Refresher Course 103: Rate of Return
The Rate of Return (ROR) is a generic reference to the gain or profit derived from a certain decision, investment or action. There are, in fact, many different kinds of rates of return, and a variety of formulas for determining the benefit or profitability of decision, investment or action. Calculating rates of return is another useful tool for attorneys and business managers engaged in a variety of practice specialties.
The basic calculation for ROR is expressed as a fraction. The numerator is generally the difference between the money invested or lost and the money earned, gained or received. The denominator is the money invested or lost. The basic formula is:
ROR = fV – iV / iV [Final Value minus Initial Value divided by Initial Value]
- ROR = Rate of Return
- fV = Final Value (Money earned, gained or received)
- iV = Initial Value (Money spent, invested, or lost)
Assume, for example, that you invested $1,000 in a business activity. At the end of one year, your initial investment of $1,000 paid off, yielding $1,500. Your iV would be $1,000, and your fV would be $1,500. What is your ROR? Applying the formula, we find that the ROR is 50%
ROR = fV-iV / iV
= $1,500 – 1,000 / $1,000
= $500 – $1,000
= 1/2 = 50%
Of course, the ROR must be considered in the context of other external factors, such as the inflation rate and the tax consequences. In future articles, we will discuss other rates of return, including return on investment (ROI), return on equity (ROE), and return on assets (ROA), as well the internal rate of return (IRR) and net terminal value (NTV).