ROI - Return on Investment

 

What is ROI ? 

 

The Return On Investment (R.O.I.) is a ratio that measures the company's operating profitability in relation to the total assets used (i.e. net of financial, extra-fiscal, extraordinary and fiscal management). In other words it measures the return (return) of the total capital invested in the company to run its business activity and up to a certain extend the degree of competitiveness of a company.

The Return On Investment (ROI) is an important indicator in the field of accounting, enterpreneurship, investments, finance, risk management and financial management because it allows You to evaluate the profit a company (or entity) will earn if You invest in that company business.

It is an indicator that provides information on the financial well-being of a company and it reveals the efficiency of the overall operating activity of the management. 

 

 

 

 

THE DUPONT FORMULA

 

According with the formula of DuPont, the ROI is a Key performance indicator that comes from other two important financial ratios. However, depending on the analysis the ROI can be broken down into two important factors: the profit margin ratios (net or gross) and the asset turnover ratio. 

 

 

This formula shows that the break-down of the Return On Investment is based on the thesis that company profitability is directly related to management's ability to manage assets efficiently and to control expenses effectively. In fact the Net Profit Margin (percentage of profit earned on sales) is a measure of profitability and the Total Assets turnover measures how well a company manages its assets. 

 

 

 

By using the ROI with the DuPont formula the management can gain a great deal of insight into how to improve profitability and therefore improve investment strategy. The main advantages coming from the ROI break-down are therefore in the importance of turnover os a key driver for the overall profitability in fact turnover is just  as important as profit margin in enheancing overall return. It recognise the importance of sales and it stresses the possibility of trading margin for turnover in an attempt to improve the performance of the company. In other words a low turnover of assets can be made up by a high margin and vice versa.

 

FACTORS INFLUENCING ROI 

 

Main factors influencing the Return On Investments (ROI) are therefore "margin" and "turnover". So that for profit improvement, the copany's management can take various actions to enheance the ROI like improving margin, improving turnover or improve both. Generally improving margin can be achieved by reducing expenses, raising selling price or increasing sales faster than expenses. Improving turnover can be achieved by increasing sales while holding the company's investment relatively constant or by reducing assets. 

To conclude the factors are Cost of Goods Sold (COGS), General Costs that impact on the total cost and Selling Price. And also, Acounts receivable, Inventories and other assets included in the total assets book value (current assets and fixed assets). 

 

 

IS THERE AN OPTIMAL ROI ? 

 

There is no one R.O.I. that can be considered satisfactory for a company. Even if the success of the operations comes from the optimum combination of profit, sales, and capital employed, the precise combination necessarely varies  with the nature of the business and te characteristic of the product. As a fact of the matter an Industry may have different tailored customers specification and dynamics with different margins and turnover ratios. 

 

 

 

ROI DEEP ANALYSIS: 

 

A deep analysis conducted on the R.O.I. can reveal strenghts and weaknesses of the company business and its segments, and, it can give a detailed path over what needs to be done to improve performance and profitability.

High variability of R.O.I. could lead lenders and banks to adopt prudent behaviour towards the company, which, despite having good economic margins, has a significant debt ratio. 

The R.O.I. must always be compared with the company's Return On Debt for the purpose of conducting a deep profitability analysis that considers the structural dynamics of the company as a whole.

 

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