How do I get a high ROI

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What actually is the return on investment?

If you want to invest your money, you need an indication of whether the investment is worthwhile. How much of the capital invested will you get back? This is exactly what Return on Investment (ROI) is about: a financial term translated as "return on investment" or "profitability".

That's what it's about

A company sets up a new production plant in its machine shop, the output increases significantly - and a profit is generated that can clearly be attributed to this plant. In this example, the ROI can be reasonably calculated because the company Costs and benefits can precisely assign this investment.

The ROI reflects that percentage ratio between profit and invested capital against (profit: invested capital = ROI). A comparison is possible by using the ROI of two investment objects. The investment with the higher ROI is more profitable. Important: the same Observation period must be available. However, the ROI does not make a statement about the amount of profit - and the risk of the investment is not taken into account.

The situation becomes more difficult when complex decisions to be met: It is not always easy to establish a clear, causal relationship between costs and benefits. The greater the impact of indirect or general costs, the less reliance on ROI as a measure of profitability. For example, administrative costs can play a big role in an investment.

So what is behind the term "Return on Investment" (ROI)? The ROI shows the relationship between investment and profit. It expresses the percentage that the profit has in an investment - and in this way shows the value that flows back from an investment. This view is possible for individual investment objects, but also for the profitability of an entire company (Du Pont key figure system).

This is what practice looks like

A pyramid as a model: General data from accounting form the basis, the ROI is the top. This is how the Du Pont key figure system is structured, which was developed in 1919 by the American chemical company "Du Pont de Nemours and Co". No isolated key figures should be collected, the company was concerned with interactions and mutual dependencies. A closed model should describe interdependent target values. How does this model work? You have to find two ways in the pyramid: On the one hand, data on business activity are to be collected, on the other, data on the financial position.

Operations: The turnover is determined by the sales, differentiated according to regions, customer or product groups. The prime costs, which include all manufacturing, sales and administration costs, are deducted from him. The result is that Income from operations. It is now related to sales (Profit: sales), the size determined in this way is the Return on sales, i.e. the percentage of profit in sales.
In order to get out at the top of the pyramid, it is now necessary to also take the second path.

Financial position: The path starts again at the base of the pyramid. This is made from inventories, receivables and cash Current assets determined. In addition, there are fixed assets, which are made up of intangible assets, tangible assets and financial assets. Current assets and fixed assets represent the invested capital, which is set in relation to sales (Turnover: invested capital). The calculated number is the Capital turnover, thus an indication of how often the invested capital was "turned over" by the turnover. The second way also led shortly to the top of the pyramid.

Calculation of the ROI: At the top of the pyramid, the two key figures return on sales (profit / turnover) and capital turnover (turnover / invested capital) are brought together.

Return on sales x capital turnover = ROI
(Profit / Revenue) x (Revenue / Capital Invested) = ROI

A little excursion into the fractions: The turnover in the denominator of the return on sales is reduced against the turnover in the numerator of the capital turnover, so the result is:

Profit / Capital Invested = ROI

The ROI is therefore a percentage and shows the relationship between profit and invested capital, the "return on investment".

Conclusion

Many companies today use the Du Pont key figure system, often in a modified form. The ROI has become an indispensable part of investment decisions: Whether computer systems are purchased, marketing measures are discussed or new employees are hired - the ROI is often one identification numberthat at the decision helps. This is also the case with traditional investments in stocks or with the question of which companies Venture capital should flow.



A contribution by Ingo Leipner