The measurement of return (ROI) on investment is guided by the data type or type of investment that is being measured. Therefore, the differences in the types of ROI stems from the diverseness of data that is being measured. The most basic and common type of ROI method is dividing invested value with the return from the investment, i.e., Net Income from investment/Cost of Investment. A case where $1000 is invested and the returns after one year is $1200; ROI will be (1200-1000)/1000 = 0.2 or 20%, return on investment, in this case, is 0.2 or 20% (Brooks, 2014). The method is simple because it considers two parameters only, i.e., return net income and cost of investment. If ROI is positive, the investment is worth investing in, but if ROI is negative, it means the investment will make a loss thus it is not worth investing in it.
The method of finding ROI (Gain on Investment/Cost of Investment) is advantageous as compared to others. First, the method is easy to use to use and compute since it does not require any complicated data. Additionally, the results can be easily interpreted. The only disadvantage with the method is that it does not take into account the period of return thus it treats both short and long-term return on investment similarly. The approach is only applicable to investments that do not involve a wide range of data thus making it limited in sustainability.
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The second type of ROI is achieved by dividing net income and income taxes by proprietary equity and fixed liabilities to get a rate of earnings on invested capital. The second method is more expanded since it takes into account the equity and liability parameters. As earlier mentioned, the differences in the method of ROI measurement largely arises from the difference in data and investment types. In the second type, measurement is anchored on companies or corporations that raise their funds through equity as well as incur liabilities. The advantages that accrue to the type of ROI include; the recognition of time value for money makes it a better measure of profitability as compared to the first method (Rackley, 2015). The approach is mostly sustainable, but it becomes limited when interest rates and inflation is taken into consideration.
The third type of ROI method is the achieved by dividing net income by the total capital plus reserves to find income that accrues from proprietary equity and stock equity while taking into account the time value for money. The ROI method is considered to be the most accurate owing to its advantage of the inclusion of time. Thus it is advantageous because it takes into account time value for money (Arrow, 2013). On the same note, it is a better measure of profitability it takes into account income from divisions thus companies can make informed decisions regarding divisions or investments that utilized resources well.
On the other hand, the method has its disadvantages that include; it does not take into account the different accounting policies (Westcott, 2013). For companies to register comparable ROI measurement, they must use the same accounting method. Similarly, the method does not differentiate between investment and profit. The two terms are technically different, but the method identifies them as one term. As compared to the other two, the third is more sustainable since it can apply to numerous investments. Perhaps the only disadvantage that accrues to the method is that it requires the proper definition of data thus making it difficult to be used by none experts.
References
Arrow, K. J., & Kruz, M. (2013). Public investment, the rate of return, and optimal fiscal policy . RFF Press.
Brooks, C. (2014). Introductory econometrics for finance . Cambridge university press.
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Rackley, J. (2015). Return on Investment. In Marketing Analytics Roadmap (pp. 71-85). Apress, Berkeley, CA.
Westcott, R. (2016). Return on Investment. Quality Progress , 49 (1), 47.
