What does ROI
ROI: Interpretation and meaning for companies, real estate and investors
ROI: An overview
- ROI means "Return on Investment"
- helps to decide whether an investment is worthwhile
- determines the return on investment
- shows profitability of capital employed
- is often used as a KPI in companies
- Balance figures such as turnover, profit and invested capital can be easily read off
What is the ROI anyway?
The return on investment is an economic key figure for determining the profitability of the capital employed (return on capital) in the company. For entrepreneurs, the ROI is an important indicator because it provides information about whether a Investment lucrative is. It can be referred to as a generic term for return metrics and describes both the return on total capital and the return on equity. The profit is set in relation to the invested capital. This key figure can also be of interest to private investors, because the ROI is an indicator of the profitability of a company.
The approach goes back to 1919: The US engineer Donaldson Brown, who worked for Du Pont, was already doing the first calculations Determination of the returns on capital investments at. The term DuPont key figure system goes back to this.
This is how the ROI is calculated
Today the ROI is part of the Everyday work for numerous controllers and managers in the company to measure the profitability of investments and to compare investments with one another. The value can be calculated using a simple formula. This, in turn, is an important consideration for investors because, after all, only worthwhile investments should be made.
An example: A balance sheet total of 10 million euros is assumed as total capital. The company XY AG generated a profit of 2 million euros with a turnover of 15 million euros. This results in the following simplified ROI:
(Profit / sales) = 0.13 * 1.5 (sales / total capital) * 100 = 19.5 percent
Calculation of the ROI in detail
The ROI is defined as follows:
The return on sales and the capital turnover can be calculated using two formulas:
Driver tree scheme according to Du Pont
In the German-speaking world, the ROI is also known as the return on investment or total return on capital. A graphic should clarify the ROI:
This simple representation already shows how all areas of the company can be included with the formula for the return on investment. The ROI scheme is usually structured in a tree structure starting with the return on investment. It is divided into the two levels Return on sales and capital turnoverthat have to be multiplied together to determine the return on investment.
The return on sales in the third level is determined by the Relationship between sales and profit calculated. The fourth level of the ROI scheme contains the difference between expenditure and revenue that leads to the contribution margin (revenue - variable costs). The fifth level usually shows the operating expenses (sales, administration and production costs). The capital turnover is shown on the other side of the ROI scheme. The calculation is done by dividing the turnover by the invested capital.
The capital in turn consists of the fixed and current assets, which are composed of liquid funds, receivables and stocks. The Capital assets Usually consists of real estate, property, plant and equipment, investments, but also intangible assets such as patents.
Application in practice
With the ROI scheme, the occurrence of other variables such as return on sales, contribution margin or capital turnover can be traced back relatively easily. It also serves that Weaknesses and strengths of a company to uncover. Approaches for improvements or changes in the business process can be derived from it. This means that the ROI scheme also has a certain planning and control function.
In practice, only monetary indicators used to derive clear results for corporate management. The focus is particularly on the result per unit of capital employed, for example to be able to compare investments with one another. Many key figures only consider the cost side or only the profit presentation, such as EBIT and EBITDA. It is different with return on investment: Here profit and invested capital are directly related to each other. By calculating the return on investment, the profitability of individual products, projects or entire company areas is shown with a single key figure. This is particularly useful for comparing products and projects and weighing up where the company's capital is best invested.
Sample calculation makes it easier to understand
A fashion house would also like to sell its products via the Internet in the future. It costs the company 50,000 euros to set up a corresponding shop. The expected turnover is 900,000 euros. The company can book a third of this as a profit. First of all Capital turnover be calculated. To this end, 90,000 euros are used in the formula for net sales and 50,000 euros for total capital.
The result of this calculation is 18. The return on sales is then calculated by dividing the profit of 300,000 euros by the net sales of 900,000 euros. The Return on sales is therefore one third. With the help of these already calculated numbers, the ROI can now be determined. To do this, divide a third by 18. The result is 6.
In principle, the following applies: the higher the result of a calculation, the more worthwhile the investment is for the company. The The target value should already be above 10, but is heavily dependent on the industry. For trade, the value should be higher, for industry a value below 10 is also sufficient.
