The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement. The cash flow statement reflects a firm's liquidity or solvency.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation or write-offs on bad debts to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Noncash activities are usually reported in footnotes.
The cash flow statement is intended to
- provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances
- provide additional information for evaluating changes in assets, liabilities and equity
- improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
- indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
Cash flows for the particular period can be counted from the firms operating, investing and financing activities. Cash flow shows the require capital for the project in future.
1.3.1 Effect of inflation on cash flow: -
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. The term "inflation" once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation. Inflation can also be described as a decline in the real value of money—a loss of purchasing power. When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time.
Inflation can cause adverse effects on the economy.
For example, uncertainty about future inflation may discourage investment and saving. Inflation may widen an income gap between those with fixed incomes and those with variable incomes. High inflation may lead to shortages of goods as consumers begin hoarding them out of concern their prices will increase in the future.
1.3.2 Effect of the different depreciation method for cash flow: -
The great effect for the cash flow is made by applying the different method for the depreciation calculation. According to the international accounting standard the particular method of depreciation can be selected for each group of assets. And it cannot be replaced by other method. Depreciation is a term used to describe any method of attributing the historical or purchase cost of an asset across its useful life, roughly corresponding to normal wear and tear. It is of most use when dealing with assets of a short, fixed service life, and which is an example of applying the matching principle as per generally accepted accounting principles. Depreciation in accounting is often mistakenly seen as a basis for recognizing impairment of an asset, but unexpected changes in value, where seen as significant enough to account for, are handled through write-downs or similar techniques which adjust the book value of the asset to reflect its current value. Therefore, it is important to recognize that depreciation, when used as a technical accounting term, is the allocation of the historical cost of an asset across time periods when the asset is employed to generate revenues. This process of cost allocation has little or no direct relationship to the market value or current selling price of the asset, it is simply the recognition that a portion of the asset's cost--the portion that will never be recuperated through re-sale or disposal of the asset--was "used up" in the generation of revenues for that time period.
The most used method of depreciation: -
- Straight line method: - Straight-line depreciation is the simplest and most often used technique, in which the company estimates the salvage value of the asset at the end of the period during which it will be used to generate revenues (useful life), and will expense a portion of original cost in equal increments over that period.
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Reducing balance method: - Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most useful when they are new. One popular accelerated method is the declining-balance method.
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Sum of years – digit methods: - Sum-of-Years' Digits is a depreciation method that results in a more accelerated write-off than straight line, but less than declining-balance method. Under this method annual depreciation is determined by multiplying the Depreciable Cost by a schedule of fractions.
- methods for project valuation: -
Economical valuation of project shapes financial measure of attractive investment for company. These measures are empowered in the decision making process into which capital company should invest and how they are prioritized. In economic terms the method of project valuation shows the profitability of the project. There are lot of methods used while implementing the analyzing and valuation of the capital investment project.
2.1. Net present value calculation: -
Net Present Value (or NPV) is a calculation used to determine the return on investment of a purchase, project or study over its lifetime. NPV calculations are often used during an analysis of the net cash flow benefits of a cost segregation study.
A cost segregation study identifies real estate assets that qualify for accelerated tax deductions through their reclassification to shorter recovery periods. For many clients, the net present value (NPV) savings generated by the study equals an amount large enough to make the cost of the analysis a worthwhile investment.
If you have used a net present value calculator or table to estimate whether you have a positive NPV, you may already know if a cost segregation study is right for you. In fact, while tax savings vary, based on calculations involving your overall tax situation and the specific assets in any given property the positive benefits of a cost segregation study may be quite significant.
Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore NPV is the sum of all terms
Where
t - The time of the cash flow
I - the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.)
Rt - the net cash flow (the amount of cash, inflow minus outflow) at time t (for educational purposes, C0 is commonly placed to the left of the sum to emphasize its role as investment).
