Money makes money. This statement is a key description of the modern economic model. In fact, it can be called true, however, in order for the money to work and make a profit, it is not enough just to possess it. It is also necessary to be able to carry out sometimes quite complex calculations and choose only those projects in which the invested money can bring the necessary return.
There can be no guaranteed return, and therefore there is a need to analyze the profitability of the project before risking it with our own funds. The investment process itself resembles a game in a casino, but unlike gambling, here the player has a positive expectation. It is the magnitude of this expectation that determines the attractiveness of the project in the eyes of the investor
As for profitability, this indicator reflects the ratio of expected profit to the amount of invested funds. Thus, it is calculated using one simple mathematical action - division, however, both the numerator and the denominator of this fraction are not so easy to determine. The fact is that the profitability of the project is not based on ordinary figures, but on discounted values that reflect the theory of the time value of money.
This theory is based on the assumption that $ 100 today is worth more than the same money tomorrow. This absurd, at first glance, statement makes sense if we recall inflation and lost profits. That is, the investor could have the funds on hand in the bank and pick them up after a while, therefore, the calculation of the project’s profitability is carried out taking into account this fact.
To calculate the numerator, which indicates the estimated income, it is necessary to summarize all expected amounts to be received over the entire life of the project, previously discounted. The life of the project can be known in advance, if it is not defined, then it is supposed to take into account in the calculations no more than ten years or the period for which receipts can be predicted with sufficient accuracy.
For discounting, it is necessary to divide the expected income by a discount coefficient raised to the extent how many years have passed since the moment of investing the money. The coefficient is calculated as a unit plus the average bank rate existing at the time of investment, divided by one hundred.
Having considered all the possible income, you can move on to expenses. At the same time, keep in mind that in order to reliably determine the profitability of an investment project, it is necessary to take into account all investments in the project throughout the entire period of existence, and not just the initial investments. Do not forget to discount these additional investments, in the same way as the income was discounted.
In addition, it will not be amiss to take into account all the alleged risks. This includes possible fines, property damage, etc. Calculate the possible losses and multiply by a coefficient that determines the probability of a risky event. The resulting amount must also be added to the denominator.
Now, finally, you can determine the very profitability of the project. If it is more than one, then the project will be profitable for the investor, if less - unpromising. When comparing various projects, the one with the profitability indicator will be higher in a more advantageous position.
Now you know how to calculate the profitability of the project, and you know how to use this indicator to make investment decisions. However, do not forget that a number of other indicators also influence decision-making, and it is not necessary to invest in a project only because its profitability will be higher.