Return on investment. Return on investment is the rate of return on investment (ROI). ROI analysis
ROI is one of the basic economic indicatorsthat investors and entrepreneurs rely on to assess the performance of a business, financial instrument, or other asset. Since investments mean long-term investments, it is important for a potential business angel to know how quickly his investments will pay off and what income they will bring in the future.
Why the ROI is calculated
The Return On Investment (ROI) ratio is constantly monitored by entrepreneurs and investors with one simple goal: to determine how effectively a particular asset is generating income.
ROI - Return on Investment Ratio
ROI is a versatile enough way to figure out:
- is it worth investing in a particular startup;
- business modernization or expansion is so justified;
- how effective is an advertising campaign that is conducted offline or online;
- whether it is worth purchasing shares of a certain campaign;
- whether the acquisition of a share in a mutual fund is justified, and so on.
Using indicators that are freely available and available for analysis to everyone, you can easily calculate the ROI coefficient and draw an appropriate conclusion. If ROI is less than 100%, then this financial asset is ineffective. If more than 100 is effective.
Usually, the following data is sufficient for calculations:
- the cost of the product (includes not only production costs, but also the remuneration of employees, the cost of delivery to the warehouse and to the point of sale, insurance, and so on);
- income (that is, profit earned directly from the sale of one unit of goods or services);
- the amount of investment (the total amount of all investments, for example, advertising or presentation costs);
- the price of an asset at the time of acquisition and at the time of sale (this indicator is of greater importance not for businessmen, but for investors who use fluctuations in the price of an asset - a share, currency, a share in a business, and so on - for its resale and profit).
For businessmen, when analyzing products, calculating ROI has a special meaning. With a wide range of goods or services, analysts analyze each group of goods for different indicators. As a result, to put it simply, it turns out what is selling worse and what is better. Sometimes business owners make interesting discoveries for themselves. So, it may turn out that low-margin products bring in more income than high-margin products, although according to reports in absolute numbers, everything looks different.
Depending on the results obtained, you can develop an action strategy: strengthen those positions where the ROI is the highest to get even more profit, or “pull up” weak positions in order to “pull up” the business as a whole.
There are several formulas for calculating ROI. The simplest one used by investors and marketers looks like this:
ROI \u003d (income - cost) / investment amount * 100%.
The same formula can be expressed in a slightly different way if you need to evaluate financial assets, the cost of which changes over time (for example, shares):
ROI \u003d (return on investment - investment amount) / investment amount * 100%.
These formulas are designed for the short term, that is, they are designed to calculate efficiency for a given time period. But it often happens that for a more accurate ROI value, you need to add a period. Then these formulas are converted to next view:
ROI \u003d (Amount of investment at the end of the period + Income for the selected period - Amount of investment made) / Amount of investment made * 100%.
For some financial assets the following formula is more suitable:
ROI \u003d (Profit + (Sale Price - Purchase Price)) / Purchase Price * 100%.
Thus, these formulas are flexible enough to substitute a wide variety of values \u200b\u200band use them in different situations for different financial instruments.
One of the simplest examples of calculating the ROI ratio when you need to compare the sales efficiency of various products in one outlet.
For example (goods and prices are conditional).
To calculate ROI, the following formula was used: ROI \u003d (profit - cost price) * number of purchases / expenses * 100%.
Analysis of the data obtained prepares the owner of the outlet for many interesting discoveries. So, the sale of bicycles is clearly unprofitable to him, scooters are profitable, and skates bring neither expense nor income.
In order to fix the "weak" position, he needs to either reduce costs (for example, find a cheaper supplier), or increase the selling price. As for the skates, you need to think about it. If it is summer, the number of small sales may be justified by the fact that it is “not the season”. In the fall, it will be necessary to carry out similar monitoring again.
For stocks, the ROI will be calculated as follows.
We use the formula ROI \u003d (Dividends + (Selling Price - Buy Price)) / Buy Price * 100%.
From the analysis of the above table, the shareholder can draw several conclusions. Although the share price may have gone up, not receiving dividends on the share results in a low ROI, despite the fact that the transaction looks profitable overall. Conversely, receiving dividends led to a large ROI despite the fact that the value of one share fell.
This example perfectly illustrates the basic principle of investing in stocks: their long-term nature.
ROI pros and cons
The return on investment ratio helps investors and potential business co-owners assess how effective a project is. The higher the ROI, the more attractive the project looks in the eyes of other financial market participants.