NPV estimation
In the practical or theoretical, the company will select the entire project with the positive effect or net present value. The NPV analyze should be combined with the financial evaluation tools. The future cash flows can be calculated on the base of the NPV. The higher the NPV, more opportunity for investment.
Example
A corporation must decide whether to introduce a new product line. The new product will have startup costs, operational costs, and incoming cash flows over six years. This project will have an immediate (t=0) cash outflow of $100,000 (which might include machinery, and employee training costs). Other cash outflows for years 1-6 are expected to be $5,000 per year. Cash inflows are expected to be $30,000 per year for years 1-6. All cash flows are after-tax, and there are no cash flows expected after year 6. The required rate of return is 10%. The present value (PV) can be calculated for each year:
The sum of all these present values is the net present value, which equals $8,881.52. Since the NPV is greater than zero, it would be better to invest in the project than to do nothing, and the corporation should invest in this project if there is no alternative with a higher NPV.
Cash flow and discount rate: -
Discounted Cash Flow (DCF) is what someone is willing to pay today in order to receive the anticipated cash flow in future years. DCF means converting future earnings to today's money. The future cash flows must be discounted in order to express their present values in order to properly determine the value of a company or project under consideration as a whole.
The DCF for an investment is calculated by estimating the cash you will have to pay out and the cash you think you will receive back. The times that you expect to receive the payments must also be estimated. Each cash transaction must then be discounted by the opportunity cost of capital over the time between now and when you will pay or receive the cash.
For example, if inflation is 6%, the value of your money would halve every ±12 years. If you are expecting an asset to give you an income of $30.000 a year in 12 years time, that income stream would be worth $15.000 today if inflation was 6% for the period. We have just discounted the cash flow of $30.000: it's only worth $15.000 to you at this moment.
The DCF method is an approach to valuation, whereby projected future cash flow are "discounted" at an interest rate that reflects the perceived riskiness of the cash flows. The discount rate reflects two things:
1. The time value of money (investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay)
2. A risk premium that reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all.
The Free Cash flow (Free Cash Flow) method is an expression of the amount of cash that is left over for the stockholders.
How does a corporation make money?
It makes money by operating business units where it manufactures products or provides services. A company generates revenue by selling its products and services to another party. In generating revenue, a company incurs expenses—salaries, cost of goods sold (CGS), selling and general administrative expenses (SGA), research and development (R&D). The difference between operating revenue and operating expense is Operating Income or Net Operating Profit.
The cost of Capital, taxes and Free Cash flow
To produce revenue a firm not only incurs operating expenses, but it also must invest money in real estate, buildings and equipment, and in working capital to support its business activities. Also, the corporation must pay income taxes on its earnings. The amount of cash that's left over after the payment of these investments and taxes is known as Free Cash flow (Free Cash Flow).
The use of Free Cash Flow
Free Cash flow (Free Cash Flow method) is an important measure to shareholders. This is the cash that is left over after the payment of all cash expenses and operating investment required by the firm. It is the hard cash that is available to pay the company's various claim holders, in particular the shareholders.
2.1.1 Benefit and limitation of net present value method: -
Time value of money. The concepts of present and future value hinge upon the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In particular, the time value of money represents the interest one might earn on a payment received today, if held, earning interest, until that future date.
All of the standard calculations derive from the most basic algebraic expression for the present value of a future sum, discounted to the present by an amount equal to the time value of money.
Cash flows. Cash flow is the balance of the amounts of cash being received and paid by a business during a defined period of time, sometimes tied to a specific project. Measurement of cash flow can be used
To evaluate the state or performance of a business or project.
To determine problems with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.
To generate project rate of returns. The time of cash flows into and out of projects are used as inputs to financial models such as internal rate of return, and net present value.
To examine income or growth of a business when it is believed that accrual accounting concepts do not represent economic realities. Alternately, cash flow can be used to 'validate' the net income generated by accrual accounting.
Available capital for the project: -
According to the NPV calculation the company members can find out the available capital for the project. Therefore the higher the NPV higher the available of capital.
