put into the business has been worthwhile by comparing returns against investment.
$$\text{Return on Investment} = \frac{\text{Return / Profit / Earnings}}{\text{Investment}} \times 100$$
Because the meaning of investment varies, ROI splits into three broad categories:
1. Return on Assets (ROA)
2. Return on Capital Employed (ROCE)
3. Return on Equity (ROE)
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## 1. Return on Assets (ROA)
Measures profitability against the assets employed to earn that profit.
$$\text{ROA} = \frac{\text{Return}}{\text{Average Assets}} \times 100$$
- Return could be EBIT, EBIT(1−t), EAT, or EAT + Interest.
- Average Assets could be Average Total Assets, Average Tangible Assets, or Average Fixed Assets. If average figures are unavailable, closing/total figures may be used.
The key rule: the numerator must correspond to the denominator.
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## 2. Return on Capital Employed (ROCE)
A variation of ROI based on capital employed (= Net Worth + Debt). As a benchmark, ROCE should always exceed the rate at which the company borrows — otherwise borrowing destroys value.
$$\text{ROCE (Pre-tax)} = \frac{\text{EBIT}}{\text{Capital Employed}} \times 100$$
$$\text{ROCE (Post-tax)} = \frac{\text{EBIT}(1-t)}{\text{Capital Employed}} \times 100$$
Alternatively:
$$\text{ROCE} = \frac{\text{EAT (PAT)} + \text{Interest}}{\text{Capital Employed}} \times 100$$
On capital employed:
- Intangible assets (goodwill, patents, trademarks) should be included in capital employed.
- Fictitious assets (e.g., deferred expenses) should NOT be included.
- If information is available, use average capital employed.
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## 3. Return on Equity (ROE)
Measures profitability of the equity (owners') funds — how profitably the owners' money has been used.
$$\text{ROE} = \frac{\text{PAT} - \text{Preference Dividend (if any)}}{\text{Net Worth / Equity Shareholders' Funds}} \times 100$$
Where Net Worth = Equity Shareholders' Funds.
## Doubt Busters
- In the absence of preference dividend, PAT itself can be taken as earnings available to equity shareholders.
- Ratios should be computed per the requirement and availability of information and may deviate from the original formula — state assumptions where needed.
- Investment may mean Total Assets or Net Assets. Funds employed in net assets = capital employed = Net Worth + Debt.