Return on investment is an indicator characterizing the amount of profit that a company receives from each monetary unit invested in it, aimed at forming assets. It is the return on assets that tends to express the level of profitability of a company in a clearly defined period of time. Profitability is calculated based on the following formula:
Return on assets = net income / average annual value of assets * 100%
Return on investment: a concept from the inside
The use of a material resource, in which not only expenses overlap, but also profit is formed, can be called profitability. At the same time, the profitability of each company is calculated using a relative and absolute indicator. Relative values characterize the very profitability of investments, can be measured in a ratio format or calculated as a percentage. Absolute figures are expressed exclusively in monetary terms.
On these indicators has a significant imprint of inflation, but not the amount of income. When calculating the values, it is worthwhile to compare the final indicator of calculations with planned figures, with indicators of previous time periods or data for other companies. This will allow an objective look at the efficiency of using your capital. The calculation of return on investment should be as complete as possible.
Today, the calculation of the indicator in most cases is based on several interpretations of the concept. Only three common formulas are used:
- The ratio of profit before the payment of taxes and interest to sales volumes, which is multiplied by the ratio of sales volumes to the assets of the company.
- The ratio of interest and profits until the payment of taxes to the assets of the enterprise.
- The ratio of interest and profit before taxes to the assets of the company.
How to determine the profitability of investments?
In order to clearly realize the return on investment of the project, it is necessary to concretize the profitability from the infusion of funds. Initially conducted the most complete study of all investor resources. The process is carried out in several stages. Initially organized and carried out a financial analysis of the company. The second step is the calculation of the projected size of investments. The third stage involves the removal of indicators of the effectiveness of the solution, including the calculated index of profitability of investments. At the same time, factors that can influence the forecast should not be overlooked: inflation, transformation of sales markets, changes in politics and economics, and so on.
The main indicator is calculated on the basis of the formula above. At the same time, the moment is taken into account that within each specific firm, their own criteria for calculating investments and estimated profits are used. Return on investment will not be objective if you do not take into account the dynamics. Its level should be much higher than the overdraft interest. Profit from fixed payments without taxes should also be higher. The increase in revenues is possible due to an increase in the volume of turnover of assets and due to an increase in the profitability of goods or services.
The index of profitability of investments must exceed the profit from investments without risk. Profit should be calculated not at the standard rate, until all taxes are paid, but with payments. If this is not taken into account, the income will be recorded only through investments and receiving interest from the invested capital. When the interest on overdraft is higher than the level of income, profits are not able to cover all the costs of borrowed investments. Practice clearly shows that the value of profitability should be much higher than the generally accepted standard. It is important to take into account compensation for both the used management resources and the risk taken. Operating assets should not be less than 20%.
ROI requires clear management. Control is a kind of appeal to the ability to manage not only profit, but also money invested in a business. If the object to invest is attractive, but the indicators do not reach the optimal values, the following development scheme can be applied:
- Increase sales profitability.
- The increase in asset turnover.
To simplify the capital management scheme, each of the areas is divided into separate components that are more easily amenable to modernization and improvement.
Profitability in the broad sense of the word
ROI is important to calculate not only when investing in companies and enterprises. The index is very useful for investing in Bank deposits, in PAMM-accounts, portfolios, and other tools. The counting rate and to further compare the priorities, you can use the following formula:
Profitability index = Profit + (Asset sale price - Asset acquisition price) / Purchase price * 100%
The selling price can be considered as a potential value. For example, the profitability of investments, the formula of which was mentioned above, will make it possible to rationally assess the benefits of capital injections into a profitable PAMM account and from investing in a bank. The difference will be noticeable at the level of 2-7%. In a similar pattern, you can compare proposals for investing in commercial structures.