Option investments: -
The capital required for the project may change from the time to time. And it may change the risk profile of the project. And the NPV uses the information at the time called time option. It helps company for the optional investment.
2.2. Rate of return analyses: -
2.2.1 Internal rate of return: -
The second discounted cash flow measure, IRR, has traditionally been defined as the [sic, any] discount rate at which NPV is equal zero. NPV has been applauded and IRR criticized for decades. While the focus of the criticism has been on using IRR in capital budgeting decisions, the unfavorable coverage has spilled over into other areas. Analysis of the reasons given for supposed IRR inferiority is the focus of this paper. Correcting the misperception is the result.
IRR is used extensively despite the textbook criticism. Business people often favor it. For one thing, IRR is very good for screening projects. NPV is highly sensitive to the discount rate, while IRR bypasses the problem of deciding the "correct" one. Because IRR is a rate or ratio, not an absolute amount, it is more useful for comparing unlike investments, say stocks and bonds. It also is more useful for making comparisons between different periods and different sized firms and for making international comparisons. The intention here is not to argue for either point of view, but instead to put the issue into balance. The aim is to show:
NPV and IRR have essentially equivalent utility;
they are complementary ways of looking at a problem or opportunity;
IRR and NPV together give a better analysis than either alone;
if properly viewed, NPV and IRR give identical signals, including capital budgeting decisions;
IRR is particularly useful for comparing different sized projects, where it receives some of its greatest criticism; and
IRR is useful alone.
We will critically examine the professed reasons for the superiority of NPV over IRR in capital budgeting.
As it shown in the graph above the project that have the NPV less then the IRR have the positive NPV and vice-a-versa. The higher the discounted rate higher the cash flow will be reduced and the lower the discount rates lower the cash flow reduction. The company will accept that project which have NPV greater then zero.
For example, if the company has capital of 30% and IRR of the company will be 20% then company will accept the project as company will have profit of 10%.
2.2 Benefits and limitation of internal rate of return: -
The concept of internal rate of return has been accepted by many companies. They compare the cost of capital against the IRR for the specific investment. The main benefit of IRR is the simplicity. If IRR is higher then the cost then the project can be approved and vice-a-versa. The IRR method does not need to establish the discount rate as it compulsory in the NPV method. And the IRR concept has a lot of limitation as it simple so it can be misinterpreted easily.
A problem of the IRR is that it ignores the reinvestment potential of intermediate positive cash flows. Unless a better number is known, the firm's cost of capital is a reasonable proxy for the return to be expected.
In the case of a project with an unusually high IRR, the cash spun off from it will probably be reinvested at a moderate rate of return rather than in another unusually high-return investment. This mitigates the attractiveness of the project, which is reflected in the MIRR. Conversely, this reinvestment also mitigates the unattractiveness of an unsuccessful project, which is also reflected in the MIRR.
Similarly, money reserved for negative cash flows after the start of the project cannot be expected to have the same unusually high or low rate of return as the project itself perhaps has, so a normal rate of return is assumed for this money until it goes into the project.
2.2.3 Modified internal rate of return: -
The rate of return which equates the initial investment with a projects terminal value, where the terminal value is the future value of the cash inflows compounded at the required rate of return.
This better reflects the profitability of a project, as standard IRR assumes the cash generated from the project is reinvested at the IRR, whereas MIRR assumes that cash is reinvested at the firms cost of capital.
The modified internal rate of return assumes all positive cash flows are re-invested for the remaining duration of the project. All negative cash flows are discounted and included in the initial investment outlay. MIRR ranks project efficiency consistent with the present worth ratio, considered the gold standard in many finance textbooks.
For example, when analyzing a real estate deal, the most important thing you need to consider is the modified internal rate of return. This is the figure that will determine how profitable an investment could be, and will ultimately decide whether you invest or not. The modified internal rate of return is the same concept as the internal rate of return. The difference between the two indicates that the formula has been slightly modified to get a more realistic idea of how lucrative a deal you are considering.
