Balance Sheet Applicability On Return On Investment (ROI)

 

Question one; Can balance sheet aid in determination of return on investment?

The answer is YES.

Question two; Is return on investment (ROI) the same as return on asset (ROA) and return on equity (ROE)?

The answer is YES.

This is because the investor uses his or her capital (ie equity) to finance the purchase of income generating assets, which can either be of non-current or current asset or of both nature (ie total assets). Then the returns realized by those assets is compared with the initial capital outlay to assess the rate at which the investor is recovering his or her amount of cash or non-cash resources invested therein.

Return on Investment (ROI) is the profits or returns generated by the assets acquired. The rate at which income or returns are generated depends on the efficiency of the assets acquired. ROI is useful for it guides the investor to know whether the directors of the company were careful in doing the right investment

Example one

Light Power ltd provided you with the following comparative balance sheet of its three financial reports of 2018, 2019 and 2020 as follows;

 

If the net profit after tax (ie net income) for the three years, 2018, 2019 and 2020 was $220, $500 and $1,000 respectively;

Required

(i)Determine Return on Investment (ROI) for the three years

(ii)Compare the value of ROI with that of ROA and ROE and comment on their relationship of the three ratios

(iii)Interpret the results for each financial year

(iv)Comment on the general trend of the returns for the three years

(v)Advise the owners of this company on their investment

Solution 

 

 

Interpretation;

For every one $1 invested, the business recovered $0.275 through its acquired assets. In other word, the assets acquired were able to generate 27.5% of the one USD invested in the business in the year 2018.

Compared with;

 

Interpretation;

For every one $1 invested, the business recovered $0.33 through its acquired assets. In other word, the assets acquired were able to generate 33% of the one USD invested in the business in the year 2019.

Compared with;

 

 

 

Interpretation;

For every one $1 invested, the business recovered $0.5 through its acquired assets. In other word, the assets acquired were able to generate 50% of the one USD invested in the business in the year 2020.

Compared with;

 

Comment

There exists an increasing ROI trend of Light Power ltd between 2018 to 2020, which is a sign of good financial windfall, which could have been due to economic growth.

 Advisory service is that the owner of the company should continue with the business for the returns are worth the investment. The owner should also consider opening of new branches for it shows that the product is doing well in the market and the market share is big