In addition, the profitability index has several more pronounced advantages:
- takes into account the time factor, that is, the change in the value of assets over time, the profit received during the measurement;
- considers the sum of all investment effects, not just short-term profits;
- allows you to adequately evaluate projects with different scales of production or sale at the same level, for example, a large factory and a small workshop, a boutique selling fashionable handbags and a clothing hypermarket;
- allows you to take into account in its formula the interest that will have to be paid for the use of borrowed funds;
- flexible formula allows you to use different indicators and modify it depending on the need.
At the same time, this coefficient is not without its drawbacks:
- rOI itself does not give any kind of assessment of the profitability of a business or financial instrument (which is clearly seen in the example of stocks);
- rOI does not take into account the effect of depreciation of money;
- it is impossible to predict the inflation rate, so long-term forecasts are rather vague (but you can rely on the average annual inflation rate).
The ROI value, together with other indicators, allows you to sensibly assess how profitable a financial instrument will be and whether it is worth risking your money and time to invest in another project.
The main goal of any investment is its effective placement for profit. And one of the important indicators that reflects how effective the investment is, is the rate of return.
So the ROI is financial indicatorallowing the investor to determine whether the investment is profitable or unprofitable. You can also use the following interpretation of the concept: shows what expenses in the form of investments must be incurred in order to achieve the desired level of profitability / profit.
Accepted abbreviation: Return on Investment (ROI). The formula shown below in the photo reflects in more detail and clearly:
Where:
- PE - net profit;
- And - the amount of investment
In financial practice, the concept of profitability is also used. investment capital... In fact, this concept is analogous to return on investment, and you can simply say that this is a different name. The considered indicator is calculated when determining the effectiveness and profitability of any investment project (see).
Its calculation allows you to solve such problems as:
- approve or reject the project based on the calculated performance level data;
- allows you to compare two or more projects and choose the most cost-effective;
- how much an investor can get profit from a unit of invested capital.
Taking into account the above, the profitability of an investment project is an indicator reflecting the ratio of income / profit to the total amount of the investor's initial investment in percentage terms.
In financial practice, the analysis of the return on investment capital and projects can be divided into two main groups.
There are groups that are based on the following:
- methods with calculations based on discounting;
- methods based on accounting estimate investment.
Discount methods
The first group includes the following methods:
Let's take a closer look at each method.
What does the profitability index show? The answer is simple: it reflects whether the revenues from the project cover the costs incurred by the investor. If, as a result of the calculation, the indicator is greater than or equal to 1, the project is expedient for approval, otherwise, it is rejected. Calculated using the formula below.
Where: NPV - clean discounted income (discounted amount cash flows for the analyzed period); And - the investment.
Advice! When choosing a project from a number of alternatives, you must use the PI calculation. It is the most convenient for determining the effectiveness of the project at the initial stage.
The internal rate of return on investment is the rate at which discounted net income is equal to zero.
The formula looks like this:
Where, r is the cost of capital of the investment project
What does this indicator reflect? Answer: reflects the maximum allowable level of costs / expenses for the project, at which the expediency of capital investment is maintained
Thus:
- the project is accepted at a value higher than or equal to the capital;
- the project is rejected if the indicator is less than the cost of capital.
Both methods described are based on an estimate taking into account time changes.
Simple analysis methods
The second specified group includes the following method for calculating the return on investment - the calculation of the accounting rate of return (ARR). What does it show? Answer: what is the average annual profit that can be obtained as a result of the project.
This method of return on investment is used mainly in the analysis of short-term investments. What is the reason for this? Firstly: it does not take into account the temporary change, and secondly: income is treated as net profit. The method is considered simple to calculate. Statistical methods of return on investment are also characterized by the simplicity of calculations without the use of discounting.
It is for this reason that the calculation of the ARR indicator is used in the analysis using statistical methods and can be represented in a simplified formula:
Where:
- SP is the average profit for the year;
- SI is the average investment amount.
Advice! It is advisable to calculate the ARR indicator only when analyzing short-term projects using the balance sheet data.
For a more efficient investment of capital and a more accurate determination of the possible profit that will be obtained in the future, it is necessary to use not only statistical methods, but it is imperative to apply discounting. What will it give? Answer: a more precise definition of what will be the most profitable investment for the owner of the capital.
Indicator standards
Along with the calculated indicators, there is the concept of their normative values... They are actually the basis on the basis of which a conclusion is made based on the results of the calculation. Namely: whether the calculated coefficients and indices comply with the standards.