2.3. Payback analysis
2.3.1. Payback period
Simple payback is common economic analysis method and is understood by most business owners. Simple payback is the amount of time it will take to recover installation costs based on annual energy cost savings. The equation for simple payback is annual energy cost savings per year divided by the initial installation cost.
Calculation of payback period formula: -
Payback period = cost of project/investment
Annual cash flows
For example, if a recommendation cost $5,000 to install and will save $2,500 per year, then the simple payback is 5,000 divided by 2,500 or 2.0 years. Note that this calculation does not consider the time value of money, inflation or maintenance costs. To take these factors into account, use a life cycle cost analysis.
$ 5000 = 2 year payback
$ 2500
If two different lighting projects have different economic "lives," then do not use simple payback to compare the two. Simple payback won't provide information about a project's profitability; only how long it takes to recoup the investment. However, a simple payback of two years or less usually suggests a profitable project. A longer simple payback requires more study.
2.3.2. Discounted payback period.
Discounted payback takes the time value of money into account. When an investment is made in a project today, that investment needs to return more in the future because $1 today is worth more than $1 in the future, since we live in an inflationary world. One must also consider that this $1 could have been invested elsewhere, especially in less risky investment vehicles, so not only does a $1 investment have to compete with inflation, but it competes with other opportunities. Thus too really break-even, $1 today has to return more a year from now, and even more two, three and four years down the road (as interest compounds).
With a discounted payback period, the costs and benefits of the project are discounted as they occur over time to take into account the lost opportunity of investing the cash elsewhere (usually set equal to a company's cost of capital) and further by a relative measure of the projects risk (the cost of capital + a risk generated discount rate). For projects with long payback periods, discounted payback periods are more accurate at determining the real payback, but for shorter projects, a non-discounted payback period is normally a good enough indicator. As with regular payback period, making investment decisions based purely on payback period can orient the team towards quick payback projects without regard to the ultimate benefit quantity – which is best measured using NPV.
2.3.3 Advantages of Payback Period
• It is easy to understand and apply. The concept of recovery is familiar
To every decision-maker.
• Business enterprises facing uncertainty - both of product and
Technology - will benefit by the use of payback period method since the
Stress in this technique is on early recovery of investment. So
Enterprises facing technological obsolescence and product
Obsolescence - as in electronics/computer industry - prefer payback
Period method.
• Liquidity requirement requires earlier cash flows. Hence, enterprises
Having high liquidity requirement prefer this tool since it involves
Minimal waiting time for recovery of cash outflows as the emphasis is
On early recoupment of investment.
2.3.4 Disadvantages of Payback Period
• The time value of money is ignored. For example, in the case of project
• A Rs.500 received at the end of 2nd and 3rd years are given same
Weightage. Broadly a rupee received in the first year and during any
Other year within the payback period is given same weight. But it is
Common knowledge that a rupee received today has higher value than
a rupee to be received in future.
• But this drawback can be set right by using the discounted payback
Period method. The discounted payback period method looks at
Recovery of initial investment after considering the time value of
Inflows.
Management Science-II Prof. Indian Institute of Technology Madras
• Another important drawback of the payback period method is that it
Ignores the cash inflows received beyond the payback period. In its
Emphasis on early recovery, it often rejects projects offering higher
Total cash inflow.
• Investment decision is essentially concerned with a comparison of rate
Of return promised by a project with the cost of acquiring funds
Required by that project. Payback period is essentially a time concept; it
Does not consider the rate of return.
2.4. Total cost of ownership.
Cost of ownership analysis (or total cost of ownership, TCO), is a business case designed especially to find the lifetime costs of acquiring, operating, and changing something.
Those who purchase or manage computing systems have had a high interest in cost of ownership since the 1980s, when the large difference between IT cost and IT purchase price became known. The five year cost of ownership for major computing systems can be five to eight times the hardware and software acquisition costs.
