Question

Which of the following is the correct formula for calculating return on investment?

A) Net profit / Sales
B) Gross profit / Sales
C) Operating income / Average total assets
D) Earnings available to stockholders / Number of outstanding shares of stock

Answer 1

The correct formula for calculating return on investment is option C) Operating income / Average total assets.

Step-by-step explanation:

Return on investment (ROI) is a key financial metric that evaluates the profitability of an investment relative to its cost. The formula for ROI is typically expressed as a percentage and can be calculated using various financial metrics. In this case, option C) Operating income / Average total assets is the correct formula.

To break it down, operating income represents the profit generated from a company's core operations, excluding non-operating expenses. This figure is divided by the average total assets, which provides a measure of the resources employed in generating the operating income over a specific period.

Mathematically, ROI is calculated as follows:

`\[ ROI = (Operating\ income)/(Average\ total\ assets) \]`

For a more detailed understanding, operating income is the difference between a company's revenue and its operating expenses. The average total assets are calculated by adding the beginning and ending total assets for a given period and dividing by 2.

Using the correct formula ensures a more accurate representation of how efficiently a company is utilizing its assets to generate profits from its core operations. This metric is crucial for investors and analysts seeking insights into a company's operational efficiency and overall financial performance.