ROI - return on investment

Post date: Apr 7, 2013 9:00:50 PM

It applies to many areas but here focus is IT and investment decisions in IT. In its simplest form ROI analysis is comparing cost with benefits. One thing to consider is returns, whether they will be realized or not to recover investment amount and another things is how soon benefits will be realized means time frame.

Sometimes following terms are also called return on investment: Return on total assets, Return on invested capital, Return on capital employed,” and Return on net worth.

One of the forms simple ROI also known as cash on cash analysis. In cashflow ROI analysis, amount and time of investment cost is compared with amount and timing of returns or investment gain or benefits.

Simple ROI = ( Gains - Cost)/Cost

(a ratio or percentage)

Calculate all the costs

    • Initial or one time cost

    • Recurring or maintenance costs

    • Cost to mitigate risk etc.

Examples are as follows:

    • Software and hardware purchase/ licensing cost

    • Installation cost

    • Cost of a service and maintenance

    • Testing, training and education cost.

    • Power consumption, cooling cost; and other supporting infrastructure like including rack mounts, space required for the system etc.

    • Migration and conversions (server migration, data conversions and migration if required)

    • Cost to maintain redundant resources for contingency and risk mitigation

    • Cost to integrate with other systems (if there are legacy systems it may be a requirement)

    • Operational costs to make sure reliability, availability and performance.

Estimate returns

    • Returns direct or indirect

    • When benefits are expected

Identify a timeline for investment and returns

List investments and returns in chronological order.

Annual percentage yield of return

Calculating annualized returns is called annual rate of return and there are other similar terms such as annual percentage yield, compound annual growth rate etc. Sometimes it is important to compare returns of two investments, if we have to know benefit of an investment in mid of an investment, comparison can be done by calculating APY

APY =100* [ (Final Return/Investment)(365/NoOfDays in terms) -1 ]

APY = 100*[ (1+interest/principal)365/days_in_terms -1]

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