Today, however, TCO analysis is used to support acquisition and planning decisions for a wide range of assets that bring significant maintenance or operating costs across a usable life of several years or more. Total cost of ownership is used to support decisions involving computing systems, vehicles, laboratory and test equipment, medical equipment, manufacturing equipment, and private aircraft, for instance.
Good TCO analysis brings out the "hidden" or non-obvious ownership costs that might otherwise be overlooked in making purchase decisions or planning budgets.
The analysis begins with the design of a comprehensive cost model that completely covers the subject of the case, and which supports the purpose and needs of decision makers. The figure above, for instance is the structure of an IT acquisition cost model that works well for many situations. Cells of the matrix identify cost items that are planned and managed together (have common cost drivers); rows represent major resource categories, and columns represent IT system lifecycle stages.
The model provides an effective tool for assuring business case builders and case recipients that every important cost item is included and that everything irrelevant is excluded.
TCO analysis is not a complete cost benefit analysis, however. Strictly speaking, TCO pays no attention to business benefits other than cost savings (and this show up in TCO analysis only when different TCO scenarios are compared). When this approach is used in decision support, it is usually assumed that the benefits from all alternatives are more or less equal, and that choices differ only on the cost side.
Total cost: defining and validating
The first phase of the project was to prepare for interviews and collection of various types of cost data, which required development and validation of an ‘industry typical’ baseline operational video surveillance scenario, after which structured materials for interviews with study participants could be defined
And reviewed. Prior to development of this operational scenario to compare total cost, a definition of total cost of ownership had to be developed and validated. Several preliminary interviews were conducted to develop and validate total cost of ownership definition for this study. The emphasis was on quantifiable “Hard Costs” that could be supplied by study participants
With a minimum of interpretation or ambiguity. Consideration was given to non-quantifiable costs including “Soft Costs” (productivity gains, depreciation
costs) and “Hidden Costs”, however, the consensus was to exclude analysis of these types of costs from the study and final quantitative analysis, and instead capture these cost elements as observational points as provided by interview participants, and compiled as cost considerations that could not
Be directly quantified (see section: “Additional Observations and Considerations”).
How does TCO modeling differ from “life-cycle cost analysis” or “full cost accounting?”
Life-cycle cost analysis and full cost accounting are both systematic accounting approaches that seek to evaluate all costs associated with a product or practice, but TCO modeling is distinguished because it specifically evaluates IT products. These approaches can help organizations reduce total costs over time and document the benefits of practices like energy conservation and environmentally sound recycling.
Life-cycle cost analysis is often applied to energy technologies and building projects. For example, a life-cycle cost analysis can show that spending more initially on additional building insulation can produce a net savings (due to reduced heating and cooling costs) over the lifetime of a building.
The term full cost accounting is sometimes used interchangeably with life-cycle cost analysis, but is typically used to evaluate ongoing programs. For example, the U.S. Environmental Protection Agency promotes full cost accounting as an appropriate tool for evaluating the costs of local solid waste management programs. It allows a municipality to account for such things as avoided disposal costs associated with recycling that otherwise might not be taken into account.
Direct costs and indirect costs: -
The identification and measurement of direct and indirect costs is critical requirement of TCO analysis. Direct costs include all expenditure related to clients, servers, and network, including capital, fees and labor in each area. Indirect costs include downtime and service to end user. These costs often are hidden and difficult to indentify or measure. While direct costs usually related to tangible assets, indirect costs are found in time and productivity losses due to downtime in technology. Once direct and indirect costs are known the basic strategy is to conduct what-if simulation of various implementation scenarios to see which yields the best TCO. All of there calculation obviously rely on making good assumption as a basis for evaluating the TCO comparisons.
