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.

Why Do SWOT?

One of the components of strategic thinking requires the generation of a series of strategic alternatives, or choices of future strategies to pursue, given the company’s internal strengths and weakness and its external opportunities and threats. The comparison of strengths, weaknesses, opportunities and threats is normally referred to SWOT analysis.

Public Provident Fund Scheme (PPF)

This was introduced on July 01, 1968 and is primarily meant for self-employed individuals. The salaried individuals are also allowed to make contribution to this scheme over and above their contribution to the recognized provided funds in their respective organisation.

At the option of the investor, the tenure of the account opened under this scheme can be extended by blocks of 5 years each.

A PPF Account can be opened in a Head Post Office or in a branch of SBI or its subsidiaries or at specified branches of some other nationalised banks by an individual on his own behalf or on behalf of a minor of whom he is a guardian or on behalf of a Hindu Undivided Family of which he is a member.

Corporate Fixed Deposits

Investors can also consider depositing their money for a fixed term with companies. These fixed deposits which are considered as a part of the unsecured liabilities of the company, have a maximum maturity period of 3 years and carry a maximum rate of interest of 12.5% (earlier 14%). The public deposits accepted by the companies are governed by the provisions of the Companies (Acceptance of Deposits ) Rule, 1975. 

The important features of these regulations are:

1. Public Deposits cannot exceed 10% of the share capital plus free reserves

2. The maximum maturity period cannot exceed 3 year and the minimum maturity period cannot be less that 6 months.

3. No company with a net owned fund of less than Rs.1.00 crore shall invite public deposits.

4. The company inviting public deposits must disclose the prescribed information relaing to its financial performance and position

These guidelines apply with certain modifications to finance companies

The interest on public deposits is paid semi-annually on a cumulative or non cumulative basis. While the rate of interests offered on company deposits are attractive vis a vis bank deposits, it should be noted that there is no tax benefit on the interest income, nor, does the investment in CFD qualify for any tax rebate.

Besides, company deposits have a higher degree of default risk that bank deposits. For one thing, these deposits do not enjoy any risk cover form the Deposit Insurance Corporation like bank deposits. Further, these deposits are serviced and finally repaid from the earnings of the company which by nature are uncertain and fluctuate over time. To add to this, theses deposits are unsecured and rank pari passu with other unsecured liabilities for repayment in the event of liquidation. Therefore, the decision to invest in public deposits\ must be necessarily based on a thorough analysis of the financial stability and profitability of the company or on the credit rating provided by various rating agencies.

Debentures and Types of Debentures

Debentures are promissory notes issued by the joint stock company in the private sector. They are the debt obligations of the issuing corporation. Like government securities, they have an issue price at which they are originally issued. A coupon interest rate and a specified maturity date.

Types of Debentures: Following are the types of debentures

Current Ratio / Working capital Ratio

Definition: Current ratio is a metric which determines the ability of the company to pay off its short term debts/obligations.

Formula: Current Ratio =   Current Assets

                                                  Current Liabilities

Implication: The current ratio gives a sense of efficiency of a company’s operating cycle or its ability to turn its product into cash. A ratio under 1 implies that the company would not be able to pay off its obligations if, it stands due at that point of time. Generally a ratio in between 2 to 2.5 is considered sufficient. An efficient ratio might vary from industry to industry.

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.