Calculating and Interpreting Return on Investment

In this video, we discuss return on investment, how to calculate return on investment, and interpreting return on investment. We also discuss profit margin and asset turnover and how those ratios will also allow you to calculate return on investment

In this video we’re gonna talk about return on investment and how to interpret it so the way that return on investment also called roi the main way that it’s calculated is by taking operating income which i’ll say is oh i operated income okay which is right here on my income statement divided by total assets okay this is the primary way that we calculate it but

There’s also another way that you can calculate it you can calculate it by taking margin which is actually your profit margin ratio times turnover okay and most managerial textbooks will just say margin times turnover but it’s actually your profit margin times your asset turnover and that confuses some students because there are so many different turnover ratios

So in this one you’re going to use the asset turnover ratio okay so let’s talk about why this works first this margin times turnover so profit margin is equal to operating income divided by sales and your asset turnover is sales divided by total assets okay so if you remember back from your math classes if i have sales in the denominator for a profit margin and

I’ve sales in the numerator for asset turnover then those two would cancel each other out and that would leave me with operating income over total assets okay so let’s go through let’s run through all three of these calculations and then we’ll talk about what they mean okay so let’s start with we’ll start with return on investment so roi is equal to my operating

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Income divided by my total assets so essentially what this ratio tells me is it tells me if i’m gonna spend start with this if i’m going to spend ten million dollars in assets what percentage what kind of return am i getting for my ten million dollar investment so in this case 1 million 76,000 is being earned off of ten million dollars in assets and the percentage

For that is ten point seven six percent so now if i put you know if i put ten million dollars in a savings account right now in 2015 i am gonna get a return of probably a quarter of a percent maybe a half a percent but if i invest my ten million dollars in these assets i’m gonna get a return i did get a return of ten point seven six percent okay so that’s one

Way to look at it i could put that money in the stock market and right now i could probably get a return about equal to that okay but then in that case i’m not creating jobs i’m not working so you kind of have to be able to put this number into perspective so let’s say that the desired rate of return that management would like to see is equal to let’s say 8% well

If that’s the case then we’re doing a lot better than that okay so with rate of with return on investment you kind of need to have some perspective okay so all right let’s look at margin okay so profit margin my margin is operating income over sales so if i do that calculation that is 1 million seventy six thousand over six million six hundred fifty thousand so

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Essentially what this ratio does is it tells me the percentage of each sales dollar that is going to become profit so in this case if i do the math on this this is 16.8 one percent so it means that for every dollar in sales 16 point one eight cents okay or 16 point one eight percent is profit okay now with turnover i remember this is asset turnover asset turnover

Is sales over total assets what this ratio tells you is it tells you how efficiently you are using your assets to generate sales so if i have sales of six million six hundred fifty thousand and i have ten million dollars in assets that means that my assets are turning over into sales six point six seven times okay so the higher this number is right the more sales

You’re generating with your assets okay the lower the number is the less sales you’re generating with your assets so you want to have this be a high number if the number is over one then that means that your sales are exceeding your assets so if i take these two numbers and i multiply them together that equals ten point seven six percent okay so remember return on

Investment this is used for investment centers where we are trying to measure asset efficiency so it’s really the turnover part that measures the asset efficiency okay so that’s really where you get that so that’s it that’s all there is to return on investment now if you have any questions about this video feel free to leave a comment at the bottom if you thought

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Transcribed from video
Calculating and Interpreting Return on Investment By Kristin Ingram