In order to accurately assess the effectiveness of management or the policies implemented by a company's leadership, it is essential to consider only the amount of capital that has been specifically invested in the core activities of the enterprise as investment capital.
Under this calculation policy, profits should also be accounted for solely from the primary line of business of the company. In simpler terms, not all funds invested in the enterprise generate income; thus, for calculations, it is advisable to use the capital invested that was initially allocated to generate profits from the company’s core operations.
If a simplified formula is employed for calculations, based on the total profit from all areas of the company's activities, a certain degree of error in the investment coefficient will be permitted. The magnitude of this error, arising from such calculations, will be directly proportional to the amount of non-operating income earned by the company during the analyzed period.
Practical Applications of Investment Ratios
Firstly, this ratio is a primary parameter through which shareholders can judge the effectiveness of management’s performance, utilizing the Return on Equity (ROE) ratio. When considering the investment ratio, the formula that calculates the Return on Invested Capital (ROIC) is often used as an indicator of management’s effectiveness in relation to all capital under its control.
Therefore, for successful investment, it's crucial to first conduct an analysis of costs and expected profits. Following this, it will be straightforward to calculate the total return on investment.