2.4.1 Benefits and limitation of total cost of ownership: -
Limitation of TCO:-
The limitation to TCO is lack of data resources, training, and education and corporate culture. While total cost of ownership is fairly simple to grasp conceptually, in practice the complexity of gathering TCO data may limit its widespread adoption. The firm stated the area of allocation issues is the biggest problem in TCO implementation. The major problem is lack of computer system/information to support TCO. due to the nature of the firm’s accounting and reporting system, these firms simply could not get the data needed to support the TCO. Thus, much data had to be gathered manually. Accounting system could provide relevant labour rates, overhead costs and so on. However, they did not provide detail regarding issues such as labour cost from rework due to particular supplier. As a result, development of TCO modelling approaches tends to be very labour intense tends to be very labour intense. Unless the data are made accessible through systems modification or new reporting.
Benefits of TCO: -
TCO analysis is used, widely, for planning, decision support, program evaluation, proposal evaluation, and other purposes, in organizations of all kinds, even though the term itself has no precise definition beyond the implication that both positive and negative impacts are going to be summarized and weighed against each other. Some key points to remember about TCO analysis include the following:
A good cost/benefit analysis for a major acquisition or action will include a time dimension and other characteristics of a good business case. In order to evaluate a TCO analysis properly, your audience needs to see the timing of expected inflows and outflows as well as the cost and benefit models that determine what is included in the case and what is not.
A cost/benefit analysis will on the one hand attempt to quantify every benefit and cost for inclusion in the financial analysis, even the so-called intangible or “soft” costs and benefits. On the other hand, it will not omit discussion of important non-quantified benefits and costs. The reason it is important to quantify everything possible is this: If no financial value is assigned to an agreed cost or benefit, that impact contributes exactly nothing to the financial analysis. Is this really appropriate? Often it is not. A company may invest in technology in order to improve its “professional image,” improve customer satisfaction, or create a “more professional work environment.” But how much monetary value should be credited to these benefits? They will be valued at 0 if an acceptable valuation is not agreed.
Return on investment: -
The term Return on Investment (ROI) is commonly used in different ways.
In financial circles, the strict meaning of Return on Investment (ROI) is Return on Invested Capital, a measure of company performance: The Company’s total capital is divided into the company’s income (before interest, taxes, or dividends are subtracted). Alternatively, ROI is sometimes equated with Return on Assets: a company's income for a period divided by the value of assets used to produce that income.
Most business people, however, use “ROI” simply to mean the “Return” from an action, divided by the cost of that action. In this sense, an investment that costs $100 and pays back $150 after a short period of time has a 50% ROI. When ROI is requested, it is prudent ask specifically how that is to be calculated. Understand clearly, that is, how both the “return” and the “investment” are derived and what time period is covered.
Three ways to maximize ROI are suggested by the figure shown with "what’s a business case?" Minimize costs, maximize returns, and accelerate the returns. A relatively small improvement in all three may have a major impact on overall ROI.
ROI is an appealing concept because its meaning seems self-evident and easily understood. Many factors can complicate its calculation or interpretation, however, and for that reason many business cases do not attempt to present ROI as a quantitative result, but focus instead on financial metrics such as Net cash flow, DCF, IRR, and payback period. Problems with ROI include the difficulty of finding a truly appropriate investment cost figure (this may call for arbitrary cost allocation judgments or the addition of “opportunity costs,” for instance). Other problems with ROI come from the passage of time. Investment costs typically come early, while returns may come years later. Thus, the time value of money (discounting) may need to enter the ROI equation; and, it may be especially difficult to match specific returns with specific costs. In brief, the simple ROI concept is probably appropriate only when both "Investment cost" and "Return" come over a short time period, are clearly tied to each other, and can be derived simply and unambiguously.
THE BASIC ROI PERCENTAGE CALCULATION
Many experts seem to agree, "calculating an accurate return on investment (ROI) is not an easy thing to do."
I do not intend to give you a thorough analysis of the ROI calculation process. Calculating an accurate ROI is hard to do, but explaining the full scope of ROI calculations in less than 1000 words is far more difficult.
