ROI and Business Profit

Return on Investment (ROI) is arguably one of the most important tools, and ROI analysis (when applied correctly) is a powerful technique in making informed decisions.  However, we need to know what precisely is a return first in order to get the clear picture?  Firstly, I would say ROI analysis is a powerful tool for measuring the net financial benefits of an investment and is commonly used by business-oriented organization when evaluating where to spend their resources.

For instance, in the stock market it should has two components: the market value of the asset and the cash flow from it.  The two are intertwined; for example, an older bond with a coupon higher than would be offered by a similar bond today will see its market price go up.  

In fact, there are quite precise calculations to show this effect.  Nevertheless, if you hold a share or bond to maturity, you know what its value will be at maturity; it will be the par value and it is that which you will get back.  

Likewise, a share offering a good dividend will be valued, under normal circumstances, more than a share generating as much profit, but not distributing that profit partly by dividend.  It must be admitted, however, that some hi-tech companies even boast that they do not distribute dividend as there is so much potential for company growth in the future.

In the project ROI is a project’s net output (cost savings and/or new revenue that results from a project less the total project costs), divided by the project’s total inputs (total costs), and expressed as a percentage. The inputs are all of the project costs such as software, license, maintenance, programmers’ time, hardware, services and  training. Therefore if a project has an ROI of 100%, from this definition the cash benefits out of the project will be twice as great as the original investment. 

So apart of the bonds or stocks as individual investment, if we need to address the ROL to company or organization.  We need to answer this question; Should a manager invest a company’s money in an e-business project if it has a projected ROI of 100%? 

• The answer is: There are many factors one should consider when making an investment decision. These factors include, but are not limited to those listed below:
• The assumptions underlying the costs of the project
• The assumptions underlying the potential benefits
• The ability to measure and quantify the costs and benefits
• The risk that the project will not be completed on time and on budget and will not deliver the expected benefits
• The strategic context of the firm; that is, does the project fit with the corporate strategy?

Written by Yasser Al Mimar