Return on investment (ROI) measures the efficiency of a business’ use of its ope

Question

Return on investment (ROI) measures the efficiency of a business’ use of its operating assets and is the ratio of the business’ net operating income to the value of its operating assets. That means that the higher the business’ net operating income and the lower the value of the business’ operating asset, the better its ROI. But, ROI can be misleading. For instance, many Internet businesses like Groupon and LinkedIn do not have much in the way of operating asset, but they have a lot of operating income. What does ROI disclose about how efficiently these kinds of businesses are operating? Are there better measures of how well managed companies like Groupon and LinkedIn are?

Explanation / Answer

There are other financial indicators which can be used to measure the financial efficiency of online companies:

The profitability of a company influences its value and the amount of income it generates for its owners. Two financial indicators that measure the profitability of a company are the net profit and the return on assets. The percentage of net profit is the amount of net profit divided by the amount of sales times 100. The percentage of return on assets is the amount of net profit divided by the total value of the assets of the company times 100. The percentage of net profit, or net profit margin, measures the ability of the company to generate surplus cash. The percentage of return on assets measures how efficiently the company is using its resources.

Companies can have high debt but still perform well if they have used their debt to purchase assets such as equipment or other companies. You can calculate the debt-to-assets ratio by dividing total debt by total assets. This financial indicator tells you how much of the debt the company used for assets that retained their value, and a ratio below one means the company has the long-term ability to pay all its obligations and survive challenges.

the other indicators include the PE ratio, and the rate and consistency with which the companies declares and pays off the dividend to its shareholders.

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