As an example, we will give the main indicators of the efficiency (profitability) of investments in the context of industries and types: foreign investment and the profitability of the industry - not less than 0.16; agriculture - not less than 0.12; trade - 0.25; construction - at least 0.22 is considered the norm.
If we consider the standards for statistical methods that do not take into account the temporal nature of cash flows, do not use discounting and use accounting data for analysis, then:
- the standard profitability indicator for trade enterprises is allowed from 0 to 0.07;
- standard for industrial enterprises from 0 to 0.16.
The profitability ratio is unsatisfactory for any industry, without exception, if its value is less than 0.
Profitability ratios are the main indicators characterizing the profitability of the enterprise and the effectiveness of its various elements. Profitability indicators are relative indicators, that is, they represent the ratio of income items to types of activities, sales volumes, size of property, etc.
The analysis of profitability ratios is carried out by researching the historical dynamics of change, direction and rate.
This article will consider the main coefficients of profitability of the enterprise, which are used in financial analysis.
Return on assets ratio (ROA)
Foreign abbreviation ROA - Return on assets. This coefficient characterizes how much of the company's net profit falls on 1 ruble of assets, in other words, what is the profitability of the company's property. The return on assets ratio shows the effectiveness of the functioning of enterprise managers and the effectiveness of decisions made by the management and owners of the enterprise (organization). The formula for calculating the return on assets ratio is:
Return on assets ratio (ROA) \u003d Net profit / Average assets of the company
ROA \u003d line 190 / (0.5 * (line 300 at the beginning of the year + line 300 at the end of the year))
Return on equity ratio (ROE)
Foreign abbreviation ROE - Return on shareholders' equity. This indicator characterizes how much of the net profit falls on the company's capital, which includes both equity and debt. The return on equity ratio allows you to compare various investment options according to the degree of profitability, for example, investments in the authorized capital of an enterprise, investments in deposits, stocks, bonds, real estate, etc. The formula for calculating the return on equity ratio is as follows:
Return on Equity (ROE) Ratio \u003d Net Profit / Average Equity
ROE \u003d p. 190 Form No. 2 / (0.5 * (p. 490 at the beginning of the year + p. 490 at the end of the year))
For more information about the return on equity ratio (ROE) and factor analysis of profitability, see the article
Profitability ratio of current assets (RCA)
The foreign abbreviation of the return on assets ratio is Return on Currency Assets, which is translated as return on current assets. This ratio shows the profitability of current assets, that is, how much profit a unit of current assets brings. The formula for calculating the profitability ratio of current assets is as follows:
Return on current assets ratio \u003d Net profit / Current assets
RCA \u003d p. 190 Form No. 2 / p. 290 Form No. 1
Return on non-current assets ratio (RFA)
The indicator of profitability of non-current assets - Return on fixed assets (RFA), shows how much profit the non-current assets of the company give. Since the efficiency of non-current assets is assessed, this coefficient shows the degree of efficiency of using long-term assets of the enterprise, such as buildings, structures, etc. The formula for calculating the profitability ratio of non-current assets.
Return on non-current assets ratio \u003d Net profit / Non-current assets
RFA \u003d p. 190 Form No. 2 / p. 190 Form No. 1
Return on investment ratio (ROI)
Return on investment ratio - ROI shows the profitability of an enterprise when using debt and equity capital. Another name for the rate of return on investment is the rate of return on constant capital. This indicator reflects the competitiveness of the enterprise to generate profit in market economy.
Return on investment \u003d Net income / Equity + Long-term liabilities
ROI \u003d p.190 Form No. 2 / (p.490 + p.590)
Return on sales ratio (ROS)
The return on sales ratio shows the profitability from the sale of the main products of the enterprise. The indicator evaluates the effectiveness of sales of the company's products. The formula for calculating the indicator:
Return on sales ratio \u003d Profit from sales / Revenue
ROS=
page 50 Form No. 2 / page 10 Form No. 2
Product profitability ratio (ROM)
The coefficient of profitability of production shows the ratio of the company's net profit to the cost of production and has the following form:
Profitability ratio of production \u003d Net profit / Cost price
ROM =
p. 190 Form No. 2 / p. 20 Form No. 2
Coefficient accounting profitability from ordinary activities
The indicator determines how many rubles are there for 1 ruble products sold enterprises (organizations). The calculation formula is as follows:
Accounting profitability ratio from ordinary activities \u003d Profit before tax / Revenue from the sale of goods
Accounting profitability ratio \u003d line 140 Form No. 2 / page 10 Form No. 2
Staff profitability ratio (ROL)
The coefficient of profitability of personnel shows the effectiveness of employees in creating profit for the enterprise (organization).
