Return on investment (ROI) is a term that investors frequently inquire about when exploring potential investments. But what does it really mean? How is it calculated, and what exactly do investors expect? This page delves into the features, advantages, and limitations of this essential investment performance metric.

Calculating Return on Investment
Return on Investment literally translates to "return on investments," which precisely reflects its purpose. When someone asks for your ROI, they want to know the return on previous or projected investments.

• If the investment results in a loss, the ROI will be negative.
• If the investment generates profit, the ROI will be positive.

ROI Formula:
Return on Investment (ROI) = (Expected) Revenue / Investment (Cost) × 100%

Advantages of ROI
The primary advantage of calculating ROI is that it provides a quick and clear assessment of whether an investment is worth pursuing. Investors prefer to avoid unprofitable ventures, and in 99 out of 100 cases, they will not invest if the ROI of a project, product, or service is negative.

Additionally, ROI allows investors to easily compare your business’s potential returns with other investment opportunities, helping them make faster and more informed decisions.

Disadvantages of ROI
A major limitation of ROI is that it does not account for risk. ROI is purely a profitability measure and does not reflect the potential risks associated with the investment. Risk factors are assessed through other financial indicators, such as liquidity and solvency ratios.

These ratios help determine whether the investment can realistically be repaid. Entrepreneurs and investors must also consider factors like payback periods and the overall business climate when evaluating an investment.

Calculating Payback Period
When discussing investments with potential investors, especially for large sums, calculating the payback period is essential.

Example:
If an investor contributes €100,000 to your business and your company's current value is three times that amount, the investment may seem substantial. However, if you demonstrate that the investment will increase monthly revenue by €5,000, the payback period is:
€100,000 / €5,000 = 20 months.

This means the investor will recover their money in less than two years, making the investment more appealing. Investors often calculate the payback period themselves, and providing a clear example can strengthen your proposal.

What Is an Ideal ROI?
An acceptable ROI varies by industry and the stage of the business. For new businesses, investors typically expect an ROI of 15-20% on average. In slower-growing companies, ROI expectations are lower.

Expectations also depend on the type of investor. For instance:

• Friends and family investing in a loved one’s business often prioritize support over returns.
• In crowdfunding, ROI expectations vary by platform and project type – sometimes, emotional appeal outweighs financial returns.
• When approaching investment firms or seeking large-scale loans, profitability and well-documented financials are crucial.

Networking with other entrepreneurs in similar situations can also provide insights into what ROI their investors expect.

Adriaan Smit – Real Estate Broker in Curaçao
Would you like more information about return on investment in Curaçao? Feel free to reach out for advice.

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