Return on investment on invested capital is determined in several ways, depending on the basis of measurement. Capital can be invested in the real sector of the economy or in the financial sector.
Many investors simultaneously invest in assets of the real sector of the economy and financial instruments. The tool for analyzing the profitability of such investments are indicators:
The return on investment ratio shows the return on invested capital in the business at the current moment and is regularly assessed in the course of the activity of the invested object.
It is defined as the ratio of the difference in income minus production costs to the total investment in the business as a percentage.
Full business investment includes equity and long-term liabilities of the investee:
Where:
This indicator reflects the effectiveness of management investment capital, according to which the investor evaluates the work of the management of the invested object. A positive performance assessment occurs when ROI > 100%, which means that the investment has paid off and is making a profit. The size of this profit and the dynamics of its change serve as an assessment of the effectiveness of the company's activities.
For example:
Then ROI, in accordance with formula (1), at the beginning and end of the year will be: 40% and 50%, i.e. the return on investment ratio increased by 10%, which indicates the high efficiency of the company's management.
Another indicator of the return on investment on invested capital is the ROIC (Return On Invested Capital) indicator - translated from English as “return on invested capital”, and in fact, the return on invested capital.
It is defined as the ratio of net profit to the capital invested in the main activity of the investee.
In Russian economic terminology, this is an indicator of the return on investment, but only those that are invested in core activities, that is, the return on investment in fixed capital. Fixed capital in this case means fixed assets plus net other assets with the amount of working capital for the main activity. A prerequisite for calculating this indicator is that the net profit created only by the capital that is in the denominator of this indicator is taken into account. Sometimes, in case of difficulty in isolating total cost fixed capital and the determination of the profit created by it, they resort to a simplified calculation, dividing all profit by the cost of capital. If the size of non-fixed assets is small, then the error of the indicator will be small and acceptable for analysis, but if this is not the case, then such an indicator cannot be trusted.
This indicator demonstrates to the investor the ability of the management of the investee to generate added value in comparison with other investee objects of the investor. For such assessments, a certain standard is used - the rate of return on investment in a competitive environment.
The rate of return on an investment is the ratio of the return received to the investment that generated that return in percentage terms over a specific period of time.
For example, an investor has three investable objects:
Accordingly, ROIC at the beginning and end of the year:
Accordingly, the rate of return is:
If the investor considers the minimum allowable rate of return per 1 ruble of investment to be 10%, then 1 and 2 investment objects do not meet this requirement and the reasons for such a low return on investment should be analyzed, and for the second object an additional analysis of the decrease in investment return is required. If it is impossible to increase the profitability of 1 and 2 investment objects, the investor raises the issue of closing the investment project.
If the analysis of the return on investment is carried out over several years, then cash flows are discounted by the time the profitability is analyzed at the discount rate adopted by the investor.
The disadvantage of this indicator is that the management is focused on "squeezing" profits from investments in any way at the current moment, which can lead to a lag in the renewal of production and ultimately lead to a loss of the company's competitiveness.
Return on investment on invested capital in financial assets consists of current and capitalized components.
Current income is defined as the difference between the sale price received at the end of the investment period and the purchase price security.
I = St - So
For example, an investor purchased 10 shares at a price of 1,000 rubles at the beginning of the year, and at the end of the year, his income from the sale of shares amounted to 11,500 rubles. In this case = 11,500 - 10,000 = 1,500 rubles.
The ratio of current income to invested investments is called the capital gain or interest rate and is expressed by the following formula:
Where rt is the interest rate, and for this investment it is 15%.
Another indicator for evaluating the return on invested financial capital is called the relative discount. It is defined as the ratio of current income to income at the end of the period:
Or for our example: dt = 1500 / 11500 * 100 = 13%.
This indicator is also called the discount factor. The interest rate is always greater than the relative discount.
The total return reflects the increase in invested capital for a defined period, taking into account the redemption of the security.
The main indicator used in the analysis of total return is yield to maturity YTM, which is akin to the internal rate of return of an investment, IRR, is the average effective interest rate at which the value of all income received is discounted to the value of the initial investment. Like IRR, this indicator is rather complicated to calculate, but the formula for a simplified calculation of this indicator is presented below:
For example, purchased 10 shares for 10,000 rubles bring annual income:
The capitalization of 10 shares by the end of 3 years amounted to 1,500 rubles:
YTM = 4500+(11500-10000)/3/(11500+10000)/2= 46.5%
Obviously, the yield to maturity is significantly higher interest rate, which allows us to assert the expediency of these investments in a financial instrument.
