There are a number of methods that allow you to evaluate the effectiveness of a particular activity of the enterprise. One of the most popular methods, which can be called one of the simplest, is the calculation of profitability indicators. By determining profitability, they evaluate the production and marketing activities of the enterprise, the degree of efficiency of the use of assets and equity, and much more. One of the most important indicators of this group is the return on investment index, and we will dwell on it in more detail.
As the name suggests, the ROI allows you to evaluate the degree of efficiency (profitability) of a particular investment. This indicator can be used for both financial and real investments. However, the calculation in each of these cases may differ in some way. The main difference is that in determining the profitability of investments in certain financial instruments often do not take into account the time factor. This is due to the fact that such investments are usually made for a much shorter period than real investments.
The return on investment index, like any other rate of return, characterizes the ratio of profit to a certain indicator. In this case, the profit is compared with the amount of investment. In the case of financial investments, for example, the acquisition of a particular type of securities, the calculation is as follows: the numerator is the total amount of income received from owning the security (interest income and the difference between the purchase and sale prices), and the denominator is the price purchases, i.e. initial investments.
In the case of a project related to the implementation of real investments, the calculation of the index in question will be somewhat more complicated. Given the time factor, it is necessary to divide the discounted amount of cash flow for the analyzed period by the amount of discounted investments for the same period. It should be noted that for such a coefficient a value has been established that clearly indicates effectiveness or inefficiency. This value is 1. Accordingly, if the resulting index is larger, then the project should be accepted, if less, reject. In the case of a coefficient equal to unity, it is necessary to take into account the presence of other positive effects besides the economic one. Obviously, this ratio can be calculated in a slightly different way, namely, by the ratio of the net present value to the current date to the value of the discounted investment. The resulting value will need to be increased by one. Based on the foregoing, we can conclude that indicators such as NPV and profitability index are interrelated. With a negative current project cost, the ROI will be less than one, and vice versa.
Profitability assessment has found wide application in various areas of the enterprise. For example, there is a method of return on investment, which is one of the pricing methods. Its essence is that the implementation of a project related to the production of certain products should ensure profitability at a level that will allow you to pay borrowed resources.
In addition, there are a number of indicators that characterize not a single project, but the enterprise as a whole. For example, the rate of profitability of an enterprise is determined by the ratio of profit to cost and allows you to judge how effective production activities are. Such indicators do not have established normal or boundary values, so they need to be analyzed in dynamics.