The equation to calculate the Return on Investment (ROI) is Net Profit/Sales x Sales/Investment?

Posted: 07-08-2010 | Author: admin | Category: Investing


What do I put in as my investment in this equation? The only information I have is an income statement that has total net sales, total cost of goods sold, and total expenses.

Category: Investing by admin

One Response to “The equation to calculate the Return on Investment (ROI) is Net Profit/Sales x Sales/Investment?”

  1. Heber, on August 9th, 2010 at 1:25 pm Said:

    You can simplify your original question by cancelling out sales in the denominator of the first fraction and in the numerator of the 2nd fraction the formula becomes:

    Net Income / Investment.

    Now, since you state that all you have is the income statement than this formula becomes unworkable. I would suggest you get the firm’s balance sheet (you need that anyway if you intend to make any financial decision regarding the firm).

    The formula for ROI would be:

    Sales / Average Assets

    Where average assets would be the average of the assets at the beginning of the period under consideration and tha assets at the end of the period under consideration.

    A more complete analysis of profitability, however, would include the ROE and either the 3 stage DuPont breakdown or the 5 stage DuPont breakdown.

    The basic ROE formula is:

    Net Income / Average Equity

    The 3 stage breakdown is:

    NI / Sales x Sales/Av. Assets x Av. Assets/Av Equity = NI / Av. Equity

    With this breakdown you can evaluate the ROE in terms of:

    Profit Margin or expense control = NI / Sales
    Asset Turnover or efficiency is use of assets = Sales / Av. Assets
    Leverage = Av. Assets / Av. Equity

    If you desire more information on interest rate expense efficiency and tax efficiency you can use the 5 stage DuPont breakdown:

    NI/EBT x EBT/EBIT x EBIT/Sales x Sales/Assets x Assets/Equity = NI/Equity.

    (Anytime you compare income statement items with balance sheet items the balance sheet items should be the average during the period)

    This simply expands the profit margin and lets you compare a company’s interest and tax efficiency against its peers or against its own past results.

    Again, if you want to go further than efficiency margins you are going to need to find the company’s balance sheet. In the case of a publicly traded company you should be able to find this on EDGAR or on the company’s IR website. It this is a private company either they should give this to you or they are trying to hide something.

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