What is ROI?

ROI is the acronym for return on investment. Originally the objective of ROI was to relate a return (the income statement benefit) to the amount invested (such as the asset information from the balance sheet).

During the first half of the 20th century, ROI was helpful in monitoring the decentralized divisions of large diverse corporations. The ROI calculation may have divided a division's operating income by the average amount of operating assets being utilized by the division. For instance, a division with an operating income of $1 million that used $10 million of operating assets had an ROI of 10%.

A drawback of ROI is that the accounting amounts (revenues, expenses, asset book values, etc.) ignore the time value of money. As a result, companies began using discounted cash flows to better assess the profitability of its investments. Calculations such as net present value and internal rate of return became common and ROI was referred to as the accounting rate of return.

In the 21st century we see ROI used in the context of internet marketing and the adoption of wellness programs at large companies. In these examples the income statement benefits (more sales, lower health insurance expense) are related to the amounts being spent. Here, too, the ROI calculations do not consider the time value of money.