Employee profitability ratio \u003d Net profit / Average headcount
The number of personnel is determined according to the form No. 5 of the balance sheet.
Net profitability ratio
The net profitability ratio shows the profitability of the enterprise in creating a net profit rate per 1 ruble of products sold. This ratio is strongly correlated with the ratio of the accounting profitability. The calculation formula is as follows:
Net profitability ratio \u003d Net profit / Revenue from the sale of goods
Net profitability ratio \u003d p. 190 Form No. 2 / p. 10 Form No. 2
Gross profitability ratio
The indicator determines how many rubles of gross production is created per 1 ruble of sold and sold products. The gross margin is calculated using the formula:
Gross margin ratio \u003d Gross profit / Revenue from the sale of goods
Gross profitability ratio \u003d p. 029 Form No. 2 / p. 10 Form No. 2
Cost-benefit ratio
The cost-benefit ratio shows the ratio of pre-tax profit to the sum of production and sales costs. The calculation formula is as follows:
Return on Cost Ratio \u003d Profit before Tax / Total Cost of Goods Sold
Cost-benefit ratio \u003d p. 140 Form No. 2 / (p. 20 Form No. 2 + p. 30 Form No. 2 + p. 40 Form No. 2)
Return on investment Is an index that shows the relationship between costs and the projected profit of the project.
This indicator is calculated:
PI \u003d NPV / IC
- PI ( Profitability Index) Is the profitability index of the investment project; NPV ( Net Present Value) - net present value;
- IC ( Invest Capital) - the initial spent investment capital.
If the profitability index is 1, this is the lowest acceptable indicator. Any value below 1 indicates that the project's net profit is less than the initial investment. As the index value increases, the financial attractiveness of the proposed project also grows.
The profitability index is a valuation technique applied to potential capital expenditures. This method divides the projected capital inflows by the projected capital outflows to determine the profitability of the project. The main feature of using the profitability index is that the method ignores the scale of the project. Therefore, projects with a large influx money may show lower index values \u200b\u200bin calculations, since their profit is not so high.
NPV - Net investment value or net real (present) investment value
NPV \u003d PV - Io
- PV - the current value of the cash flow;
- Io — initial investment.
The above NPV formula shows monetary income in a simplified way.
Calculation of the planned net worth investing in an enterprise is quite difficult. This is due to the fact that money depreciates over time (inflation occurs). Therefore, the $ 1 earned now cannot be equated to the $ 1 received in a year. In order to compare the resulting profit with the predicted one, you will need to use indexation coefficient.
When investing, it is believed that the faster the same $ 1 is earned, the more valuable it will be in the future.
- I - the size of investments in the t-th year;
- r is the discount rate;
- n - investment period in years from t \u003d 1 to n.
Investment amount: initial investment and additional capital costs
Discounted projected cash outflows represent the initial capital costs of the project.
The initial investment is only the cash flow required to launch the project.
All other costs can occur at any time during the existence of the project, and they are taken into account when calculating using the company's discounted net profit. These additional capital expenditures can affect tax or depreciation benefits.
Decision Making - Return on Investment Index
The return on investment index (PI from the English Profitability Index) should not be less than one. If so, then it is necessary to create conditions for its increase.
- PI\u003e 1. If the indicator exceeds one, it indicates that the expected cash inflows in the future exceed the projected discounted cash outflows.
- PI< 1. A value less than one indicates that the spending will be more than the projected profit. In this case, you should not run this project.
- PI \u003d 1. A value of one indicates that any profit or loss from the project is minimal. Therefore, the project will not attract the attention of investors.
When using the profitability index, projects are considered, the value of which will be more than one.
The name does not mean benefit!
As a rule, the most stable and profitable investments come from companies that produce everyday products. And high-tech innovative organizations can often only bring a loss.
Wealth is the right investment!
Most owners of large companies and networks invest their savings in investments. Thus, they protect themselves from possible adverse situations.
Evgeny Smirnov
#
Investments
How to calculate ROI
ROI is a coefficient that does not show a clear level of profitability, but only indicative figures, a forecast of potential profit.
Navigating the article
- What is ROI
- Return on investment (ROI) ratio: calculation and analysis of the indicator
- How to calculate ROI: formula and examples
- Universal ROI Formula
- PI formula for ROI
- What is a good indicator?
