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Hello,
In Chapter 6 “Divisional performance measurement” there is a formula of Return on Investment measure. In that formula annual profit is divided by the cost of the investment.
Could you please explain why only ANNUAL profit is used in that formula? I thought it is the overall return from investment that should be considered when calculating the ROI.Thank you in advance.
Hi,
Thanks for your question – and its definitely a valid point.The formula for ROI has many acceptable calculations… (just like ROCE where there are known to be many variations in acceptable calc)
The term return – can mean different things depending on the results you want to show ( eg net profit. or return on a project maybe gross profit etc)Therefore – ultimately, ROI it is calculated as you said the RETURN / COST
However, to allow for some universal understanding and like-with-like comparison – where possible the ROI should be an annualised figure – which can then be compared to other investments which are also annualised.
So if you have enough information to make the figure annual – especially when using financial statements and the capital employed is the year end figure – you should ensure you are using annual profit.
Otherwise on a project basis – if the time period is not stated you should revert back to an approximation of project return /project cost type calculation.
Hope this explains ok
Thanks
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