As such, this article is only intended to introduce you to the basic concepts behind ROI calculations. Here is a very basic equation for calculating the ROI:
ROI = net operating income
Average operating assets
Where,
Net operating income is the income before taxes and interest. And average operating assets is cash accounts receivable, inventory, plants and equipments and other productive assets.
Your payback is actually the total amount of money earned from your investment in your company. Investment relates to the amount of resources put into generating the given pay back.
You should run ROI calculations on both monthly and yearly timelines.
For example: -
A company have the following
Net operating income: - 30,000 Rs.
Average operating assets: - 2, 00,000 Rs.
Sales: - 5, 00,000 Rs.
Then
ROI = 30,000 = 15%
2, 00,000
2.5.1) Benefits of ROI: -
Communication: By providing both credible numbers and qualitative and narrative value information, and the systematic story to support all of these it can ‘talk’ to stakeholders with different preferences. It can help in communicating information with stakeholders and provide a means of drawing them into conversation.
More effective decisions: If being used for planning, and not review, the focus on stakeholders can highlight interrelationships and help define activities with stronger synergies and increase planned social value. Monetized indicators can help analysis by management to consider what happens if they change their strategy. It allows them to think about whether their strategy is optimum in generating social returns, or if there may be a better means of using their resources. It can help investors more efficiently select investments that are aligned with their value objectives.
Focus on the important: By focusing on the critical impacts, an ROI analysis can be completed relatively quickly and is an effective way of defining management information systems necessary to make it quick in future
Investment mentality: The concept of social return helps people understand that any grant or loan into an organization can be thought of as an investment rather than as a subsidy. The focus shifts to the creation of value, and away from the risk mentality and opportunity cost of using money here rather than there.
Clarity on governance: If more accountable organizations are more sustainable, then understanding and explaining these impacts and then responding to them is critical. ROI analysis can help clarify impacts and focus the response. Responding to stakeholder’s means that they can influence the organization and so the organization’s governance will be better related to stakeholders requirements.
2.5.2 Limitation of ROI: -
-
Benefits that cannot be monetized: There will be some benefits that are important to stakeholders but which cannot be monetized. An ROI analysis should not be restricted to one number, but seen as a framework for exploring an organization’s social impact, in which monetization plays an important but not an exclusive role.
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Focus on monetization: One of the dangers of ROI is that people may focus on monetization without following the rest of the process, which is crucial to proving and improving. Moreover, an organization must be clear about its mission and values and understand how its activities change the world – not only what it does but also what difference it makes. This clarity informs stakeholder engagement. Therefore, if an organization seeks to monetize its impact without having considered its mission and stakeholders, then it risks choosing inappropriate indicators; and as a result the SROI calculations can be of limited use or even misconstrued.
-
External accreditation: There is no external accreditation, and no brand or mark is available.
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Intensive for the first time: If an organization does not have an existing social accounting system, ROI will be more time intensive the first time but is designed to focus on the most important areas, It is most easily used when an organization is already measuring the direct and longer-term results of its work with people, groups, or the environment.
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Some outcomes not easily associated with monetary value: Some outcomes and impacts (for example, increased self-esteem, improved family relationships) cannot be easily associated with a monetary value. In order to incorporate these benefits into the ROI ratio proxies for these values would be required. ROI analysis is a developing area and as ROI evolves it is possible that method of monetizing more outcomes will become available and that there will be increasing numbers of people using the same proxies.
Conclusion: -
As it could be seen from the project and examples given in this project. The methods of project valuation can be less or more limited. Therefore the both practical and theoretical discussion on the methods expresses the affectivity of project.
It comes with out uncertainties, in order to implement the profitable analyses. It is the combination of the both to using the method and perform analyze as a professional.
It is often the first step to use method such as simple payback method for the primary project valuation. It is important to use the specific method for particular project for the investment. This is evaluated by the profitable by the one method.