Profitability ratios - Return on Investment

Rate of Return (ROR), also known as Return on Investment (ROI), Rate of Profit or sometimes just Return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or net income/loss. The money invested may be referred to as the asset, capital, principle, or the cost basis of the investment. ROI is usually expressed as a percentage rather than a fraction.

Return on Investment = Net Income or Net Profit (after Tax) / Investment

or,

Return on Investment = Net Income / Book Value of Investment

or,

Return on Investment = Net Income / Cost of Investment 

Note :- Return on Investment evaluates the efficiency of an investment, means how much Company is generating return on its investment.

ILLUSTRATION:


There is unaudited financial results for the quarter/half year ended 30, Sept 2010 and Balance Sheet also:

From the above information we have following details:-

Net Profit After Tax for 30 Sept 2010 = 61.87

Investment for 30 Sept 2010 = 13082.34 (Fixed Assets + Investment + Current Assets Loans & Advances + Unamortized Expenditure) 

Return on Investment = Net Profit After Tax / Investment

So, Return on Investment = 61.87 / 30175.55 = .0047 or .47%

Analysis:-

Return on Investment is .0047 means Company is generating Rs. .0047 or .47 % from its every unit of its investment. 

Profitability Ratios - Return on Equity

Return on Equity (ROE) measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth.

Return on Equity = Net Profit (after Tax) / Shareholder's Equity

Shareholder's Equity :-A firm's total assets minus its total liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders' equity represents the amount by which a company is financed through common and preferred shares. 

Also known as "share capital", "net worth" or "stockholders' equity" or Shareholder's Fund".

Note:-  Return on Equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

Illustration :-

This is the Balance Sheet of Reliance Industries Limited as at 30 Sept 2010.

From the above Balance Sheet we have relevant information 

Shareholder's fund or Shareholder's Equity = Rs. 1,45,740 cr. (Capital + Share Application Money + Reserves & Surplus) or {(Total Assets = Fixed Assets + Investment + Current Assets, Loans & Advances) - (Total Liabilities = Loan Funds + Deferred Tax Liability/(Assets) + Current Liabilities & Provisions)}

From the above key highlights we have Net Profit (after Tax) as at 30 Sept 2010 


Net Profit (after Tax) = Rs. 4,923 cr.


So,
Shareholder's Equity = Rs. 1,45,740 cr.
Net Profit (after Tax) = Rs. 4,923 cr


Return on Equity =  Net Profit (after Tax) / Shareholder's Equity


Return on Equity = 4923 / 145740 = .0337 or 3.37%


Analysis :-


So, Return on Equity is .0337 means Company generates Rs. 0.0337 profit from every unit of Shareholder's Equity or 3.37% profit with money shareholders invested.

Profitability ratios - Profit Margin

Profit margin, Net margin, Net profit margin or Net profit ratio all refer to a measure of profitability. Profit margin is an indicator of a company's pricing strategies and how well it controls costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.

Profit Margin = Net Profit (after tax) / Sales

Note :- A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss. It measures how much out of every rupee of sales a company actually keeps in earnings.

Illustration :-

This is the 2nd Quarter & Six Months Results ended 30 September 2010 of "ACKRUTI CITY LIMITED".

From this Result we have relevant information to calculate Profit Margin :-


Net Profit (after Tax) for Six Months ended 30.09.2010 = Rs. 7,174 lac
Sales for Six Months ended 30.09.2010 = Rs. 20,687 lac
So, Profit Margin = Net profit (after Tax) / Sales
Profit Margin = 7174 / 20687 = 0.35


Analysis :-


So, Profit Margin is 0.35 means Company has a Net Income Rs. 0.35 paise of each rupee Sales for Six Months Results ended 30.09.2010.