You have a plan to strategically invest your business capital. You want growth in sales and value for your company and you have identified one or more opportunities to deploy your company’s cash and accomplish your business objectives. How can you identify the most financially attractive investment?
The easiest and most common method to evaluate a business investment is by calculating a static pro forma return on investment (ROI). The word pro forma comes from the sixteenth century Latin word meaning as a matter of form. The pro forma return calculation looks at what will be when the investment is fully operational or stabilized. This calculation ignores the planned ramp up period for the strategic investment but takes into account any operating capacity slack at stabilization.
Time value of money is not a consideration in the pro forma ROI calculation. In other words, if it takes several years after you make the investment to begin generating profit there is no discount for the delay in investment return. Time value of money is a financial principle that a dollar today is worth more than a dollar tomorrow due to expected or realized inflation. To calculate a static ROI simply take the expected stabilized net operating income divided by the expected costs to acquire and improve the investment. You can evaluate competing capital investment opportunities using ROI because all the calculations are made using dollars at today’s value.
Make the right investment choice and your business will bloom with new revenue and added value. Make the wrong choice and you will spend years untangling from an unwise investment and incurring substantial financial losses.
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