2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16
The main objective of investing is to get the maximum return on investment. In order to predict the likely profit and evaluate the financial performance of the project, various mechanisms are used. In this article, we will consider the return on invested capital and find out how and with what mechanisms it is correct to calculate it.
Invested Capital
Under the concept of invested capital is understood the amount of funds aimed at the implementation of the project, the development of the production of goods and services in order to obtain the maximum possible profit. At the same time, the sources of investment can be internal or external.
Among internal investment funds, one can single out a part of the net profit that is directed to the implementation of financed projects. External, or borrowed, funds include resources, the use of which is associated with the subsequent withdrawal of part of the profits to pay off these investments.
The first option involves investing a share of the profits in the development or improvement of production, as well as increasing labor efficiency. This, in turn, leads toincrease in revenue from goods and services sold. Borrowing from external sources is most often bank loans or raising funds from partners.
It should be noted that the investment capital consists of several structural units. These include tangible assets, financial resources, as well as intangible funds. The former include, for example, land and real estate. Financial assets include shares, debentures and interests in other enterprises. Intangible assets are activities aimed at increasing business, such as increasing market presence or conducting market research.
Return on invested capital
One of the main places in the field of investment is the rate of return on invested capital. This parameter shows how effective is the investment of own or borrowed funds in the investment object. The task of any business is to increase the company's share in the market, gain financial stability, as well as occupy new free niches in the production and sale of goods and services. Return on invested capital is a convenient indicator of these processes.
ROI
To determine profitability, it is customary to use the ROIC (Return of Invested Capital) ratio. It should be noted that this index belongs to the category of indicatorsefficiency in the use of such means as total assets, share capital, gross and operating profit. The formula for calculating this ratio is as follows: income - cost / investment amount.
What is the profitability ratio for?
It should be emphasized that the determination of the return on invested capital before investing in a project makes it possible to find out how expedient the initial investment is in a particular situation. In addition, in many enterprises, economists use the ROIC indicator to understand the need for investment as such.
Return on invested capital is inextricably linked with such a factor as payback. It is this indicator that indicates the period of time for which the invested funds will bring the expected income. The payback is influenced by several circumstances, including macroeconomic indicators, as well as the characteristic features of a particular sector of the national economy.
In conclusion, we should mention the main advantages and disadvantages of calculating profitability. The advantage is a fairly simple method for calculating the ROIC coefficient. As mentioned above, for this it is enough to know the value of the probable profit and the amount of investment. The main disadvantage of calculating profitability is the presence of errors caused by the presence of unrecorded financial actions.
However, for small businesses and nottoo large investment projects, the described formula for calculating the return on invested capital is certainly sufficient.
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