# What is Return: Definition, Formulas, and an Example

What is the definition of return and how can you calculate it?

How can you calculate return? Return is a term widely used in both the technical world and the financial world. It involves putting in energy or money and getting energy or money back out. And what goes in is usually not the same amount as what comes out. The ratio between what goes in and what comes out is called return. In the technical world, return can refer to the amount of energy produced relative to the amount of energy used in a given process. It should be noted that in the technical world, the term efficiency is also often used. In the financial world, return has a specific meaning and refers to the profit or loss made on an investment or security. Here we will delve into the economic meaning of return and use examples and formulas to show how you can calculate return.

The concept of return is easy to understand. It simply represents the difference between what you initially had and what you have now, expressed as a percentage. For example, consider a scenario where you initially had an investment of 100 units and now, over time, you see an increase to 120 units. The return in this case is 20%, as you now have 20 units more than at the beginning. Return is often associated with time, such as 20% per year or per month, and is applied in various fields ranging from finance to energy.

In our series on the valuation of a company, it is necessary to be able to calculate return. But first, we need to understand the meaning of the term return. Consulting the dictionary reveals the economic definition of return as: "yield of an economic activity." In the financial world, return is an essential concept. It is the yield obtained on an investment, expressed as a percentage of the invested amount. The return can come from various sources, such as dividend payments, interest, or capital gains. However, this definition is not entirely complete when we need to compare returns. Suppose we have two economic activities, activity A and activity B. The yield from selling a product produced by A is $10, and the yield from selling a product produced by B is $100, which one has the highest return? According to the dictionary definition, it's B, but is that really the case?

## Calculating Return: An Example

Problem 1: Let's provide more information about the meaning of return. To produce product A costs $1; to produce product B costs $95. The profits are then $9 and $5 respectively, so based on these figures, A has the highest return.

Problem 2: But we're not done yet. Suppose the time to produce product A is 10 months; the time to produce product B is two months. A generates a yield of $9/10 months = $0.90 per month or $10.80 per year, and B generates $5/2 months = $2.50 per month or $30 per year. Now B has the highest return again.

We see that there is a need to be more precise in our definition of return. So what is return? A general definition could be:

## Definition: Return is the total yield of an economic activity in one year divided by the costs or purchase of that activity

We have now solved problems 1 and 2, but is that all? No, not quite. It may not surprise you that there is no universal definition of return, as the yield from different economic activities can be measured in different ways. These differences range from simple definitions, such as the return on stocks, to complex definitions like the Internal Rate of Return (IRR). In any case, it is important to pay attention to how return is communicated to interested parties. Below are some definitions and methods of calculation for the most common everyday returns:

## Calculating Return: The Formulas

Dividend yield on stocks (%): Sum of dividends in the last 12 months / stock price;

Return on stocks (%): Sum of reported earnings in the last 12 months / stock price;

Return on bonds (%): Sum of coupons in the last 12 months / bond price;

Return on rental property (%): Sum of rents in the last 12 months / current value of the property;

Note that when we refer to "price," we mean the current price and that returns are usually expressed in "%", mainly for readability. When we want to report a return, we must consider the time period in which the yield is generated and the (purchase) costs to obtain the product or unit. A more general definition could be:

Yields over a specific time unit / purchase and production costs

It should be noted that in the financial world, many definitions for different returns are used. Examples include Return On Investments (ROI), Return On Equity (ROE), and the aforementioned IRR. We would prefer to save these for another time. We now want to continue with the series on valuing a startup using the DCF method.