Calculating return on investment with cash flows

Return on investment (ROI) is used to know the yielding capacity of an investment. The ROI tends to show the profit or loss on an investment contrary to the money invested. Return on investment is important in that it draws insights on the profitability (yielding forms) on different investments incurred. It’s usually shown in percentage (%). It's imperative that any business employ the ROI tracking platform to ensure that profits that should have been lost is properly accounted for leading to good management of the asset balance of the business. The ROI is a good technique to employ in that cash flow (money going in & out of the business) is contained to prevent excessive losses on investments done by the business owner/trader. An elevated ROI intends more profitability on an investment in relation to the losses & as such every business should strive to keep the ROI on its apex to ensure more gains on investment & to know if it's feasible to undertake an investment.

WHY THE ROI IS IMPORTANT TO THE TRADER

The ROI is one of the most relevant tools out there to be employed by any trader to ensure profit. If the ROI is low then it indicates that the business is heading towards bankruptcy and as such the ROI should be analyzed quarterly to ensure better business relationship among the stakeholders and build asset balance leading to better business management & proficiency. The ROI is important in that;

  1. To indicate feasibility of an investment

  2. Provides clear overhead of gains

  3. Making quality marketing decisions

  4. Used to beat market competition...

WHAT IS CASH FLOW?

Cash flow is the measure of money going in & out of the business. The cash flow could be positive (that is the end balance is greater than the initial balance) or negative (that is the opening balance is greater than the end balance). This positive cash flow means that the business liquid assets are not declining which could be put out for reinvestment on other business ideals, clear out debts, reduce expenses & prevent monetary future obstacles. Cash flow could be in any of the following;

  1. Operational cash flow

  2. Investment cash flow

  3. Finance cash flow

Operational cash flow are used for daily transactions, investment cash flow are used for acquisition of assets i.e. lands, whereas finance cash flow are set apart for dividend sharing among the different stakeholders in the business.

Why calculating cash flow statement is important

The cash flow statement is an overall document showing the monetary assets/liabilities incurred by the business. The cash flow statement shows in precise order how money are spent / used in relative to the gross income & assets. The cash flow statement is important in that;

  1. It indicate if the IOUs of the business is increasing

  2. Cash flow indicates the quality of business income

  3. In cases where the cash outflow is greater than the cash inflow then it's justifiable to see that the company is heading towards bankruptcy.

DIFFERENT METHODS OF CALCULATING CASH FLOW

There are different methods out there of checkmating the cash flow index of a business. These methods could be employed to eliminate losses. Among them are the following;

  1. Free cash flow

  2. Discount cash flow

  3. Levered cash flow

  4. Unlevered cash flow

  5. Operational based cash flow

How to calculate ROI with cash flow

CFROI (cash flow return on investment) is among the methods of calculating ROI. The cash flow method tends to show the ratio of cash inflow to that of cash outflow through the internal rate of investment(IRR).This calculation is done by;

  1. Calculating the total cash flow of the business & base the currency on the prevalent rate of dollars which could be  influenced by inflation

  2. Calculating the total assets also based on the dollar influenced by inflation

  3. Calculate the CFROI as though you calculate the IRR (i.e. at the extent where the cash flow is equal to the cash outflow). Remember that the ROI is always shown in (%).

IMPORTANCE OF CALCULATING ROI WITH CASH FLOW

The ROI is important to be calculated using the cash flow in that it takes into account the day-day trading transactions that couldn't be recorded on other accounting booklets. The ROI cash flow is based on gross income & gross assets. The following are reasons to calculate the ROI on the cash flow;

  1. It indicate good investment

  2. Uses gross assets & income therefore it takes into account the time worth of money.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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