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.

roic formula

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.

high margin turnover companies

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


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