What it means
Accounting rules reduce the recorded value of assets over time through depreciation (spreading the cost of an asset across its useful life). That means an old factory can show a small book value even if it is still producing plenty of cash, which can make return ratios look unrealistically high.
CROGI avoids this by using the original, or gross, cost of the assets instead. The numerator is a measure of cash flow, often cash earnings before interest and sometimes with an adjustment for depreciation.
The denominator is the gross investment, which includes the original cost of fixed assets and the working capital (the money tied up in stock and customers' unpaid bills) needed to run the business. Because the denominator does not shrink as assets age, the ratio is steadier from year to year.
CROGI is closely related to CROCI, and the two are often used together. The main difference is the treatment of the asset base: one measure uses gross figures, which ignore age, while the other can use adjusted or net figures.
Definitions vary among analysts, so always confirm which one is being used. This measure is helpful when comparing a company that bought its plant decades ago with a rival that has recently invested heavily.
On a net basis the older firm would look far more profitable, but on a gross basis the comparison is fairer. Analysts also use CROGI to judge whether past investment decisions have paid off.
A falling figure can indicate that new spending is earning less than the old, which is a warning sign for management and shareholders.
In practice
Real-world examples.
Example
An analyst compares two paper mills. One was built forty years ago and one was built recently, and CROGI shows they earn similar cash returns on the money originally invested, which would not be obvious from book values. Management had assumed the older mill was the weaker business simply because its equipment looked tired.
Example
A holding company reviews its subsidiaries. It uses CROGI to identify a division where the cash return on historic investment is below the group's cost of capital and decides to sell it. The group redirects the proceeds to a division with a stronger cash return on the capital already invested.
Example
A fund manager screens utilities for investment. She finds that one operator has a low CROGI because it added costly new assets that have yet to produce cash, and she waits to see whether returns improve. Her notes record that a ratio on a gross basis keeps the new assets from being unfairly penalised or the old ones unfairly rewarded.
Formula
Calculation
CROGI = Cash flow / Gross investment x 100
Worked example: a printing company generates cash flow of $18,000,000. Its gross investment, meaning the original cost of its plant plus working capital, is $150,000,000.
CROGI = $18,000,000 / $150,000,000 x 100 = 12%.
Suppose the same company's net book value of assets, after years of depreciation, is only $90,000,000.
A return based on that lower figure would be $18,000,000 / $90,000,000 x 100 = 20%, which looks more impressive but ignores how much was originally invested.Case study
Seen in the real world.
Greenfield Steelworks is a fictional manufacturer, and this story is illustrative only. Its reported return on assets looked excellent because much of its equipment was almost fully depreciated.
A new finance director calculated CROGI using the original cost of the plant and found the cash return was only 7%, well below the company's borrowing costs. The earlier ratio had masked the fact that replacing the equipment would require far more capital than the books suggested.
The board used the figure to plan a phased replacement programme and to set a cash return target for each new project. The finance director said the gross view made the true economics visible for the first time. Two years later, the first new project to pass the target delivered a gross cash return of 13%, and the board used it as a benchmark for future proposals.
Watch out
Common mistakes.
- Using net book value in the denominator and calling the result CROGI, which flatters older businesses. Remember that a falling asset value through depreciation does not mean the original money has been recovered.
- Comparing a CROGI figure with another measure without checking that both use the same definition of cash flow. Always read the notes to see how each analyst defines cash flow before comparing one set of figures with another.
- Ignoring working capital, which is part of the investment required to operate a business. Stock, receivables and similar items must be funded just as assets are, so leaving them out overstates the return.
Questions
People also ask.
What does gross investment mean?
It is the original cost of the assets a business has bought, before any depreciation has been deducted. It is the starting price tag of an asset, not what it is worth after years of use.
How is CROGI different from CROCI?
CROCI compares cash flow with invested capital, while CROGI specifically uses the gross, undepreciated investment as its base.
Is a higher CROGI always better?
Generally yes, but it should be compared with the company's cost of capital and with similar businesses in the same industry. A very high figure may also hint that the business is under-investing, so look at the trend in spending as well.
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