The main objective of investing is to maximize the 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 profitability of invested capital and find out how and using which mechanisms to correctly calculate it.
Invested capital
The concept of invested capital is understood as 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. Moreover, the sources of investment may be internal or external.
Among domestic investment funds, one can distinguish a part of net profit, which is directed to the implementation of funded projects. External or borrowed funds include resources, the use of which is associated with the subsequent withdrawal of part of the profits to repay these investments.
The first option involves investing the share of profit in the development or improvement of production, as well as improving labor efficiency. This, in turn, leads to an increase in revenues from goods and services sold. Borrowing from external sources most often represents bank loans or raising funds from partners.
It should be noted that investment capital consists of several structural units. These include tangible assets, financial assets, and intangible funds. The first include, for example, land and real estate. Financial assets include stocks, debt instruments and parts in other entities. Intangible assets - these are actions aimed at increasing the 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 indicator of return on invested capital. This parameter shows how effective is the investment of own or borrowed funds in the investment object. The goal of any business is to increase the company's market share, gain financial stability, as well as occupy new free niches for the production and sale of goods and services. Return on invested capital is a convenient parameter for indicating these processes.
Profitability ratio
To determine the profitability, it is customary to use the ROIC (Return of Invested Capital) coefficient. It should be noted that this index belongs to the category of indicators of efficiency of use of such means as total assets, share capital, gross and operating profit. The formula for calculating this coefficient is as follows: income - cost / amount of investment.
What is the profitability ratio for?
It should be emphasized that the determination of the return on investment ratio before investing money in the project makes it possible to find out whether the initial investment is appropriate in a particular situation. In addition, in many enterprises, economists use ROICs to measure ROIC to understand the need for investment as such.
The return on invested capital is inextricably linked to such a factor as payback. It is this indicator that indicates the period of time for which the invested funds will bring the expected return. Several factors affect the payback, 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 plus is a fairly simple method of calculating the ROIC coefficient. As mentioned above, for this it is enough to know the value of the probable profit and the volume of investments. The main disadvantage of calculating profitability can be called the presence of errors caused by the presence of unaccounted financial actions.
However, for small businesses and not too large investment projects, the described formula for calculating the profitability ratio of invested capital is certainly sufficient.