Consider return on equity enterprises. Let's delve into the analysis of two coefficients that determine the return on capital: return on equity(ROE) return on capital employed(ROCE).
Return on equity ratio (Return On Equity , ROE) shows how effectively own funds were invested in the enterprise.
Return on capital employed(Return On Capital Employed, ROCE) shows the effectiveness of investing in the enterprise, both own and borrowed funds. The indicator reflects how effectively the enterprise uses its own capital and long-term attracted funds (investments) in its activities.
To understand the return on equity, we will analyze and compare two ratios ROE and ROCE. The comparison will show the difference between one and the other. The scheme for parsing two ratios of return on capital will be as follows: consider economic essence coefficients, calculation formulas, standards and we will calculate them for a domestic enterprise.
Return on equity. Economic entity
The ratio of return on capital employed (ROCE) is used in practice financial analysts to determine the profitability that the company brings to the invested capital (both own and attracted).
What is it for? In order to be able to compare the calculated profitability ratio with other types of business in order to justify the investment of funds.
| ROE | ROCE | |
| Who uses this ratio? | Owners | Investors + owners |
| Key differences | Own capital is used as an investment in the enterprise | As an investment in the enterprise, both equity capital and borrowed capital (through shares) are used. In addition, we must not forget to subtract dividends from net income. |
| Calculation formula | =Net profit/Equity | =(Net income)/(Equity + Long-term liabilities) |
| standard | Maximization | Maximization |
| Industry to use | Any | Any |
| Evaluation frequency | Annually | Annually |
| Accuracy of valuation of the company's finances | Less | More |
To better understand the difference between return on equity ratios, remember that if the company does not have preferred shares (long-term obligations), then the value of ROCE=ROE.
If the return on equity ratio (ROE or ROCE) decreases, then this indicates that:
If the return on capital ratio (ROE or ROCE) is growing, then this indicates that:
Consider synonyms for return on equity and return on capital employed, since they are often referred to differently in the literature. It is useful to know all the names in order to avoid confusion in terms.
| Synonyms for return on equity (ROE) | Synonyms for return on capital employed (ROCE) |
| return on equity | return on capital raised |
| Return on Equity | return on equity |
| Return on shareholders' equity | return on equity |
| equity efficiency | capital employed ratio |
| Return on owners equity | Return on capital Employed |
| return on invested capital |
The figure below shows the accuracy of assessing the state of the enterprise using various coefficients.
The Capital Employed Ratio (ROCE) is useful for the analysis of enterprises where there is a high intensity of capital use (often invested). This is due to the fact that the ratio of employed capital uses the attracted funds in its calculation. The use of the ratio of capital employed (ROCE) allows you to make a more accurate conclusion about the financial results of companies.
Calculation formulas for return on equity.
Return on Equity Ratio = Net Profit/Equity Equity=
p.2400/p.1300
Capital Employed Ratio = Net Income/(Equity Equity + Long-Term Liabilities)=
p.2400/(p.1300+p.1400)
AT foreign version the formula for return on equity and return on capital employed will be as follows:
Net Income - net income,
Preferred Dividends - dividends on preferred shares,
Total Stockholder Equity - the amount of ordinary share capital.
Another foreign formula (according to IFRS) for the return on capital employed:
Often foreign sources use EBIT (earnings before taxes and interest) in the formula for calculating ROCE, in Russian practice net income is often used.
In order to better understand what the return on capital is, let's consider the calculation of its two coefficients for a domestic enterprise.
To assess the return on equity of Mechel OAO, we take from the official website financial statements for four periods of 2013 and calculate the ROE and ROCE.
Return on equity for Mechel OAO-1
Return on equity for Mechel OAO-2
Return on equity of Mechel OAO
Return on equity ratio 2013-1 = -3564433/126519889 = -0.02
Return on equity ratio 2013-2 = -6367166/123710218 = -0.05
Return on equity ratio 2013-3 = -10038210/120039174 = -0.08
Return on equity ratio 2013-4 = -27803306/102274079 = -0.27
Return on capital employed 2013-1 = -3564433/(126519889+71106076) = -0.01
Return on capital employed 2013-2 = -6367166/(123710218+95542388) = -0.02
Return on capital employed 2013-3 = -10038210/(120039174+90327678) = -0.04
Return on capital employed 2013-4 = -27803306/(102274079+89957848) = -0.14
I did not quite successfully choose the example of the balance of the enterprise, since the profitability for all periods was less than 0, which indicates the inefficiency of the enterprise. However, the general calculation for return on equity ratios is clear. If we had income, then the ratio of these two coefficients would be as follows: ROE>ROCE. If we also consider the return on assets of the enterprise (ROA) in relation to the return on capital ratios, then the inequality will be as follows: ROA>ROCE>ROA.
