Business owners discuss the rate of return in the same manner that they quote prices. A business owner might say, "That new machine had a 40% rate of return," or "This marketing campaign has a three-time rate of return." However, rarely do they state the following information: the period of time, comparison basis, or does the rate of return account for all expenditures?
A rate of return is a ratio that illustrates the gain or loss on an investment in relation to the cost and is usually expressed as a percentage. By converting the quantitative amount gained or lost on an investment to a percentage it allows us to compare a $20,000 equipment purchase with a $200,000 investment to a one-year investment or a five year investment.
The calculation is extremely simple; it's the interpretation and implementation that can be subjective. The accuracy of the rate of return is based upon the expenditures, revenues, and period of time factored in the calculation. In conclusion, the manipulation of numbers can allow an otherwise poor investment to have a profitable rate of return.
The rate of return I distrust most is the one with no time period attached. A client tells me a property or piece of equipment returned 50%, and it turns out that was over seven years, which works out to around 6% a year, less than they could have earned leaving the cash in an index fund.
The other common gap is ignoring the owner's time. A side business that returns 25% on cash invested but takes twenty hours a week isn't returning 25%. Always annualise the number, and ask what the same money and effort would have earned elsewhere.
Abhinav Gupta, CPA, CA, MBA · LinkedInRate of Return Formula
Rate of Return (ROR) measures how much gain or loss an investment or business activity generates relative to its cost. It converts absolute profit or loss into a percentage, making it easy to compare investments of different sizes, across different time periods, or against alternative uses of capital.
ROR (%) = [(Final Value − Initial Value) / Initial Value] × 100
Or equivalently: ROR (%) = (Net Profit / Cost of Investment) × 100
Worked Example
| Scenario | Calculation | ROR |
|---|---|---|
| Bought equipment for $50,000; sold for $35,000 after 3 years | ($35,000 − $50,000) / $50,000 × 100 | −30% (loss) |
| Invested $100,000 in a project; earned $130,000 over 2 years | ($130,000 − $100,000) / $100,000 × 100 | +30% |
| Bought shares for $5,000; now worth $6,200 after dividends | ($6,200 − $5,000) / $5,000 × 100 | +24% |
Types of Rate of Return
| Type | Definition | Used For |
|---|---|---|
| Simple ROR | Basic percentage gain/loss on an investment | Quick comparison; single-period investments |
| Annualised ROR | Simple ROR adjusted to a per-year basis for comparability | Comparing investments held for different time periods |
| IRR (Internal Rate of Return) | Discount rate that makes NPV of all cash flows equal to zero | Capital budgeting; comparing multi-year projects with uneven cash flows |
| ROI (Return on Investment) | Net profit / cost of investment, functionally the same as simple ROR | Marketing spend, business investment decisions |
| ROE (Return on Equity) | Net income / shareholders' equity, specific to equity-funded investments | Measuring how efficiently owners' capital is deployed |
| ROCE (Return on Capital Employed) | EBIT / Capital Employed | Assessing overall capital efficiency; popular with lenders |
Annualised Rate of Return
A simple ROR of 30% over 2 years is not the same as 30% per year. To annualise:
Annualised ROR = [(1 + Simple ROR)^(1/n) − 1] × 100, where n = number of years
Example: 30% over 2 years = [(1.30)^(1/2) − 1] × 100 = 14.0% annualised
What Is a Good Rate of Return for a Business Investment?
| Benchmark | Typical ROR | Context |
|---|---|---|
| Index funds (S&P 500 historical average) | ~10% annualised (nominal) | The passive alternative, any business investment should target above this |
| Small business investment (general) | 15 to 25%+ annualised | Compensates for illiquidity and operational risk |
| Real estate rental property | 6 to 12% annualised (total return) | Includes both rental yield and capital appreciation |
| Venture capital (portfolio) | 20 to 30%+ (target) | High target to offset the majority of investments that fail |
For most business decisions, the practical test is simple. Would this investment beat paying down debt, keeping cash available, or putting the money into a lower-risk alternative, once you account for the extra risk and effort involved?
We were considering spending about $150,000 on new equipment, and the projected increase in production capacity looked attractive at first. Profitjets calculated the expected return based on the additional revenue, operating costs, and payback period, and the numbers showed that the investment would take longer to recover than we initially expected. We decided to delay the purchase and invest in a smaller capacity upgrade instead.
Profitjets fractional CFO engagements typically evaluate major investments against projected ROI, payback period, and cash-flow impact, with clients using these models to assess equipment purchases, software investments, and expansion plans before committing capital.
Book a free consultation and we will model it against the alternatives.
FAQs
What's the difference between ROI and ROR?
In most everyday business uses they're the same calculation: gain or loss divided by what was invested. ROI tends to be used for business decisions such as marketing spend or equipment purchases. Rate of return is more common for investments. Whichever term you use, be clear about the time period and what's included.
What does a negative rate of return mean?
It means the investment lost money. What you got back, including any income received, was less than what you put in. A −20% return on $100,000 is a $20,000 loss. A single negative period isn't unusual for markets or early-stage projects. Returns that stay negative year after year are a sign to reassess.
Why should I annualise a rate of return?
Because a total return hides how long it took. A 50% return is excellent over two years and weak over ten. Annualising turns every investment into a yearly rate, so you can compare them fairly with each other and with alternatives like an index fund or debt repayment.
When should I use IRR instead of simple ROR?
Use IRR when money goes in and comes out at different times over several years, such as a project with staged investment and uneven cash flows. Simple and annualised ROR work well when there's one upfront investment and one ending value. IRR accounts for timing but is harder to calculate and explain.
Does rate of return account for risk?
No. Two investments can show the same return with very different chances of losing money. Compare returns against alternatives with similar risk, or require a higher return from riskier investments, before treating the numbers as equal.
Written by
Abhinav Gupta, CPA, CA, MBA
Abhinav works with business owners across the US on industry-specific bookkeeping, from dental practices and restaurants to construction and e-commerce. He writes about what each trade's books actually need. Connect on LinkedIn
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