Each business needs to continuously evaluate, gather, and forecast its performance data to improve its processes, develop, and expand. Measurement of ratios is a useful approach to assess profitability, liquidity, and risks for a company based on its financial statements (Lambert, 2018). Moreover, the calculations can help an organization determine unobvious challenges and prevent them from harming financial health. One of the fundamental ratios that provide valuable numbers is the return on investment (ROI), the profitability measurement, which evaluates performance. The term traditionally equals the return on assets, such as cash, facilities, equipment, yet the modern business also considers ROI per a specific investment (Berman & Knight, 2008). This paper aims to discuss why ROI is the component that identifies a company’s financial health.
The financial health status of an organization is identified by its capability of balanced utilization of assets to generate sales and revenues. To determine if a business has the optimal rate of that parameter, financial statements must be indicated. However, the numbers revealing business performance do not provide crucial information about the processes, therefore they need to be analyzed and re-calculated through different formulas and ratios (Berman & Knight, 2008). The most common calculations are gross, operating, net profit margin percentage, return on assets (ROA), and return on equity (ROE), debt-to-equity, return on investment (ROI), and turnovers (Berman & Knight, 2008). Such measurements’ main purpose is to highlight strong and weak financial points, evaluate a company’s competitiveness, forecast possible challenges, and opportunities (Lambert, 2018). Combined, the ratios can provide valuable information about a firm’s profitability, leverage, liquidity, and efficiency.
To understand if the ratios present a company’s financial health’s profound status, benchmarks need to be applied to the numbers. An organization can use its financial statements and measurements of the past, compare themselves to competitors, or the industry averages (Berman & Knight, 2008). New approaches to performance evaluation are vital to apply for businesses that aim to expand and develop. Moreover, ratios like ROI can help enterprises increase their competitiveness, attract investors, and adequately work out capital expenditures.
Most businesses implement ROI to index the efficiency of total assets utilization to generate sales. ROI’s primary function as a ratio is to measure a company’s performance by dividing its total worth by profit. Return on assets frequently means the same calculation, however, the financial terms define ROI as a separate measurement that analyses capital expenditure efficiency. The important data to collect for the ROI calculation is the cost of the investment, its benefits, and influence on the ongoing cash flow, net value, paybacks, internal rates of a return, and expected profit (Berman & Knight, 2008). Although ROI can not reflect the time value of money invested, the calculated percentage can be applied in other ratios to search for optimal financial decisions. If ROI is greater than zero, the investment can be considered profitable, while the opposite result might signal losses or potential risks.
There are several strategies to integrate ROI in a company’s performance analysis effectively. Firstly, if ROI is unexceptionally low, it might signal that some business processes have to be optimized. For example, HR specialists can revise the number of employees required for a certain project. Secondly, if the data about a competitor’s investing and profit is public, their ROI can be calculated and compared to improve the business strategy (Lambert, 2018). Lastly, if ROI is greater than zero, an investment can be considered profitable, while the opposite result might signal losses or potential risks (Berman & Knight, 2008). The application of successful strategies depends on accurate measurements, and ROI allows businesses to predict the profit and optimize the costs.
ROI indicates a company’s financial health status from the perspectives of its liquidity, leverage, and overall efficiency of applied practices. The company’s liquidity as an ability to turn assets into profit complies with ROI when the costs are being evaluated (Berman & Knight, 2008). Financial health is crucial when it is represented to investors, and ROI can reveal the result of ongoing or assumed funding. Moreover, ROI requires to conduct cash balance, debt ratios, and profitability ratio – factors essential to determining a company’s financial health (Berman & Knight, 2008). ROI for overall or certain investments needs to be considered while defining financial operations’ effectiveness, business strategy updates, and working on weak points or potential risks. These actions can be performed productively only in conditions of proper financial health.
A company’s success in the market might be temporary, and it does not determine its financial health. Internal measurements and analytics provide more accurate information about the operations and identify a firm’s worth. Return on investment indicates the financial health of a company as one of the measurements of its performance. ROI is tied to capital expenditure efficiency that would be at a low level in case of poor financial health and can be applied to forecast the outcomes of strategic updates. Calculation of this indicator can help business owners, executives, and investors optimize processes, determine the value of money, and improve a company’s financial health.
References
Berman, K. & Knight, J. (2008). Financial intelligence for HR professionals. Harvard Business Press.
Lambert, R. (2018). Financial acumen for non-financial managers [Video]. Coursera. Web.