Interpretation and significance of the ROI
If we look at the value from the example calculator of 19.5 percent, it now means that the capital employed has produced a profitability of 19.5 percent. This means that the investment has paid off for the company. A conservative company is usually satisfied with an ROI of 7 to 10 percent. A fast-growing company that takes higher investments and more risks, on the other hand, often strives for an ROI of 15 to 25 percent. However, the ROI is de facto one periodic reference valueto measure the return on capital employed. On the other hand, it does not allow an individual investment, such as a new machine, to be assessed.
Furthermore, the RI only takes direct costs into account. Indirect costs, such as management salaries or fire insurance, are not taken into account, which makes interpretation more difficult. The problem: With complex projects and long-term investments, direct and indirect costs can hardly be distinguished, which can lead to a distortion of the ROI. Another point of criticism: the value says nothing about the specific amount of the return flow of capital. It also does not allow any conclusions to be drawn about the investment risks, which makes interpretation even more difficult. An example: A promotion leads to an ROI of 200 percent. However, if you consider the investment sum of only 5,000 euros, which led to a profit of 15,000 euros, this view is put into perspective again.
The ROI is not enough as a basis
The ROI should never be the only key figure on the basis of which an investment is made. A Risk analysis would be a complement, for example.
A calculation of the ROI does not only have advantages: Because the result is purely statistical, the influence of time on the overall profitability is not sufficiently taken into account. Further considerations that take this into account are recommended here. The ROI also describes only a small part of what is happening in the company and only delivers one Top metric. The development of the company's liquidity, for example, is not taken into account at all.
What investors should look out for in real estate
Real estate is back in trend. As a result of the financial crisis, investors are looking for safe investments again. Rental properties in particular promise secure income and high returns: A return on investment that is impressive. But not all property is the same.
The ROI for real estate depends not least on the location, size, year of construction and equipment of the property. The main role is played by the Rental yield to.
It all comes down to the net rental return
A distinction must be made between the gross rental return and the net rental return. The Gross Rental Return only gives the simple relationship between the annual rent and the purchase price. In the case of condominiums, this is often between 4 and 5 percent, and even a little higher in the case of nursing homes. As a rule, it is therefore worthwhile to look for properties with gross rental returns of 6 percent and more and to forego properties with a gross rental return of less than 4 percent.
That is even more important Net rental return to. This is calculated by adding the ancillary costs (land transfer tax, notary and land registry fees) incurred when buying a property. Excluding any brokerage costs, these are often 4 to 5 percent of the purchase price. If the property is acquired through a broker, this is usually another 3 to 7 percent.
A calculation example
|Purchase price of a property||120.000 €|
|+ Additional costs||12.000 €|
|= Investment costs||132.000 €|
|Net rent of the property per year:||6.400 €|
|- Administrative expenses||220 €|
|- Interest income||380 €|
|= Annual net income||5.800 €|
Gross Rental Return: Net rent / purchase price. In this case, the return is 5 percent
Net cold return: Annual net income / investment costs. In this case, the return is 4.8 percent
Calculation of the total return on capital in real estate
However, the RoI for real estate can also be used to determine Return on investment to calculate. Here, too, a concrete example: A property worth 1 million euros generates an annual profit of 60,000 euros, with the total rental income adding up to 100,000 euros. Depreciation (30,000 euros) and ancillary costs, for example for maintenance (10,000 euros), are deducted. The total return on capital or the ROI for real estate can be derived from these figures:
Total return on investment: Profit / total capital = 60,000 euros / 1,000,000 euros = 6 percent
Care properties are considered attractive
Investments in nursing homes have increased significantly in recent years. In the coming years billions are likely to flow into these properties, estimate consulting firms such as Avivre. The reason for the boom in nursing homes lies in the demographic development: People are living longer and longer, but having fewer children.
The number of elderly people will increase over the next few decades. Accordingly, it is assumed that there will be a greater need for nursing homes. With returns of 5 to 6 percent, some of these have a very high ROI for real estate. Nevertheless, investors should not underestimate the risks here, because a home place is very expensive. Should the trend towards stronger government subsidies for outpatient care at home continue, care properties could soon be less attractive.
Conclusion: ROI only partially meaningful!
The ROI is as meaningful as the underlying accounting values. The informative value can therefore be viewed as rather limited, as these values primarily relate to the purely financial view of the company restrict. The ROI disregards other important aspects such as customer and employee satisfaction or the company's image in public, which means that any undesirable developments in the company are often recognized too late.
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