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Return On Investment

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ROI

Accounting Valuation: Summary of Return On Investment (ROI). Abstract

Accounting value

Single period measurement

Traditional income measure


Return On Investment (ROI) is an accounting valuation method.

 

Because the numerator (Net Income) is an unreliable corporate performance measurement, the outcome of the formula for ROI must also be unreliable to determine success or corporate value. However the ROI formula still keeps showing up in many annual reports...

 

The degree to which ROI overstates the economic value depends on at least 5 factors:

  1. The length of project life (the longer, the bigger the overstatement)
  2. The capitalization policy (the smaller the fraction of total investment capitalized in the books, the greater will be the overstatement)
  3. The rate at which depreciation is taken on the books (depreciation rates faster than straight-line basis will result in a higher ROI)
  4. The lag between investment outlays and the recoupment of these outlays from cash inflows (the greater the time lag, the greater the degree of overstatement)
  5. The growth rate of new investment (faster growing companies will have lower Return On Investment )

 

Formula

Net Income / Book Value of Assets = ROI

 

(Better) alternative:

 

Net Income+Interest (1-Tax Rate) / Book value of Assets = Return On Investment


Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide

Book: Ciaran Walsh - Key Management Ratios

 

👀TIP: On this website you can find much more about net project benefits and Return On Investment!


Compare:  EBIT  |  EBITDA  |  Economic Value Added  |  Earnings Per Share  |  Return on Equity  |  Net Present Value  |  Return On Net Assets  |  Return on Invested Capital  |  Relative Value of Growth


More valuation methodologies



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