Investment income refers to any financial gain acquired from various types of investments by an individual or business. To generate this form of income, the investment must provide returns exceeding the original assets used by the investor to secure the asset.

Investments can be made in several ways:

• Opening a bank deposit account;
• Investing in businesses, startups;
• Real estate investments;
• Putting money into currencies, precious metals, stocks, bonds, and other securities.

The profit from investments, or a portion of it, goes to the investor. This profit constitutes investment income.

How investing differs from running a business

In business, the focus is on quick return on investment, with the entrepreneur benefiting from rapid profits. Contrarily, high-yield investing is long-term oriented. Investment strategies involve holding assets for periods of three years or longer—the longer an investor holds onto assets, the greater the chance of achieving high and stable returns.

Another distinction between investors and entrepreneurs is their approach to risk. Businesspersons aim to minimize risks. Investors, however, understand that higher risk can lead to greater investment portfolio yields. When strategizing, an investor aims to minimize losses while maximizing risks.

Calculating investment returns

Investment returns are calculated using specific formulas. These formulas are useful for forecasting investment payback periods and comparing various projects.

For a comprehensive understanding and accurate results, it’s advisable to use multiple calculation methods.

Current income

Current income includes cash received by an investor while owning an asset, such as interest from a bank deposit or dividends from securities. The following formula can be used to calculate current income:

Income = Receipts — Expenses,

where Income represents the profit, Receipts the income, and Expenses the costs.

Many investors focus solely on calculating current income, neglecting other indicators, which is fundamentally incorrect.

Net income

The net income calculation formula provides the financial result over the entire investment period.

Net Income = ∑Income — Investment Costs,

where Net Income represents the net income, ∑Income the total income over several periods (e.g., months), and Investment Costs the capital investments at the project’s inception.

Discount rate

The discount rate helps determine how time affects invested funds. To find the discount rate (E), a metric reflecting the relationship between future income and its present value is selected.

The final formula: a = 1 / (1 + E), where a is the sought coefficient.

Discounted income

This indicator allows assessing the profitability of a particular investment direction. Thanks to discounted income, an investor can decide whether to invest in a project.

The formula is as follows:

Discounted Net Income = ∑ (Income — Expenses)a — ∑Investment Costs*a,

where Discounted Net Income is the discounted income, Income the income for a specific period, Expenses the costs for a specific period, Investment Costs the project investments, and a the coefficient obtained in the previous formula.

Profitability index

The profitability index shows whether the generated incomes can cover the invested funds.

Profitability Index = ∑(Income — Expenses)a / ∑Investment Costs*a,

where Profitability Index is the index, Income the income for a specific period, Expenses the period costs, Investment Costs the project investments, and a the coefficient.

Average and internal rate of return

The average rate of return indicates the average annual income an investor can receive, denoted as ARR.

ARR = ∑ Net Income / Total Investment Amount * N,

where Net Income is the net income, Total Investment Amount the total sum of investments, and N the number of calculation periods.

The internal rate of return shows the interest rate at which an investor can recover the initially invested funds.

IRR = ∑ (Income-Expenses) / (1+Eirr),

where IRR is the internal rate of return, Eirr the internal discount rate, and Income the achieved result.

Determining actual financial indicators

Actual financial indicators reveal a project’s profitability and, therefore, its worthiness of investment. Recalculating these indicators periodically is useful for assessing a project’s current profitability.

Calculated profit rate

The calculated profit rate shows the changes the invested sum has undergone over a specific period.

Generally, profitability is calculated using the formula:

CPR = Average Annual Profit / Initial Capital Costs * 100%,

where CPR is the calculated profit rate, Average Annual Profit the average yearly profit, and Initial Capital Costs the initial capital expenses.

Profitability

The higher the profitability, the more advantageous the project. The profitability calculation formula is:

P = ∑ Net Income / (1+E) / ∑ 1/(1+E)),

where P is profitability, Net Income the net income (in this case, over the entire project duration), and E the discount rate.

By applying these formulas, an investor understands what to expect from future investments, which activities will be profitable, and the justification of investments in a project.