The investments are done by all of us across the world. They have become a kind of savings. Today, even a middle-class person invests his money in the shares to get back the high return. Thus, investments need to be calculated and after using, that money the profit or the loss are calculated. The IRR and ROI are the two methods using which we calculate the returns of an investment.
IRR vs ROI
The main difference between IRR and ROI is that the method by which we calculate the returns. The IRR does not have a particular formula to calculate the IRR. Whereas the ROI has a formula that is used to calculate the returns. The IRR is beneficial for the linger term calculation while the ROI is preferred to calculate the returns for a shorter period. On the other hand, the IRR is difficult to calculate as compared to the ROI.
The IRR stands for the Internal Rate of Return. It is a formula that is used to calculate the returns on investments. It is the discount rate the reason for this is that the current investments are considered as zero and the discounted money is analyzed. The IRR formula is the same as the Net Present Value (NPV). It is not for the actual value of the investment but is used for calculating annual profit or loss.
The ROI stands for the Return of Investment. The ROI is equal to the ratio of the net income to investors. The period can vary according to the investment return we are calculating. The high ROI means a profitable investment. The ROI is also used to compare different investments and calculate the profit gained in the different investments.
Comparison Table Between IRR and ROI
| Parameters of Comparison | IRR | ROI |
| Full form | The full form of IRR is the Internal Rate of Return. | The full form of ROI is Return of Investment. |
| Another name | The IRR is also called the Discounted cash rate flow of return. | The ROI is also known as the Return on costs. |
| Definition | The IRR is the method that is used to calculate the return of an investment. But the IRR excludes the other factors which may lead to the loss. | The ROI is the method to calculate the return of the investment by calculating the ratio of the Net income to the net investment. |
| Formula | There is no particular formula for the IRR. but the Net Present Value (NPV) formula is used to calculate the IRR too. | The formula of the ROI is the ratio of the net income to the net investment for the period the investment has been done which can vary. |
| Advantage | The IRR can be used to calculate long-term investments like savings. | The ROI is easy to calculate. This method of calculation is also preferable for the shorter term. |
| Disadvantage | The IRR is a method that is very time-consuming and difficult to calculate. | The ROI is the used shorter-term investment because in longer-term the ROI is not able to calculate the return and estimate the investment idea is a success or not. |
| Example | Let us say, you are investing Rs.1500 in a project and getting Rs.20,000 in return for the project. Therefore, the discount would be 14% on the project. | Suppose the money invested by a person is Rs.1200 and the return after years is Rs.1234 then there is the ROI of 16.4% per month. |
What is IRR?
The IRR stands for the Internal Rate of Return. This method is also known as the Discounted cash rate flow of return. The reason behind this other name is that this method is used to calculate the return based on the discounted amount. The Net Price Value is considered as zero. The formula of the IRR is also the same as we use to calculate the NPV.
The IRR is the method that is used for long-term investment. The reason is that the IRR can estimate the benefits of the investment which is being done. The returns can be calculated before the investment. The period of investment can vary yet the profit can b calculate for the time being. Long-term investments like loans, savings can easily be calculated by this method.
The use of the IRR is to calculate the profit of the investment. For example, if we are making an investment in a fixed deposit on a bank then we can calculate the interest on the amount before we invest the money and know its benefits. The other use of the IRR is to increase the net present value. Like, we had a Fixed deposit and it complete the present value is again fixed then the money will increase of the investments and hence the return.
What is ROI?
The ROI stands for the Return of investment. The other name of the ROI is the Return of the cost. The ROI is used to calculate the return of investment over a period. The ROI is used to calculate the return for a short-term period and is not beneficial for longer-term investments.
The ROI is used for the business models. The company invests in different business and calculate the return of the investment for some time. This helps to determine the beneficial model for the investment and it also helps to compare between the investment and know the profitable one and investment more in that particular business model.
The ROI is calculated using the ratio of the net value returned to the net value invested. The higher the ROI, the higher is the profit. The rations are often compared for knowing the profitable business model. The ROI is easy to calculate and is quite beneficial when the investment returns are made for the shorter term.
Main Differences Between IRR and ROI
- The ROI stands for the Return of investment and IRR is the Internal Rate of return.
- The IRR is beneficial for the longer-term investment whereas the ROI is beneficial for the shorter-term investment.
- The IRR is difficult to calculate whereas the ROI is easy.
- The IRR is mainly used in savings and loans whereas the ROI is used in the business model.
- The ROI is preferred more over the IRR.
- The IRR has the same formula as the Net present value but the ROI is equal to the ratio of the net return to the net investment.
Conclusion
The IRR and ROI are the methods that are used to calculate the return of an investment. The investment is being calculated to make a difference in the method we will use further. The business models mostly prefer the ROI over the IRR as it is easy and good for short-term investment. On the other hand, the IRR is the method with does not consider the risk factor that may occur during an investment. It is a method that analyses the discount while considering the net present value as zero.
References
- https://www.sciencedirect.com/science/article/pii/S1062976910000037
- https://go.gale.com/ps/i.do?id=GALE%7CA18156945&sid=googleScholar&v=2.1&it=r&linkaccess=abs&issn=10559760&p=AONE&sw=w