Return on Investment
by WAYNE WILLIAMSON Principal, Birmingham Office
Presented before the Pensacola—Mobile Chapter of the National Association of Accountants, Mobile, Alabama—March 1961
IN A CAPITALISTIC economy the basic objective of any business enter-prise is to return a profit on the capital employed, thus generating additional capital for reinvestment to return additional profit. It follows that the optimum use of capital will be the investment that offers the prospect of a profit on the capital invested greater than from any alternative use of such capital. It also follows that management, upon whose authority capital is invested, has the responsibility to determine that the capital with which it is entrusted is channeled into such investments.
Of importance equal to its responsibility in selecting for investment
the projects that offer the prospect of maximum profit is management's
responsibility for fulfilling and maintaining that profit potential once it has committed capital to investment. With the current
trend toward decentralization in corporate structure, there has followed a concomitant delegation of this managerial responsibility to the division or plant levels or both; however, top management remains
ultimately answerable for maintaining a satisfactory earnings performance.
Mathematical measurement of the relationship between earnings and capital committed to the production of those earnings can be used as one of management's tools in meeting its responsibility for informed investment decisions and for controlled operating results. Certain of the salient features of the development and use of this management tool are discussed in the paragraphs that follow.
RATE OF RETURN IN EVALUATING INVESTMENT ALTERNATIVES
In selecting projects for investment, management must consider such factors as: amount of capital to be committed and timing of expenditures in relation to availability of capital, as indicated by cash forecasts; level and pattern of earnings anticipated from the projects; urgency of projects from purely operating or marketing considera-