Simple Financial Parameters to Select Projects
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00:55 – Overview of the Simple Financial Parameters
02:25 – Defining the PBT
05:10 – Disadvantages of the PayBack Time
07:00 – Defining the ROI
08:30 – Disadvantages of the ROI
In this video, I will explain to you the principles of two simple parameters that will help you evaluate projects related to their financial performance.
The first parameter is the Payback Time or PBT:
The payback time is a simple parameter that expresses the time to recuperate the initial investment.
PBT = Initial Investment/cash flows
Although the parameter is very simple to calculate and is used in many occasions, the parameter, also has disadvantages:
– does not count in time value of money
– only considers the cash flows until the initial investment is reached
– no indication of profitability and reinvestment of cash flows
The second parameter is the Return on Investment:
The ROI is a dimensionless parameter where we compare the revenue with the costs of the production. It allows comparing investments with different sizes by eliminating the size.
ROI = Net Profit/Cost of Goods Sold
Using the ROI has some important disadvantages too:
– effect on divisional ROI may lead to decisions not to invest
– using ROI, the preference is rather on older assets than on new ones
– it can lead to inefficient comparisons
– does not take into account the generated profit of the investment
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