- Calculating the return on investment ratio in accounting
- The formula for calculating the return on investment in accounting
- Accounting ROI Effectiveness and Disadvantages
- ROI in Marketing (ROMI)
- ROI analysis
- What can be the return on investment
- Problematic moments
- How to predict profitability
Investment is a kind passive earnings, which allows you to receive dividends only thanks to the contribution. To optimize risks and get more income, a return on investment indicator is used. This value determines the ratio of risk to reward, and makes it clear whether it is worth considering this or that option for investment.
What is ROI
The main purpose of investing is making a profit. Novice investors may mistakenly believe that the more capital invested, the higher the income. Despite the fact that investing is considered a passive form of earnings, it requires careful calculations. This means that you cannot invest in any proposed project. Before deciding to invest in a project, you need to determine the profitability. The investor must understand whether the business is (or will be in the future, if it is a startup) profitable.
This does not mean that you can invest in a project where the income will exceed the investment. Even if this is so, the indicator may be minimal, and the payback period of the investment may be delayed, which will greatly increase the risks.
So, the return on investment is an indicator of the effectiveness of the use of capital (own or borrowed) invested in the company's activities for a long time. This ratio is equal to the ratio of the balance sheet profit to the average annual value or equity (borrowed) capital.
Most often in professional circles, to define this concept, they use the abbreviation ROI - return on investment or ROR - rate of return, meaning return on investment. Therefore, when meeting ROI in financial securities, an investor must clearly understand that it is important indicator return on invested capital.
ROI is a coefficient that does not show a clear level of profitability, but only indicative figures, a forecast of potential profit. Despite this, its assessment will help determine whether it is worth investing in this project, or profitability capital investments in the other it will be higher.
Return on investment (ROI) ratio: calculation and analysis of the indicator
Profitability characterizes the application material resource (capital), which covers current expenses and generates profit. That is, initially implying the return on investment, we should talk about the profitability of each company or enterprise taken. Profitability is calculated in two ways:
- The relative indicator indicates exactly the profitability and is measured in the format of the coefficient or as a percentage.
- The absolute value shows the profit in a specific monetary equivalent (that is, the amount of net profit that was received over a certain period of time from investment activities).
These two methods of ROI analysis are not mutually exclusive, but complementary. It is important for an investor when making a decision to calculate profitability using both a relative and an absolute method.
Both values \u200b\u200bwill be strongly influenced by inflation, but not by income. When making decisions, it is also important to compare the totals of the calculation with the planned values \u200b\u200bof previous periods and the data of other enterprises (if possible). Only this approach will allow for an objective assessment financial investments into business.
To determine the profitability, it is important to specify the income from financial investments. For this, an analysis of the enterprise is carried out and financial resources in several stages:
- Financial analysis of the company.
- Calculation of the size of the investment required for the full functioning of the company and making a net profit.
- Determining the efficiency of the solution and calculating the index of the rate of return on invested capital.
- Consideration of additional factors in the calculation. Most often, fundamental aspects: inflation, changes in the market situation.
It is important to compare the results obtained from the calculation by the method of return on investment with the planned figures.
The payback ratio in human capital does not show the average annual value, but the value of the total investment period. That is, the return on investment is an indicator of the effectiveness of investments for the full investment period.
If the investment project is not a startup, then a mandatory factor in the calculation will be the return on investment for previous periods. This will make it possible to make a more accurate forecast and identify existing problems both in the operation of the enterprise and in the investment process.
The return on capital investment has a broader meaning and is calculated not only when investing in every organization and enterprise. It is used when working with everyone financial instruments for the long term.
The return on invested capital is also calculated for alternative deposits:
- deposit in a bank or other financial institutions;
- investing in PAMM accounts and other types of trust management;
- deposits in various investment portfolios;
- long-term investments in exchange instruments.
Return on investment requires control. This is the ability to manage not only the level of profitability, but also investment activities... If the segment for cash injections seems attractive, but when calculating the investor did not receive the expected payback rate, then other actions can be taken using investments. For example, increasing the profitability of sales, turnover and transfer of real assets.
How to calculate ROI: formula and examples
ROI calculation can be done in several ways. For those who want to simplify their life and not engage in routine, you can use various programs, online calculators, Excel tables. You just need to enter the desired profitability formula in them, and the calculation will take place automatically.
You can also hire someone who knows how to count. This can be an accountant, financier, trustee, or a seasoned investor. But first, it's better to learn to understand all the factors yourself and calculate the return on investment ratio in order to independently manage your capital and understand how money is used.
There are 3 common methods for calculating ROI:
- The first formula for return on investment is the ratio of income (before taxes) to company assets (that is, the amounts spent on production facilities and their estimates, taking into account depreciation at the end of the investment).