An enterprise can be considered as a potential investment object when ROCE (and, accordingly, ROE) > risk-free / low-risk investments (for example, bank deposits).
Summary
So, we looked at the return on equity. It includes the calculation of two ratios: return on equity (ROE) and return on capital employed (ROCE). Return on equity is one of the key performance indicators of an enterprise, along with such factors as return on assets and return on sales. You can learn more about the return on sales ratio in the article: ““. These ratios are useful to calculate for the owners of the enterprise and investors in order to find a suitable object for investment.
Material from the site
return on equity (ROE), also used the term "Return on equity") - a financial ratio that shows the return on shareholders' investment in terms of accounting profit. This assessment method accounting similar to return on investment (ROI).
This relative performance indicator is expressed in the formula:
Divide the net profit received for the period by the equity of the organization.
The amount of net profit is taken for the financial year, excluding dividends paid on ordinary shares, but taking into account dividends paid on preferred shares (if any). Share capital is taken excluding preferred shares.
The financial indicator of return ROE is important for investors or business owners, since it can be used to understand how efficiently the capital invested in the business was used, how efficiently the company uses its assets to make a profit. This indicator characterizes the efficiency of using not the entire capital (or assets) of the organization, but only that part of it that belongs to the owners of the enterprise.
However, Return on Equity is an unreliable measure of a company's value, as it is believed to overestimate economic value. There are at least five factors:
1. Duration of the project. The longer, the greater the overestimation.
2. Capitalization policy. The smaller the share of capitalized total investments, the greater the overestimation.
3. Depreciation rate. Uneven cushioning results in a higher ROE.
4. Delay between investment costs and return from them through inflow Money. The larger the gap in time, the higher the degree of overestimation.
5. Growth rates of new investments. Fast growing companies have lower Return on Equity.
Traditionally, the effectiveness of a company's activities is assessed using profitability (or profitability) indicators. Depending on the directions of investment of funds, the form of raising capital, as well as the purposes of calculation, they can be divided into two groups: return on capital (or return on capital) and profitability of financial and economic activities (profitability of the business).
The indicators included in this set differ in the method of calculation, the purposes of their use, which makes it difficult to choose an indicator that corresponds to the task and adequately reflects the success of the business as a whole or its individual areas.
In general under profitability refers to the ratio of profit received over a certain period to the amount of invested capital. The economic meaning of this indicator is that it characterizes the profit received by capital investors from each ruble of funds (own or borrowed) invested in the enterprise.
Profitability is the result of a large number of factors, therefore, being a kind of generalizing indicators, profitability ratios determine the efficiency of the company as a whole (Table 7.6).
Table 7.6.
Return on Assets, ROA or ROTA:
Shows how much net profit the firm receives per unit of assets, and serves as an estimate of the profitability of the business in relation to its assets. The higher the return on assets, the more efficiently the company's resources are spent. For analytical purposes, the profitability of current assets can also be calculated.
For calculations, you should use the average value of assets for the period, and not their size at the end of the year. If it is necessary to level the influence of the amount of taxes and interest paid, not net, but operating profit (profit before taxes and interest) can be taken into account.
Return on All Assets (ROA) is recommended for analysis within the same industry, but not for comparing different industries. Most widely used by analysts industrial enterprises and financial organizations.
Return on equity (ROE) characterizes the return on investment of shareholders, shows the presence of profit per unit of invested equity capital:
It is of particular importance for company owners, as it serves as the best assessment of the results of its activities from the standpoint of shareholders. However, this indicator is largely determined by the structure of capital and the cost of individual elements that make up its composition.
The calculation is considered correct based on the average value of equity capital, since a certain part of the profit can be reinvested during the entire reporting period.
In general, on ROE and ROA special attention is drawn, since they are considered indicators of the profitability of a business and, accordingly, its investment attractiveness.
In addition, the coefficient ROE allows the analyst to compare the profitability of the activity of this enterprise with the possible income from alternative investments of funds (in other enterprises or securities).
The invested (used capital) is a long-term capital, i.e. sources of funding that are not subject to return within fiscal year. Calculated as the sum of equity and long-term liabilities (or assets minus short-term liabilities). In some cases, not long-term debt can be taken into account, but all debts that imply the payment of interest ( financial debt). This method of calculation is used when evaluating activities in the context of individual areas:
Describes the effectiveness of the operating room and investment activity companies; shows how competently managers work with borrowed and equity capital.
It should be noted that profitability indicators are closely related to the structure of business financing. A typical task that company managers solve is to find the optimal capital structure that provides the maximum increase in the return on equity investments, taking into account the changing market share.
