Return On Invested Capital

Category: Financial.

If you are the accountant of a business, there are certain things that you may want to keep in mind –one of these things being how to calculate the Return On Investing Capital (ROIC). ROIC is responsible for measuring the profitability of a company in relation to capital invested in the business. Is growth all that matters, or are there some other important aspects as well?

To become profitable and generate returns, a business will have to invest in a variety of assets. This portion is a little unclear, and I don’t think I have grasp enough of this concept to add a comment– are we defining “capital” and “assets” as the same thing and one of the most efficient ways of calculating it is by applying the ROIC.

Defining ROIC

Every accountant and business owner needs to know that this measuring tool doesn’t provide individual asset performance. Instead, it calculates the capital’s overall return, including human capital ROI–the amount that bondholders and shareholders receive back after investing into the business.

As an investor, you may use the ROIC to compare business – therefore narrowing down your investment choices. Businesses that have a higher return will definitely generate more profit – therefore making your investment worth it.

The Formula

The equation for calculating the return on invested capital is fairly straightforward – and luckily, with no knots and headaches on the way. Calculate the ROIC by first subtracting the yearly dividends from the company’s net income – and then dividing the result to the total capital invested.

As a result, the formula should look something like this:

Return on Invested Capital
=
(Net Income – Dividends)Total Capital Invested

As an accountant, you will likely not have any issues generating results for this formula. Investors will usually use this formula so that they can measure how much return they get for the money that they have invested.

Bear in mind that not every type of capital is used in this formula – only the invested capital. This way, an investor can get a clear picture of the company’s profit – as well as how much money they get from investing.

Analyzing the ROIC

The ROIC is calculated as a percentage, and it shows how much money a shareholder gets for investing in a certain business. Obviously, a higher return is always the preferred option – since you get more profit than with a lower return.

A high ratio will tell you that the managers are doing a good job at running the company – and they know precisely how to manage the money given by bondholders and shareholders.

This equation, however, is not focused on individuals. Indeed, it only includes the invested capital –but this equation does not tell you which investors are making more money. The result is calculated as a whole.

Final Thoughts

If you are an investor in a company, the ROIC will tell you precisely how much money the investors get – but only as a whole. To calculate your own gross profit, you need to put it against your own investments. To effectively measure and track finance metrics effectively, use the best OKR software. To know more, read through some of the best finance OKR examples and try implementing this methodology in your organization.

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