- The second formula is the ratio of income (before taxes) to sales multiplied by the ratio of sales to company assets.
- The third is the return on sales as a percentage, multiplied by the company's asset turnover.
It is impossible to determine in what way a more accurate result can be obtained. Rather, each of these options is correct. The fact is that return on investment is a fairly broad concept, and it can be interpreted differently for each individual business segment, taking into account its specifics.
Universal ROI Formula
In all three formulas, the main criteria for increasing ROI are an increase in the level of profitability from sales and asset turnover.
Based on this, an optimal formula is deduced, which can be applied in any area of \u200b\u200bbusiness (taking into account certain nuances, of course).
Let us give specific example calculation. The entrepreneur decided to make a purchase of a trading instrument, for example, let's take cryptocurrencies popular today. Amount - investment $ 100. The price of one coin is measured at $ 20. The investor expects the price to rise to $ 25 per unit after a while, after which he sells it. The profit is $ 25. Thus:
ROI \u003d (125-100) / 100 * 100% \u003d 25%
ROI (profitability) will be 25%. This figure can be considered good. But this is only a statistical method. Other important factors cannot be counted here - inflation, asset volatility, in general, any trading and non-trading risks. Moreover, the indicator is not fixed. It can vary due to changes in the price of the asset. Therefore, it is important to do periodic recalculations.
As you can see in the example, the formula can be used for investment strategies in speculative assets - Forex, exchange instruments, cryptocurrencies,
This method can be used if you need to quickly calculate several projects and find out which one will be the most attractive. You will need to know the following data:
- cost - the cost of manufacturing a product, including the cost of raw materials, production capacity, marketing;
- income - the total profit received after the sale of services and products;
- investment amount - the total amount of funds invested.
PI formula for ROI
Also, profitability can be viewed using the PI index (PI - profitability index).
It is calculated as the ratio of the amount of discounted cash flows to the initial investment. The abbreviated formula looks like this:
- PI - profitability index;
- NPV
- I - initial investment.
But NPV is difficult to calculate, especially for beginners. Therefore, it is better to entrust it to professionals. For those who have decided to calculate everything on their own, the formula for calculating cash flows (NPV) will look like this:
- NPV - the amount of discounted cash flows;
- n, t - time periods;
- CF - flow of payments (ie CFt - payment in t years);
- R - discount rate.
This indicator allows you to rank projects with limited investment resources and select only those that will provide greater investment efficiency. This formula is very effective when investing in highly volatile instruments, in particular cryptocurrency.
The formula is not suitable for speculators who invest in assets in the short term, during the day or week.
What is a good indicator?
What should be the ROI? The breakeven point is twenty. This means: if the equation showed 10 in the calculation, such an investment is unprofitable. If it turned out 20, the investor will only be able to recoup the investment, and then the net profit will go.
ROI can be an indicator of efficiency when choosing a project. If the ROI formula attractive project can be considered with a return on capital ratio of more than 20%, then PI will have different values
If PI is defined as less than 1, this indicator is negative, and investment in this project can be considered unprofitable. The average norm is 1: in this case, you can consider the investment project in more detail - this is the normative return. If it is higher than 1, then, most likely, this is a promising project with high profitability (without taking into account risks). Analytical departments of all major companies are engaged in such calculations.
Among other disadvantages of this method, it can be noted that the longer the term of the deposit, the less the accuracy of the result forecast becomes. This increases the PI uncertainty.
Calculating the return on investment ratio in accounting
The return on invested capital in accounting is calculated differently. ROI is also not based on valuation cash deposits, but on the profit of the business.
This ratio shows the ratio of the average value of the income of the enterprise according to the financial statements to the average value of the cash injections. But unlike the previous formulas, this indicator is calculated on the basis of earnings before interest and tax costs (EBIT - earning before interest and tax) or taking into account income after tax payments, but before deducting interest (that is, EBITx (1- H), H - income tax).
The second option is most often used (that is, after the tax has been paid), since it better indicates the benefits received from the company's activities. When preparing a project or starting an investment, it is very important to discuss which analysis method will be used.
The first method is based on the definition of ROI, in which profit for the year is related to the indicator of the financial injections used. In this case, the amount of annual income must be calculated until the year when production capacity is fully created. In order to reduce the margin of error, ROI is also calculated for each year of the project separately.
In the case of the second method, the indicator is calculated not as the ratio of income for a certain year, but as an average annual value to the initial investment. This takes into account the annual depreciation period for production facilities.