Let's see how it changes ROCE on profit before tax (EVT) in two companies, one of which uses a debt-free business financing scheme, and the other uses a mixed one.
Example 7.4
Analysis of a typical task
Determine the return on invested capital for companies "U" and "2", which have different business financing structures.
Initial data
Solution
Let's analyze the value of the return on equity of companies "U" and "2" in terms of profit before tax:
Conclusion. Company financing structure "2" provides a higher return on equity on profit before tax.
Now let's evaluate the sensitivity of companies "Y" and "Z" to the loss of market share.
Let us assume that sales volumes in both companies fell and EBIT will be reduced equally to 400:
ROCEm= 400/4000 x 100% = 10%; ROEBt(X) = 400/4000 x 100% = 10%;
ROCE(Z) = 10%;
ROEb((Z) = [(400-2000 - 15%)]/2000) x 100% = 5%.
ROCE< Interest rates on loans, therefore, raising debt capital reduces ROE.
The negative effect of financial leverage is high sensitivity to loss of market share.
To assess the effectiveness of the company's activities in terms of sales dynamics and the resulting revenue, indicators are used that characterize the share of profit in revenue (or total amount income).
Profitability of sales (Return on Sales, ROS):
As a numerator in exponent ROS can be used not only net profit, but any financial results, whose share in the revenue is estimated ( gross profit, EBITDA, EV/G, etc.). With the help of coefficients related to the group "Return on sales", the profitability of the business as a whole and individual areas of the company's activities can be assessed. The high value of this indicator (also called the rate of return) indicates that the company may have advantages over competitors (efficient management, advanced technology, etc.).
The value of return on sales has serious industry specifics. This is mainly determined different speed turnover of funds of companies in various industries. Accordingly, comparison of actual values ROS a specific company can be carried out either with industry average data or with the return on sales of a reference company in the industry.
At first glance, business activity ratios are easy to analyze. However, these rather "insidious" indicators can lead to incorrect conclusions and direct errors for the following reasons:
Thus, in order to analyze business activity and efficiency using the coefficient method, it is necessary to bring the reporting data into a comparable form. However, even these operations do not eliminate all the shortcomings of the methodology, and therefore the conclusions based on the results of the analysis should be formulated correctly, with a great deal of caution.
All of these indicators can be turned into a time series in order to identify the most significant factors affecting the results of the financial and economic activities of the company, as well as to determine the effectiveness of operational management.
Return on total capital is calculated using the following formula:
This indicator is the most interesting for investors.
To calculate the return on equity, I use the formula:
This ratio shows the profit from each capital invested by the owners monetary unit. It is a basic coefficient that characterizes the effectiveness of investments in any activity.
If it is necessary to analyze the profitability of sales based on sales proceeds and profit indicators, profitability is calculated for individual types of a product or for all its types as a whole.
gross margin of the product sold;
operating profitability of the product sold;
net profit margin on product sold.
The calculation of the gross margin of the product sold is carried out as follows:
The gross profit indicator reflects the efficiency of production activities and the effectiveness of the pricing policy of the enterprise.
To calculate the operating profitability of a product sold, the following formula is used:
Operating profit is the profit that remains after deducting administrative expenses, distribution costs and other operating expenses from gross profit.
Net profit margin of product sold:
If over any period of time the indicator of operating profitability has not changed, while at the same time the indicator of net profitability has decreased, then this may indicate an increase in expenses and losses from participation in the capital of other enterprises, or an increase in the amount of tax payments. This ratio demonstrates the full impact of enterprise financing and capital structure on its profitability.
gross margin of production.
net profitability of production;
These indicators reflect the profit of the enterprise from each ruble spent by it on the production of the product.
To calculate the gross margin of production, the following formula is used:
Shows how many rubles of gross profit fall on the ruble of costs that form the cost of the product sold.
Net profitability of production:
Reflects how many rubles of net profit fall on the ruble of the product sold.
In relation to all the above indicators, positive dynamics is desirable.
In the process of analyzing the profitability of an enterprise, one should study the dynamics of all the considered indicators, as well as compare them with the values of similar indicators of competitors and the industry as a whole.
52. Depreciation policy of the enterprise
The depreciation policy of an enterprise is a strategic and tactical set of interrelated measures to manage the reproduction of fixed capital in order to timely update the material and technical base of production on a new technological basis
The depreciation policy of an enterprise is determined from the economic strategy, the composition of fixed assets, methods for estimating the cost of depreciating objects, the inflation rate, etc. The depreciable property of an enterprise is most types of fixed assets (with the exception of land), as well as intangible assets. Fixed assets are accepted on the balance sheet of the enterprise at their original cost, which also includes the cost of transportation and installation work, after which depreciation is subtracted from them, i.e. resulting in residual value. Depreciation deductions (depreciation fund) are the main component of financial support for the reproduction of fixed assets.
