Return on Investment (ROI) - Definition & Calculation

Return on Investment (ROI): As the name suggests, Return on Investment means the monetary benefit earned on an investment. One may consider it as profits in percentage term on capital invested.

Formula: Net Income / Average owners equity or

                       Net Income / Invested capital

Return on Assets (ROA) - Definition & Calculation

Return on Assets (ROA): Return on Assets measures the amount of revenue generated by the company based on its investments in Assets. It may also be defined as the rate at which the assets of the company generate revenues for the company. This particular metric is very much popular in analysing the capital intensity of the company. Lower the ROA, higher the capital intensity.

Return on Equity (ROE)

Return on Equity (ROE): It measures the rate of return on the shareholder/ownership investment in the company also know as shareholder’s equity. It basically determines the firm’s efficiency to generate profits to the equity shareholders.

Formula: Net Income – Preference Dividend (if any)

                                  Shareholder’s Equity

Implication: Over here we are only talking about the common equity shareholder, which excludes preference shareholders. The financial metric is used mainly for two reasons.

1. How much is the firm’s earning for per equity share.
2. How much efficient the firm is when compared with its peers/competitors. A firm showing ROE as 15% may be considered fair but may not be good enough if the industry average is above 15%.

Operating Margin - Definition

Operating Margin: Operating Margin or Operating Profit Margin or Net profit Margin is a financial metric used to evaluate the pricing strategy vis a vis the company’s ability to pay off its finance cost i.e. interest of debt and others. Higher the margin better the company.

Formula:  Operating Profit

                               Net Sales

   

Implication: Just like operating profit, operating margin in itself has no meaning unless compared with quarterly/budgeted figures of the company vis a vis comparison with its peers. It gives per rupee earning of the company to pay off its interest burden and taxes. There is a direct relation between the company’s performance and the profit margin. Higher the profit margin better off the company.

Operating Profit - Definition

Operating Profit: Operating profit is the profit earned by the company after paying off its cost of goods sold, operating expenses, non cash expense such as depreciation and amortisation. The expense does not include interest and taxes. Operating profit may also be defined as the profit earned before interest and taxes.

It should be kept in mind that, operating profit comes from operating revenue, and thus the revenue earned from due course of business should be considered while calculating the same. For a manufacturing company, income earned from investments in market or in any company (partial interest) should not be included in operating revenue.

Gross Profit Margin - Definition

Gross Profit Margin: Gross profit margin is a financial term used to get the percentage of revenue left over to cover overheads, finance cost, taxes and future savings.

Formula: Revenue – Cost of goods sold

                                  Revenue

Implication: Many companies show huge revenues but still incur loses. This is with the obvious reason that the left over revenue after deducting cost of goods sold is not enough to pay off their operating and other expanses. This metric is again useful within the same industry. Cross industry company comparison may not be meaningful.

Example: Company A and Company B(of the same industry) both have $10 million in sales. Company A's cost of goods sold (COGS) is $8 million and Company B's COGS is $11 million. Company A's gross profit margin will be 20% and Company B incur losses worth $1 million. Company A spends less money to make the same amount of sales, and is therefore more efficient

Gross Profit - Definition

Gross Profit: Gross Profit is basically the revenue earned during a period of time say one year minus the cost of goods sold. Cost of goods involves the cost incurred for bringing the goods at saleable condition. Gross profit can also be referred as Gross margin or Gross Income.

Implication: Gross profit helps you to analyse the amount spent by the company to earn revenue. In other words it also helps you to  Gross profit should always be compared for companies within the same industry. Cross industry company comparison would not give much insights.

Example: Company A and Company B(of the same industry) both have $10 million in sales. Company A's cost of goods sold (COGS) is $8 million and Company B's COGS is $9 million. Company A's gross profit will be $2 million and Company B's gross profit will be $1 million. Company A spends less money to make the same amount of sales, and is therefore more efficient.