Return on Investment (ROI) Training
Companies should calculate return on investment (ROI) whenever they make a capital expenditure—that is, a sizable outlay of funds for an asset that is expected to generate revenue and profit in the future. Capital assets should produce a return over a period of years.
Depending on the business, its capital expenditures might include outlays for tangible items such as buildings, manufacturing equipment, computer systems, and vehicles. The category also might include outlays for intangible assets such as patents or trademarks.
Return on investment analysis typically uses one or more of the following four methods:
- Payback – the simplest analysis, it measures the time required for the cash flow from the project to return the original investment. How long will it take to get your money back? It does not include any interest in the calculation.
- Net Present Value (NPV) – this method compares future cash flows to the initial cash outlay, but it takes into account the time value of money. Your companies Cost of Capital (or Hurdle Rate) is used in the calculation. If the result is a number greater than zero you should make the investment.
- Internal Rate of Return (IRR) – allows the rate of return to be calculated when the Net Present Value equals zero. This is then compared to the company cost of capital, if the IRR is greater – you should make the investment. This method makes intuitive sense to most managers.
- Profitability Index – a tool for comparing one project to another when you have many different projects with varying initial investment requirements. This tool allows you to make apple to apple comparisons.
Financial statements training classes go through present value, future value, as well as the four methods of calculating return on investment to get a clearer picture of how to evaluate your investment.
Need help calculating ROI? It doesn’t have to be stressful or time consuming, Joe Knight wrote the Return on Investment Toolkit for Harvard to help you master the key fundamentals of Return on Investment and perform ROI analysis on your next project. Download your copy today, included are spreadsheets ready for you to drop in your numbers.