Question

What financial factors should be reviewed if an organization's Return on Investment ratio (ROI) decreases significantly?

Answer 1

The following are few of the financial factors that might be attributable to the decrease of Return on Investment:-

a.) Decreasing Revenue:-

The return on Investment is the amount of return that a business is able to make out of the capital it invests. The formula to calculate the return on investment is :- Net Income/Initial Investment. If there is a decrease in the Net income of a company, the numerator decreases with the denominator(capital/initial investment) being the same. The business should focus on increasing the revenue and reducing the expenses so that the Return on Investment would be higher.

b.) Increasing Investment/Capital:-

The higher the capital required, the greater the Net Income that would be required to maintain a healthy Return on Investment Ratio. Hence, if there is an increase in the capital that is being invested, with a not so proportionate increase in the Net Income, then the Return on Investment is bound to decrease. The business should focus on maintaining a healthy capital/investment that would yield the best returns.

c.) Economic Factors:-

The demand for a particular product is bound to change based on the consumer needs and preferences. The change in demand is attributable to various factors such as seasonal changes, economical policy changes , supply demand curve, etc. These have a bearing on the Net Income which ultimately determines the Return on Investment. The organization should focus on understanding whether there are any economic factors that is driving the declining return on investment trends.

d.) Availability of Funds:-

For any business to scale up, it would require funds. The higher the ability of the business to scale up, the higher the ability of the business to increase its operations. The lesser the funds available, the lower the Return on Investment. The organization should try to understand if the business has enough funds to carry on its operations and scaling up.

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