Simple, and therefore incomplete
ROI is net profit divided by cost. Its virtue is that anyone can compute and understand it; its weakness is that it ignores time entirely. Always pair it with an annualised figure before making a decision.
Annualising
The formula is (ending ÷ beginning)^(1/years) − 1. A $50,000 investment returning $78,000 over three years is a 56% total ROI but a 16% annualised return — a good result, though a very different number from the headline.
Payback period
How long until the investment repays itself in cash. It says nothing about total profitability but a great deal about risk: a two-year payback is far less exposed to changing conditions than an eight-year one. For small businesses where cash is the binding constraint, payback often matters more than ROI.
Opportunity cost is the real benchmark
The question is never "is this return positive?" but "is it better than the alternatives, adjusted for risk?" If a diversified index fund would deliver roughly 7% with modest effort, a business project returning 9% while consuming your attention for three years may be the worse deal. Set an explicit hurdle rate and apply it consistently.
Things ROI hides
- Your own time, rarely costed but genuinely scarce.
- Risk of total loss — a 40% expected return with a 30% chance of losing everything is not a 40% investment.
- Cash flow timing — money returned early can be redeployed; use NPV or IRR when timing varies materially.
- Ongoing obligations that outlive the return.