Virginia Contractor General Practice Test

How is the Return on Investment Ratio calculated?

1. Net income / Total assets

2. Total assets / Net income

3. Net income / Total liabilities

4. Total income / Total investments

The correct answer is: Net income / Total assets

The Return on Investment (ROI) ratio is a critical financial metric that evaluates the efficiency of an investment or compares the efficiency of several investments. It is calculated by dividing the net income generated by an investment by the total amount of assets involved in that investment. This ratio provides insight into how well the investment is performing relative to its cost, essentially indicating how much profit is made for each dollar invested in the assets. The formula for ROI highlights the relationship between profit (net income) and the resources used (total assets). A higher ROI indicates a more efficient use of assets, meaning that the investment is generating a significant return compared to the resources committed to it. In contrast, the other options present alternative ratios that do not accurately reflect the ROI concept. Total assets divided by net income would give a different insight regarding asset utilization but doesn't indicate return on investment per se. Likewise, net income divided by total liabilities focuses on a company's financial leverage rather than its investment return. Lastly, total income divided by total investments, while somewhat related, does not conform to the traditional ROI formula that emphasizes net income specifically. Thus, the correct calculation method for ROI is based explicitly on net income divided by total assets, affirming the importance of understanding proper financial ratios for effective investment