ROI might not be the best measure of firm performance

Return on investment is calculated as: (the gains from investment – cost of investment) / cost of investment. It is a popular metric used to measure the firm performance, because it is simple and comparable. If an investment has a negative ROI or lower ROI than other options, it is not a good investment. In accounting and reporting, however, the calculation of ROI varies. Thus, there is room for error, misconduct and misrepresentation of the actual performance.

ROI is not a reliable measure because it can be manipulated. The managers of the firm can manipulate the items included in the costs of the investment to artificially inflate ROI. This is an unethical accounting method, but it cannot be easily spotted by the investors. There is no right calculation of the ROI. The user can choose what to include in the costs and returns to come up with different ROIs for different audiences. Therefore, the ROI is not the most accurate representation of the firm’s performance.