The cost effectiveness is a condition of what is profitable: that is, it generates income (profit, utility, profit or benefit). Financial, for its part, is what is associated with finance (linked to flows or money).
The idea of financial profit is related to Benefits that are obtained through certain means in a given time period. The concept, also known as ROE by the english expression return on equity, usually refers to the utilities that investors receive.
What financial profitability does, in short, is reflect the performance of the investments. To calculate it, the results obtained are usually divided by the resources or own funds that were used: Net income / Equity to net statement. But this equation can have other numerators, as shown below:
* Result before taxes: with the aim of measuring the performance of own funds independently of corporation tax;
* Result of ordinary activities: so that it is possible to dispense with the effect that cause extraordinary results and corporate tax;
* Result prior to the deduction of provisions and amortizations: since it is not easy to estimate these costs and they can distort the real result;
* Operating income having deducted both direct taxes and interest on the debt.
Suppose a person invest $ 10,000 in shares and, after a year, sells them for a profit of $ 2,000. According to the aforementioned equation, the financial profitability of your investment was of twenty%.
The calculation of financial returns will vary according to how the concepts of benefits and resources are understood. Earnings, for example, can be measured before or after payment of taxes, which will change the financial profitability. Regarding resources, own funds are usually used and not those that the investor generated from contracting a debt.
For all the Business and investors, the goal will always be to maximize financial profitability: the higher the profitability, the higher the net profit. If two investments are compared, the most profitable will be the one that offers a better relationship between earnings and disbursements.
It is important to note that if financial profitability is insufficient, a limitation is created that blocks access to new equity in two ways: first, the low level indicates that the funds produced internally by the company are scarce; Furthermore, this may lead to certain external companies refuse to provide you with financing services, for fear that he may not be able to cope with his debts.
That said, it is understood that financial profitability should be in line with what the investor can perceive in the market. plus a value that protects you from potential risks inherent to your role as a shareholder. Despite this, it is important to underline that financial profitability refers mainly to the company and not to shareholders, despite the fact that equity does represent its participation.
In the first place, if we were to pretend that financial profitability refers to the shareholders, the calculation should include some magnitudes in the numerator (where up to now is, for example, the Net result), how to be dividends, distributable profit and price variation; 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 profitability 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.