For each serious person who wants to invest the most profitable client or own funds, the main financial process is the determination of the most important economic indicators for the investment project. One of them is the net cost of the project. It is determined by a number of factors, including the volume of production and sales of certain companies, as well as the amount of investment. Therefore, the effectiveness of investments does not always correspond to the net cost, and to calculate this main parameter, an additional financial instrument called the index of return on investment is used. With its help, the approximate income of the investment project will be determined with a certain amount of funds invested in it. The return on investment here will be discounted cash flow, but not net profit.
The profitability index, also called the Profitability Index and the profitability index, is an indicator that reflects the investment efficiency of a business project. The profitability index is numerically equal to the ratio of a given cost of cash flows to the initial costs of the project, and attacks to investments aimed at its implementation. The index is calculated by the formula: ID = NS / I. NS is the real value of these cash flows, And is the sum of all investments that are aimed at the implementation of the project. In the event that investments are made earlier, their value is also given to this.
If the value of the profitability index is equal to or less than one, this means that the project is unprofitable. In this case, they are rejected, as they are not able to bring the investor additional income. Usually, only those are realized whose profitability index is greater than one. If the index is equal to one, then the project is considered break-even.
Profitability Index is a relative indicator that determines the level of income per unit of cost. The greater its value, the higher will be the return on investment. That is why when choosing from a number of alternative projects, one uses the profitability index.
In general financial calculations, two types of profitability index are used:
- return on investment index (ratio of discounted expense to the amount of discounted cash flows);
- cost-effectiveness index (ratio of total costs to total profits) This index, as well as the economic outflows and inflows used in this calculation, can be discounted.
There is also an index of profitability of discounted investments, with the help of which those problems that arose when finding an internal payback ratio are solved. It allows you to not take into account the positive and negative values of cash flows of individual years in forecasting. The discounted profitability index is not used enough as an analysis tool. This can be explained by the fact that the vast majority of people holding managerial positions, even if they know that there is a discounted index, are not able to apply it.
For the internal payback ratio, the confidence score is forty percent. This assumes that the project is quite good, but if it were known that the discounted profitability index of the project is 1.10, the interpretation of this fact would become unknown. Since the profitability index is determined by cash flows, any value of this coefficient, despite the fact that it exceeds 1.0, is considered acceptable from an economic perspective.
Thus, it should be noted that the increase in investor income can be most accurately calculated using the above economic instruments.