Ratios
PROFITABILITY RATIOS
RETURN ON INVESTMENT (ROI):
The prime objective of making investments in any business is to obtain satisfactory return on capital invested. Hence, the return on capital employed is used as a measure of success of a business in realizing this objective.
Return on Investment establishes the relationship between the profit and the capital employed. It indicates the percentage of return on capital employed in the business and it can be used to show the overall profitability and efficiency of the business.
Definition:
Capital employed and operating profits are the main items. Capital employed may be defined in a number of ways. However, two widely accepted definitions are "gross capital employed" and "net capital employed". Gross capital employed usually means the total assets, fixed as well as current, used in business, while net capital employed refers to total assets minus liabilities. On the other hand, it refers to total of capital, capital reserves, revenue reserves (including profit and loss account balance), debentures and long term loans.
Computation:
The profits for the purpose of calculating return on capital employed should be computed according to the concept of ”capital employed used". The profits taken must be the profits earned on the capital employed in the business. Thus, net profit has to be adjusted for the following: * Net profit should be taken before the payment of tax or provision for taxation because tax is paid after the profits have been earned and has no relation to the earning capacity of the business. * If the capital employed is gross capital employed then net profit should be considered before payment of interest on long-term as well as short-term borrowings. * If the capital employed is used in the sense of net capital employed than only interest on long term borrowings should be added back to the net profits and not interest on short term borrowings as current liabilities are deducted
RETURN ON INVESTMENT (ROI):
The prime objective of making investments in any business is to obtain satisfactory return on capital invested. Hence, the return on capital employed is used as a measure of success of a business in realizing this objective.
Return on Investment establishes the relationship between the profit and the capital employed. It indicates the percentage of return on capital employed in the business and it can be used to show the overall profitability and efficiency of the business.
Definition:
Capital employed and operating profits are the main items. Capital employed may be defined in a number of ways. However, two widely accepted definitions are "gross capital employed" and "net capital employed". Gross capital employed usually means the total assets, fixed as well as current, used in business, while net capital employed refers to total assets minus liabilities. On the other hand, it refers to total of capital, capital reserves, revenue reserves (including profit and loss account balance), debentures and long term loans.
Computation:
The profits for the purpose of calculating return on capital employed should be computed according to the concept of ”capital employed used". The profits taken must be the profits earned on the capital employed in the business. Thus, net profit has to be adjusted for the following: * Net profit should be taken before the payment of tax or provision for taxation because tax is paid after the profits have been earned and has no relation to the earning capacity of the business. * If the capital employed is gross capital employed then net profit should be considered before payment of interest on long-term as well as short-term borrowings. * If the capital employed is used in the sense of net capital employed than only interest on long term borrowings should be added back to the net profits and not interest on short term borrowings as current liabilities are deducted