Are you feeling difficult in calculating profit or loss in your business? Here’s a solution to your problem. It’s the Rate of Return, which brings out the solution. But is this something that we get in return as money, or is that something we return? Actually, you are right. For those who don’t have prior knowledge, this article may be a platform to learn more about it. The Rate of return is one of the most efficient ways of calculating the profit or loss in our investment. To make it clearer, let’s get into the topic.
Rate Of Return (ROR)
As mentioned above, the Rate of return (or) ROR is what we get in return as profit or loss after certain initial investment years.
For example, if you and your friends have 3 chocolates in your hand. After some time, if any of your friends don’t want chocolate, then the chocolate you get is the return rate. Now you have two chocolates in hand as you had one before. So, here time represents the years after the investment. Thus, the return rate is what we get after a certain time is a profit or loss.
ROR calculates by using the formula:
(Current value – Initial value) / Initial value) x 100
So, ROR plays a major role in many places to increase our money value in upcoming years.
Before we discuss it in detail, let’s start it with an example of the same chocolate. Suppose you want to buy chocolate, which costs Rs.15 at the beginning, and you have Rs.10. So, instead of trying out with the regular means, you start to save the money in your piggy bank. But after a certain time, the rate raised by Rs. 4. Now, the rate of chocolate Rs.19. So, the increased rate of chocolate at that time is your inflation rate. The inflation rate is the increase in the original price of the product after a certain time. Then if you understood the relationship between these two, you are a genius. Deflation is the decrease in the percentage and value of the product.
EXAMPLE: The decrease in the onion price when the harvest of onion during the season is smaller.
Thus, the inflation rate matters for both the increase and decrease in the price of the product. Many cases don’t have an increase but also a decrease, which depends upon the situation.
Internal Rate Of Return (Or) IRR
IRR is the budgeting to investigate the profitability of potential investments.
For example, consider that you are a chocolate owner and want to profit from this business. So, you first list out the materials for the preparation of chocolate. So, the preparation of a list of products according to their prices is budgeting. The budget for preparing 250 chocolates is Rs.2500. So, the cost of each chocolate is Rs.10. But to make a profit, he sells the chocolate for Rs.15. After he sells all the chocolates the amount, he would get Rs. 3750. Now, the profit he makes is Rs.1250. Calculate the percentage using the IRR formula.
In this formula, NPV is Net Present Value,
t stands for the total number of periods,
Ct represents for cash flows for t period,
and C0 is the initial cash outflow.
Thus, we can say that the return rate is one of the best ways to handle your business’s profit.
Annual Rate Of Return
For those who feel more complicated, let’s start with an example. Now, the chocolate owner has sold his chocolates for the whole year. He thinks of to calculate whether his chocolate business is a profit or loss for the whole year. Now we should help the chocolate owner find a way to calculate his profit over the year.
The best way to do this is the annual rate of return.
The annual rate of return formula is:
Yearly rate of return = EYP-BYP/BYP * 100%
EYP= End of year price
BYP= Beginning of the year price
Applications Of Rate Of Return
- ROR is useful in an investment making decisions.
- The ratio of financial analysts to compare the company’s performance over time.
- Commercial finance protection uses ROR as a tool for their business.
There are lots more to go.
Real Rate Of Return(ROR) Vs. Nominal Rate Of Return(ROR)
The major difference between the nominal rate of return is:
- The nominal rate of return is not adjusted for inflation while the real rate adjusts.
- Nominal rates are always higher except when there is deflation or negative inflation.
- The nominal rate of return formula is: (Current Investment Value/Original Investment Price) – 1
Real Rate Of Return(ROR) Vs. Compound Annual Growth Rate(CAGR)
The most important distinction between (CAGR):
- CAGR is straightforward enough by which it calculates.
- More complicated investments and projects are those that have various cash inflows and outflows. The foremost way to do this is by evaluating them using IRR.
Rate Of Return On Stocks And Bounds
Stocks have been a good bet. They’ve shown an annual return of about 10 percent per year, roughly from the past 100 years. In contrast, long-term government bonds have returned between 5 and 6 percent.
Internal Rate Of Return And Discounted Cash Flows (DCF)
DCF analysis attempts to find out the value of an investment in the present case. This is based on different projections of how much money it will generate in the future.
Negative Rate Of Return (NRR)
An investment is considered to give a negative return rate when it loses its value over a measured period of time. The negative rate of return brings loss among producers. This can usually rectify by budgeting.
The NRR comes into play when the net worth of the product decrease.
Example: The decrease in the price of petrol can bring loss to petroleum companies.
Leverage With Return Of Investment (ROI)
The leverage appreciation of the asset value is a great form of return on investment. This is normally based on income.
Leveraging means that the asset is purchased, and a portion of it is paid from the buyer, and the balance left comes from the lender. The occupant’s rental payment will repay the loan to the new buyer. Thus, this increases the value of the entire asset. It is considered as a real return on the original amount invested.
1. How does the rate of return benefits people?
2. How the rate of return is beneficial in day-to-day business?
3. How does ROR bring changes among rural people?
i. It helps out the developing companies in rural areas.
ii. It helps in making a decision among producers on what a consumer needs.
iii. Many people who are thinking of starting companies can make use of ROR.
4. How to incorporate ROR among small growing companies?
ii. Initializing people about the use of ROR.
iii. Educating people about the benefits of calculating ROR.
iv. Another best way is through social media.
5. How is ROR a major tool for business?
6. How to initiate ROR among people?
ii. Schools and colleges can develop ROR learning through powerpoints, videos, etc.
7. Name some of the companies that use ROR as a tool for business?
8. You are Rohan. Your friend tries to start a business for the distribution of vegetables to the market. How would you explain to him about the need for ROR?
9. Karnal is a shopkeeper. He comes to know about the ROR, but he has no idea about increasing his sales. Guide Karnal such that he would earn a profit?
10. How does IRR help shareholders?
The rate of return is a major means to calculate and meet our demands. This article aims to understand this by even a normal man to figure out his daily needs. Thus, I conclude to encourage more people to know about ROR and bring a change in their lives.