Capital Investment Metrics – Week #14 of The Financial Operating System®

Most people look at profit margins on the income statement when assessing profitability. Equally important, however, is evaluating capital investment metrics to determine the return on invested capital in the business. Capital investment metrics provide insights into financial efficiency and help business owners optimize their investments.

A 100% return on invested capital with a 3% profit margin can be more beneficial than a 5% return on capital at a 20% profit margin. The key is to analyze capital efficiency carefully. This chapter explores the essential capital investment metrics every business should track.

Key Capital Investment Metrics

1. Debt-to-Equity Ratio:

   • Definition: Total debt divided by owner equity.
   • Purpose: Measures how the business is financed. High ratios indicate reliance on debt, while low ratios suggest more conservative financing.

2. Return on Assets (ROA):

   • Definition: Net income divided by total assets, expressed as a percentage.
   • Purpose: Evaluates how efficiently the business generates profit from its assets.

3. Return on Equity (ROE):

   • Definition: Net income divided by owner equity.
   • Purpose: Measures the profitability of equity investments. Similar to ROA but focuses on equity rather than total assets.

4. Return on Invested Capital (ROIC):

   • Definition: Operating profit after taxes divided by total capital (debt + equity).
   • Purpose: Evaluates the overall return generated from all invested capital. ROIC is emphasized as a “pure” measure of capital efficiency and the default metric for ROI in The Financial Operating System.

5. Access to Capital:

   • Definition: Availability of undrawn credit or borrowing capacity.
   • Purpose: Indicates the liquidity buffer available for expansion or emergencies.

These metrics ensure business owners understand their capital efficiency, financial leverage, and ability to deliver returns on the capital they have invested in their business.

Next Step:

Business owners can self-implement The Financial Operating System. Chapters are available to download at smartbooks.com/resources or you can buy the whole book from Amazon (the marketing firm version or the general business version).

If you would like assistance with implementation or would like to accelerate results for your business, please contact author Cal Wilder at cwilder@smartbooks.com or book a free consultation with our team directly using this calendar link.