If you haven't heard a whole lot about initial investments, that's probably because its cousin gets a lot more attention. Return on investment, or ROI, isn't just a common formula helpful for determining the viability of your investments – it's the key to estimating smart initial investments, too.
ROI is an absolutely crucial tool for projecting the profitability ratio of your investments. Rather than simply revealing your basic profit, calculating your initial investment gives you insight on actual returns or net profit. With a little reverse engineering, you can also use it to ballpark the initial investment figures you'll need to reap the returns you want.
Performing the Old-School Calculation
Fortunately for you and your business, there's a straightforward, time-tested formula to determine your return on investment: Simply divide your net profit by your total assets. For instance, if your net profit was $50,000 this year and your total assets are $200,000, your ROI comes out to 0.25, or 25 percent.
Breaking that down to get your initial investment – or the amount of capital necessary to provide a future value within a specific time frame – gets a little trickier.
- First, you'll need to divide the investment's nominal interest rate, which is the rate of interest not adjusted for inflation, by the number of interest-compounding periods per year and add one to the total.
- Multiply the sum by the number of years in question.
- Take the future value you have in mind and divide it by that sum to find out the initial investment you need.
Using Online Calculating Tools
If you'd rather not bust out your long-form handwriting or your high-school graphing calculator (it still works!), the wonderful world of the internet has your back.
GlobalFinanceSchool offers a free-to-use online calculator for determining your initial investment. Just head over to the sites initial investment calculator, enter your desired future value, the rate of return, investment period and compounding periods per year, and it'll spit out the required initial investment in seconds. You can even use the tool with euros, pounds and yen in addition to dollars.
Why It Helps
Some of the most common types of investments – including bank savings accounts and bonds – accumulate compound interest. If your future includes clear and specific financial goals – and it should – knowing the required initial investment to generate the return you want is a key first step in creating your investment plan.
Additionally, tweaking the numbers you plug into the equation or online calculator helps you determine the time value of your money. In other words, try different figures for the investment period to see exactly how much today's small amount of money will grow into a larger lump sum. This can help you figure out where each of your initial investments may fall on the long- or-short-term scale.
Dan's decade-long experience as a freelance writer and small business owner has seen him contribute to financial publications including Chron.com, Zacks.com, MSN Money, Fortune, Motley Fool and others.