Imagine that you made $1MM in revenue. That could be a lot of money. What if your costs were $999,999? That means that you have a profit of $1, which might not be so attractive now.
This is why it is important to calculate your return on invested capital (ROIC). It’s a formula to calculate how well a company is using capital to generate returns.
Having a high ROIC compared to your industry average and/or competitors is important, but it’s more insightful if you can identify the specific drivers that make the ROIC high [or low].
The formula is below. If you cross cancel Sales (or gross revenues), then it’s NOPAT (net operating profit after taxes) divided by Invested Capital.
However, I like it broken apart because it tells me the margin and turnover.
Profit margin is how much money a company gets to keep after sales. The formula is net income divided by revenues.
For example, a diamond ring at Tiffany & Co might cost the company $1,000, but sell it for $20,000, making $19,000 in income. Therefore, the margin is 19,000/20,000=95%.
Inventory turnover is how often a good is sold during a period. Whole Foods Market might sell tons of carrots in a day, while Tiffany & Co might only sell a handful of diamonds in the same period. Therefore, Whole Foods Market would have a high inventory turnover and Tiffany & Co would have a low inventory turnover.
A winner is a company that can sell a lot of a product with a high profit margin, such as Lululemon.
I hope that this helps you decide whether or not to go into a business venture because the return has to be greater than other options available. Of course, every opportunity cost includes different levels of risk, which normally have higher yields.
Lawrence Chan
P.S.
Too many times have we seen great stories not published. The criteria are simple.
- love
- passion
- adventure
They’re all philosophies that we internalize. I doubt that we are alone.
Join us in this new democracy and let your clients’s stories and your business flourish.
TOFURIOUS 