What is Financial Return? Some Equations and Calculations.

The financial return is a condition of that which is profitable: that is, generating income (profit, or benefit). Financial, on the other hand, what is associated with finance (linked to funds or money).

The idea of financial profitability is related to the benefits obtained through certain resources in a specific period. The concept, also known as ROI by the English expression return on equity, usually refers to the profits received by investors.

    What financial profitability does, in short, is to reflect the return on investments. To calculate the results obtained are usually divided by the resources or own funds that were used: Net result / Own funds to its net state. But this equation can have other numerators, as shown below:

  • Profit before taxes: to measure the return on own funds independently of corporate tax.
  • Result of ordinary activities: so that it is possible to dispense with the effect caused by extraordinary results and corporate tax.
  • Result before the deduction of provisions and amortization: as it is not easy to estimate these costs and may distort the real result.
  • Operating result having deduced both direct taxes and interest on the debt.

Suppose a person invests $ 10,000 in shares and, after a year, sells them making a profit of $ 2,000. According to the equation above, the financial return on your investment was 20%.

The calculation of the financial return will vary according to how the concepts of benefits and resources are understood. Profits, for example, can be measured before or after the payment of taxes, which will change the financial return. Concerning resources, own funds are usually used and not those that the investor generated from contracting a debt.

For all companies and investors, the objective will always be to maximize financial profitability: the higher the profitability, the greater the net profit. If two investments are compared, the most profitable one will be the one that offers a better relationship between the profit and the disbursed.

It is important to point out that if financial profitability is insufficient. A limitation is created that blocks access to new own funds by two ways: first, the low level indicates that the funds produced internally by the company are scarce; Also, this may lead to certain external companies refusing to provide financing services, for fear that they cannot cope with their debts.

That said, it is understood that financial profitability should be by what the investor can perceive in the market plus a value that protects him from potential risks inherent to his role as a shareholder. In spite of this, it is important to emphasize that the financial profitability refers mainly to the organization and not to the shareholders, although the own funds do represent their participation.

First, if we wanted the financial return to refer to shareholders, the calculation should include some magnitudes in the numerator (where, for example, Net Income is,), such as dividends, distributive profit, and variation of the quotes; in the denominator, on the other hand, it would also be necessary to take into account the investment corresponding to the remuneration .

Therefore, the concept of financial return considers the structure of a company from the financial point of view, taking into account its investments and the results of its operations, but also the factors that are included in the economic profitability.