For example, if a company purchases an installation worth 100 million rubles. for use within 5 years, and the profit growth will be about 40 million rubles, then the ROI will be 20%.
There is also a third variant of profitability analytics, in which not the initial investment is taken as a basis, but the average financial injections, that is, the average indicator of assets that will be acquired during the period of the investment project. In this case, you can use both formulas for calculating profitability.
The former is easier to use if the equipment acquired through investment is not sold at its residual value. Then the basis is taken exclusively accounting income, already minus depreciation charges.
The second formula is effectively applied if the production facilities that were created through investments can actually be sold at the residual value, taking into account depreciation, and then this factor will affect the level of return on investment projects.
The formula for calculating the return on investment in accounting
The amount of investment, to which the profitability is determined, will be calculated as the average between the cost of the equipment at the beginning and the end of the considered period of time. Therefore, the formula for calculating the return on capital will look like this:
Where:
ROI - return on investment;
E (1-H) is an indicator of profit net of taxes;
H - as already mentioned, the value of the taxable profit rate;
C2 - the value of assets on the balance sheet (production capacity) at the end of the period;
C1 - the value of all assets (production facilities) at the beginning of the period;
(C2 –C1)) / 2) - the average annual value of the investment, which is calculated as the average between book value assets at the beginning and end of the investment period.
Accounting ROI Effectiveness and Disadvantages
Financial payback indicator investment projects should be compared with other accounting indicators, and the overall value will indicate the profitability of the enterprise, which will allow assessing its business attractiveness. The clarity of this method will allow not only to stimulate employees, but also to attract additional investment.
But this method also has disadvantages. The calculation does not take into account the dynamic value of finance over time (that is, it can change), and does not distinguish between investment data that arise due to the different duration of the assets acquired through the initial investment.
There may also be cases in which the values \u200b\u200bof profitability can be equated with indicators of internal rates of return. These situations arise with such factors:
- When money is invested in enterprises with an unlimited term, where there is an equality of financial infusions for the year.
- When total amount depreciation deductions will be equal to the amount required to completely replace the device retired from the process.
- The working capital will not change over the entire period of the investment project.
Important! These valuation methods provide estimates. Other criteria will help in a more accurate assessment:
- integral cost effectiveness;
- coefficient financial assessments a single project (profitability, liquidity, financial stability);
- breakeven point and so on.
Also for financial plan it will be necessary to determine such factors as the balance of real accumulated funds, the flow of real funds, the balance of real funds.
ROI in Marketing (ROMI)
As you know, investments are required not only in production. You will have to invest in marketing, which should also bring profit.
In the aspect of marketing investments, we can also talk about their profitability. Ten rubles spent on advertising can bring 40 at the exit. Therefore, you need to know what the term ROMI is (from the English return on marketing investment, that is, return on marketing investment).
ROI and ROMI are basically the same thing, only ROMI is used in a narrower segment. More precisely, it is most often used by marketers.
ROMI will also be biased as financial and accounting aspects are not considered in its analysis. As in other cases, there are different formulas, but the basic calculation is the following:
So, if the results were less than 100%, then this means that the project will not have a return on investment in marketing. It is important to note that for startups in the early stages of marketing, this may be the norm.
If the results are equal to 100% or more, this means that the investment in marketing fully pays off and generates income, and this is the rate of return on investment.
This indicator is very often used in Internet marketing:
- Direct sales through mailings, goods and services.
- Customer feedback, timely response and resolution of conflict situations help to raise your reputation and, as a result, attract more customers.
- Various loyalty programs, which consist in collecting information about customers for the purpose of holding events.
- Sales promotion - promotions, bonuses, etc.
The concept of ROMI or Marketing ROI is closely associated with Internet activity. To promote a product and attract customers, entrepreneurs use advertising channels Yandex.Direct, Google AdWords (you can learn more about the Yandex.Direct partner program here). Therefore, it is customary to talk about the return on investment in marketing in terms of the conversion received from advertising. Conversion will be the main determinant of ROMI.
However, this approach only calculates the ROMI for some marketing options. For most critical initiatives, it is impossible to determine whether an investment pays off from marketing. First of all, due to the fact that marketing campaigns are complex in nature - promotions, packaging, additional gifts. It is almost impossible to determine which of the processes gave which conversion, and the costs for them can be completely different. In addition, marketing research can hardly be analyzed in terms of ROI.
Nevertheless, with the help of ROMI, entrepreneurs get the opportunity to analyze those segments, the return of which does not justify financial injections, and diversify capital in more promising areas.
