What is MOIC?
Furthermore, Multiple on Invested Capital (MOIC) is a financial ratio that the total return of investment is compared with the size of invested capital.
In PE, VC and RE it is used to measure the performance of an investment that has been acquired or undertaken.
While other measures can distort an investor’s perspective with additional information, MOIC gives a clear, basic picture of the amount of value created or to be created by an investment.
Formula for MOIC
The formula to calculate MOIC is:
MOIC = Total value of Investment ÷ Total capital invested
Where:
- Total Value of Investment: This is a simple sum of cash receipts which have been earned during the period and the fair value of securities that have not yet been sold.
- Total Capital Invested: The very first capital that is invested for any particular investment or in any specific business venture.
- Thus, for instance, if one is given as ₹10,00,000 and the value of investment becomes ₹25,00,00,000, then MOIC can be as follows:
- MOIC = 25000000 / 10000000 = 2.5 x
This implies that the investment has a return with greater than two and a half the required capital.
How to Calculate MOIC
Determine Initial Investment:
- Total all capital contributions made for the investment.
Calculate Realized Returns:
- Sum any distribution of the cash, dividend or partial sales.
Calculate Unrealized Returns:
- Evaluate the overall fair market value which still holds the percentage of the investment.
Apply the Formula:
- To get value to capital employed, divide the total value in terms of realized and unrealized gains by the total capital invested.
Example Calculation
Scenario:
- Initial Investment: ₹20,00,000
- Realized Returns: ₹15,00,000
- Unrealized Value: ₹25,00,000
- MOIC = (Realized Returns + Unrealized Value) / Total Capital Invested
= (15,00000+25,00000) / 2000000 = 2.0 x
This suggests that it has actually doubled in its worth and this would have made someone one happy indeed, whoever made the investment.
MOIC vs. IRR
IRR is a standard measure that can compare the outcome of an investment.
Where MOIC is to analyze the multiple of money that was invested, the rate of return to investors on an annual basis will be considered based on IRR with sufficient attention given to time value of money.
Key Differences:
Time Factor:
- The time value of money is valued by IRR yet not valued by MOIC.
Complexity:
- Looking at the two, we realize that it is easier to calculate MOIC as compared to IRR.
Usage:
- MOIC is best used to measure the total value while IRR is used to measure how soon, efficient and in what time frame the returns are generated.
Example:
- Investment: ₹1,00,000
- Year 1 Return: ₹25,000
- Year 2 Return: ₹75,000
- MOIC: Formula = [₹25,000 + ₹75,000]/₹1,00,000 = 1.0 x
- IRR is only applicable in present values as it relates to the average rate of return over a period of two years downwards due to money time considerations.
Factors Impacting MOIC
Holding Period:
- Holding Periods greater than 12 months may produce higher Unrealized MOIC but it has lesser Annualized Total Returns.
Market Conditions:
- Appropriate market conditions increase unrealized values and, therefore, the MOIC figures.
Exit Strategies:
- Timely exits ensure optimal sale of the Understanding that is in the different areas of gain and enhances MOIC.
Management Efficiency:
- During the investment period the total value of the investment rises due to the active management and value creation processes.
Sector Performance:
- Ventures in the growth poles may give a better MOIC than in fixed industries.
Unrealized vs. Realized MOIC
Unrealized MOIC:
- Stands for present value of the remaining investments that have not been realized.
- Dependent on market and the approach to its evaluation.
- Used in business valuation and is usually used to predict future performance.
Realized MOIC:
- The figure shows the amount realized through exits, dividends, or distributions thus far.
- If relative measures are not consistent with real returns, then it is a more definitive measure of success.
Example:
- Initial Investment: ₹10,00,000
- Realized Gains: ₹5,00,000
- Unrealized Value: ₹12,00,000
- Unrealized MOIC: 1200000 / 1000000 = 1.2 x
- Realized MOIC: ₹5,00,000 / ₹10,00,000 = 0.5x
Advantages of MOIC
Simplicity:
- It reduces the level of complexity or difficulty among a number of stakeholders needed to calculate percentages.
Focus on Total Value:
- Implements the principle of measuring gains that were locked-in as well as those that were lost but never achieved.
Comparative Analysis:
- It assists in determining one investment against the other, or even numerous investments irrespective of the time horizon.
Insight for Decision-Making:
- Point out whether or not an investment is generating required returns.
Disadvantages of MOIC
Ignores Time Value of Money:
- Can only show cash flows at any given time but not when these occurred.
Potentially Misleading:
- Deposits which have not been realized can distort MOIC in the wrong direction and hence over expectations.
Limited Context:
- Does not measure relative efficiency, activity or risk adjusted returns.
Steps to Maximize MOIC
Strategic Investment Selection:
- Only target those areas of operation that reveal a room for significant sales improvements and where the company may own low-profile assets.
Active Management:
- Enhance revenue and productivity of the organizations in the portfolio with better market positioning.
Timely Exits:
- Get out of investment opportunities at the right time to achieve the highest MOIC possible.
Risk Management:
- Strengthen position to form a hedge so as to avoid possible losses in the adverse condition.
Functions of MOIC in Investment Decision Making
Performance Benchmarking:
- Allows one to compare one investment or fund to another.
Fundraising:
- It is common that MOIC performance indicators are reported with the purpose of gaining investors’ attention.
Portfolio Management:
- Coaches on rebalancing ratios because of poor-performing investments.
Real-World Example of MOIC
Investment Scenario:
- Private Equity Fund contributes ₹50,00,000 in a particular company.
After 5 years:
- Realized Returns: ₹70,00,000
- Unrealized Value: ₹30,00,000
MOIC Calculation:
- MOIC = (Realized Profits + Unbooked Profit) / Total amount invested
- MOIC = (₹70,00,000 + ₹30,00,000)/₹50,00,000 = 2.0x
This it depicts that the investment has been growing up to two times of its money value within the period of five years.
Conclusion
It is particularly important to adopt the MOIC to assess the overall return of an investment.
Although it gives an unarguable picture of performance, lone consumptions of ROI is imprecise with other measures such as IRR for the assessment of efficiency and profitability of an investment.
It becomes critical to differentiate between unrealized and realized MOIC, what affects the MOIC, and how to manage it better for investing wisely.
Frequently Asked Questions
1. Does MOIC regard the timing of cash inflows?
MOIC disregards time for cash inflows. It regards equal inflows of cash and does not take cognizance of the time element.
This can be identified as a weakness of metrics, especially when comparing opportunities for investments with different time ranges or cash flow patterns.
2. Is there only one metric to estimate the profitability of investments?
No, MOIC is one of the measures of investment profitability. Other measures, like ROI, ROE, and NPV, offer different views into investment performance.
A combination of these measures is often recommended for a better understanding of the profitability of an investment.
3. How can MOIC be applied in investment decision-making?
MOIC compares the various investment opportunities and determines their potential profitability.
It helps investors evaluate the success of their capital allocation decisions and make informed choices about future investments.
Also, MOIC is a benchmark for assessing the performance of an investment portfolio and measuring the profitability of investment activities.