In the process of forming the depreciation policy of the enterprise, the following factors are taken into account:
a) the volume of used fixed assets and intangible assets subject to depreciation;
b) methods for estimating the cost of used fixed assets and intangible assets subject to depreciation;
c) the actual period of the expected use of depreciable assets at the enterprise;
d) methods of depreciation of fixed assets and intangible assets permitted by law;
e) the composition and structure of the fixed assets used;
f) the rate of inflation in the country;
g) investment activity of the enterprise in the forthcoming period.
When choosing depreciation methods, proceed from the current legislative framework in this area, the expected period of use of depreciation assets and the tasks of forming the investment resources of the enterprise in the context of individual sources. The decision to apply the method of straight-line (linear) or accelerated depreciation of fixed assets is taken by the enterprise independently.
The funds of the depreciation fund, which is formed from accumulated depreciation deductions, are targeted and should be used for the following purposes:
a) overhaul of fixed assets;
b) implementation of reconstruction, modernization, technical re-equipment and other types of improvement of fixed assets;
c) acquisition of new types of intangible assets (primarily related to innovation activities)
53. Settlement and cash services for enterprises in banks
54. The relationship of financial indicators. dupont formula
Financial indicators reflect the size, composite dynamics and the relationship of social phenomena and processes occurring in the field of finance, in their quantitative and qualitative state. The diversity of financial relations determines the diversity of financial indicators.
Factor analysis is the process of studying the influence of individual factors (reasons) on the performance indicator using deterministic and statistical research methods. In this case, factor analysis can be both direct (analysis itself) and reverse (synthesis). With the direct method of analysis, the performance indicator is divided into its component parts, and with the reverse method, the individual elements are combined into a common performance indicator. To achieve higher accuracy of the results, it is necessary to constantly adjust the set of indicators and the values of the weighting coefficients for each indicator, taking into account the type of economic activity and other listed conditions.
The method of financial ratios is the calculation of the ratios of financial statements data and the determination of the relationship of indicators. When conducting analytical work, the following factors should be taken into account: 1) the effectiveness of the applied planning methods; 2) reliability of financial statements; 3) use of various accounting methods ( accounting policy); 4) the level of diversification of the activities of other enterprises; 5) the static nature of the applied coefficients.
In the practice of Western corporations (USA, Canada, Great Britain), the following three coefficients are most widely used: ROA, ROE, ROIC.
The DuPont model allows you to determine what factors caused the change in profitability, i.e. perform a factor analysis of profitability.
The DuPont method (DuPont formula or DuPont equation) is usually understood as an algorithm financial analysis profitability of the company's assets, according to which the profitability ratio of assets used is the product of the profitability ratio of product sales and the turnover ratio of assets used.
Currently, there are three main DuPont formulas in the educational and methodological literature, which depend on the number of factors used in the analysis of ROE (return on equity).
The first model has a rather simple form, with the help of it it is easy to find the value of the return on capital, the formula looks like this:
where NP is net profit, SK is the share capital of the enterprise.
It should be noted that this formula has its drawbacks, the main of which is the impossibility of determining the factors that influenced the return on equity.
The following DuPont model is more informative and looks like:
where ROA is the return on assets ratio, defined as the ratio of the company's net profit, excluding interest on loans, to its total assets; DFL - financial leverage ratio.
If we expand this formula by supplementing it with an implementation indicator, then the model takes the form:
ROE \u003d (PE / Or) * (Or / A) * (A / Sk)
where Or - the sale of goods, works and services, excluding excise taxes and VAT; A is the total assets of the company.
The DuPont equation, which already consists of five factors, most fully takes into account the factors influencing the return on equity:
ROE = (NV/EBT)*(EBT/EBIT)*(EBIT/Or)*(Or/A)*(A/Sk)
Two indicators are additionally introduced into this formula: EBT - profit before taxes; EBIT is earnings before interest and taxes.
Using financial leverage (or leverage), you can transform the specified equation, in this case, the Dupont formula will take the form:
ROE = (NV/EBT)*(EBT/EBIT)*(EBIT/Or)*(Or/A)*DFL
NP/EBT – tax burden;
EBT / EBIT - the burden of interest;
EBIT/Or - operating margin (ROS);
Op/A - asset turnover (resource return);
DFL is the effect of financial leverage.