But the return on marketing investment alone is not enough to set up a complete program for maximum profit. It can bring tangible results only in conjunction with other promotion tools and the necessary data, as well as with clear control and analytics of all aspects of the business.
Return on investment is a relative measure. You should not be guided by it as an axiom. Only a general analysis of the business, constant research of all its segments and risk analytics will help bring profit. Several examples are given, and they show that with the same figures, some differences in the calculation are possible. This is why it is very important to take a holistic approach and assess the whole picture.
ROI analysis
IN in this case drawing conclusions from the resulting figure is much easier than calculating it correctly and reasonably. There are only three options:
ROI< 1 ... It is not even entirely clear what the company's management is counting on, promising to return less money to the investor than he will invest.
ROI \u003d 1... The situation is also strange. However, it is quite possible that not all of the investment potential is revealed in the formation of the probable income. You should go back to the calculations and double-check everything carefully.
ROI\u003e 1... The investment promises to be successful. However, vigilance will not hurt in this case.
To determine the estimated amount of profit, the investor needs to subtract one unit from the ROI and multiply the amount of his contribution by the remainder (difference).
For example, ROI \u003d 1.27. The investment amount was 100 thousand rubles. The projected annual profit is 27 thousand rubles.
What can be the return on investment
It should be borne in mind that the highest return on investment is characteristic of the most risky projects. The higher the investment reliability, the lower the dividends promised by the business initiators. At the same time, the low ROI value makes a depressing impression: the incentive to invest in a company with low profitability disappears. As practice shows, the average return on investment ranges from 15 to 25%. Everything above is most likely "golden mountains". Or "forty barrels of prisoners" - that's what anyone wants to call it.
In this case, one should also take into account the specifics of the industry to which the enterprise belongs. Trade business can bring an investor about 25% per annum, but agricultural production is hardly more than 12%.
Problematic moments
Investing is always risky. The danger of error lies in many probable circumstances that are difficult, and sometimes even impossible to foresee. Here is the shortest list:
Difficulties in assessing future payments.Each enterprise in the eyes of the investor is a "black box", at the entrance of which the invested money, and at the exit - the funds returned to him with a profit. However, this object is affected by too many external factors that threaten financial stability. Prices for raw materials, changes in the Central Bank's discount rate, whims of demand, the emergence of new competitive offers on the market - and this is far from full list... There are also natural disasters ...
Difficulties in discounting an investment.This forecast is based on probable values, but the value of the money invested can change dramatically for a variety of reasons. For example, if inflation is slow or at least predictable, then everything is fine. But it also happens otherwise.
Time factor.The longer the investment period, the greater the risks. Everyone understands this: it is easier to foresee the events of tomorrow than what will happen in a year or five years. Short-term investments are mainly interested in financial pyramids... Investments in businesses operating in real marketare always somewhat adventurous.
How to predict profitability
It is always easier to assess the situation after the fact than to be sagacity. When an enterprise is already operating, the assessment of financial performance is a technical challenge: you can take a balance sheet, select the required lines in it and determine the amount of profit, and then, correlating it with costs, get the result.
Another thing is when it comes to prospects. Not always a very good idea meets the response of even experienced investors.
Historical example: Hugh Everett Moore's business plan was to set up a disposable paper cup business in the United States. Now this product has become universally in demand, and then, in 1907, all banks refused to finance the project, considering the product to be useless. The sum of $ 200 thousand was received from the president of the American Canning Company, Graham, who suffered from misophobia, that is, a panic fear of microbes.
There are many other examples, but any entrepreneur, faced with the problem of the need to attract investment, was convinced that this is not an easy business. Everyone knows that forecasts are not always realized. At the same time, they are necessary - without them, the chances of obtaining working capital are generally zero. Fortunately, the technology for determining the return on investment has already been developed and recognized as optimal, and not because it guarantees one hundred percent efficiency. It's just that nothing better has been invented yet.
Return on investment is expressed as a percentage of the profit received by the investor after the implementation of a commercial project.
In other words, when investing, a participant in the investment market wants to know how many cents (kopecks) each invested dollar (ruble) will bring him per year. If the same idea is expressed in the dry language of mathematics, then profitability is the ratio of the amount of the investor's income and the funds invested by him.
There are several ways to form an opinion about the profitability of a business:
- By accessing accounting statements and having read financial results the activities of the enterprise;
- By contacting other investors (shareholders) and finding out the amount of their dividends;
- After listening to the arguments of the project leaders in need of funding;
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