One of the elements common to all types of investments is some degree of risk. This is even true for businesses that invest in themselves, spending money on growth opportunities and operations. For business leaders and investors alike, accounting for risks and weighing this information against historic and projected returns is essential to understanding the upside and downside of an investment opportunity.
Return on Investment
The standard measurement for returns is return on investment. ROI measures how much an investment has grown over a given period of time in the past, or how much it is estimated to grow in the future, divided by the cost of investing. The result is a percentage that indicates the value of returns per dollar invested. Accounting for returns in this way levels the field among investments with very different prices.
In corporate finance, beta refers to the risk of an investment as a comparison between its returns and the returns of the broader market. This takes into account the fact that even if an investor makes money by buying, then selling, an asset, it might not be as much as the same investor could have made by investing the same amount in another asset. Beta is based on projections, or estimates, of future returns. It can also incorporate real financial data from similar businesses in the same market.
Accounting for Beta
Beta comes from several different sources. This means that business leaders, investors and analysts interested in accounting for a company's risk must determine the beta, or betas, relevant to their situations. Business risk comes from the way a business operates, including its activities and investments. Financial risk pertains to the way a company's capital structure works, including the risk that it won't be able to repay its debts. Total corporate risk is the sum or business risk and financial risk.
There is no single unified accounting procedure for combining returns data and risk measurements to determine the overall value of a business or investment. Instead the entire process, known as equity valuation, relies on the judgement of those who need to use the information. Investors and business leaders use other measurements, such as financial ratios, market trend data and the cost of capital, to aid in decision making when money or a company's future performance are on the line.