The calculation of the project's profitability orientation is performed based on the following formulas.
As a ratio of the total value of the business to the invested funds:
Rп = Сб / Ци ,
Where:
Sat - final cost of the business;
Qi is the volume of investment.
As a ratio of net income and depreciation expenses to the investment in the startup's share:
Rп = (П + А) / Ци ,
Where:
P — net profit;
A — depreciation amount;
Qi is the total cost.
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Calculating the breakeven point
The optimal profitable threshold is a key criterion showing the level of profitability of a business at which it will become break-even. Simply put, it reflects the minimum sales volume or revenue amount required to cover all business expenses and break even.
The formula for calculating it is as follows:
Breakeven Point = (Fixed Costs × Revenue) / (Revenue – Variable Costs)
Let's briefly explain the basis of fixed and variable costs. Fixed costs are those costs that do not change depending on the volume of production. In other words, office rent, linear depreciation, accountant's salary will always be fixed regardless of the amount of products manufactured by the company.
Fluctuations in production volume are accompanied by changes in variable costs or expenses, such as wages of production workers, purchase of raw materials and supplies, payment for electricity for machines, etc.
Calculating the breakeven point
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The need to determine the breakeven point in a monetary context arises for a number of tasks:
analysis of the financial stability of the company as a whole;
search for opportunities to optimize and improve the organization of the enterprise’s production activities;
determining the payback period of projects (return on investment);
assessment of the effectiveness of the overall activities of the enterprise;
determining the cost of goods when sales volume increases or decreases.
Business Profitability Analysis
After performing calculations and obtaining profitability indicators, you can begin the analysis. Depending on the current goals, it can be aimed at determining the economic potential of the company or assessing its financial results from scratch. Three types of profitability analysis are used in reporting: comparative, factor and index.
Comparison analysis
This approach involves comparing individual profitability indicators within a company or with similar parameters of competitors. Conducting a dynamic analysis allows you to assess the effectiveness of business activity as a whole and its attractiveness for investment.
Comparison analysis
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Benchmarking can provide detailed information about the profitability of a business in a particular industry. It can also help create an overall picture of the business's prospects, taking into account the position of other companies in the market.
Factor approach
Evaluation of financial profitability may include a factor approach that combines several different models. All of them are important for identifying the relationships between key profitability factors and are divided into three groups:
summary - used in cases where factors are summed up;
multiples - division of one factor by another is used;
multiplicative - based on the product of factors.
These models can be applied to create multi-factor combinations taking into account profitability ratios.
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Index analysis
This method of profitability analysis is suitable for companies of all industries and forms of ownership. It allows you to study both one enterprise and several companies simultaneously, using indices:
variable composition;
stable (unchanging) composition;
impact of structural shifts.
Indices indicate relative values that may indicate various events. Conducting an analysis of profitability using the index method shows the change in the established indicators in dynamics for a certain period compared to previous periods of time.
The difference between real and nominal profit
Simple or nominal is the rate of profit without taking into account the impact of inflation. Over time, inflation partially or completely reduces the purchasing power of money. It can be noted that 1,000 rubles today is far from equal to 1,000 rubles thirty years ago.
To account for the time value of a currency, the discounting method can be used. When taking into account the impact of inflation, we are talking about the real (inflation-adjusted) rate of return.
Profitability and CAGR
These concepts are closely related. CAGR shows the average annual rate of return on investment over a period of more than 12 months, taking into account the growth values of the indicator for different periods.
To obtain CAGR you need:
divide the final cost of the investment by its initial value;
subtract from this result the value increased to the power of the inverse number of periods.