Are you making enough from your business – a way to measure this
A ratio that can be used to determine whether you are getting an adequate return from your business is Return on Capital Employed (ROCE).
ROCE is calculated as follows :
Let me ezplain further. EBIT means the net profit of a business before interest and taxes. The capital employed can have a number of different meanings however it is the capital necessary to make the business perform. It is commonly represented as total assets less current liabilities or fixed assets plus working capital.
Now before I go onto an example with every ratio it is not perfect. The assets figures in the financial statements are usually represented at cost or even depreicated. This means if the business is using assets purchased many years ago then the ROCE would be better than a business using assets purchased recently everything else being the same. Thus we need to be careful with this number but it is still very useful. We can make adjustments by valuing the assets at their current value to get a better idea of the true ROCE.
So lets look at an example:
|
|
ABC Pty Ltd |
XYZ Pty Ltd |
|
Operating Profit |
100,000 |
150,000 |
|
Total Assets |
500,000 |
1,200,000 |
|
Current Liabilities |
150,000 |
150,000 |
|
Capital Employed |
350,000 |
1,050,000 |
|
ROCE |
28.57% |
14.28 |
The return of both companies is above what could be obtained from investing the proceeds in shares etc but don’t get caught by a larger profit must be better. ABC has a small profit but is using the assets more effectively and thus is a better managed business.
What is the ROCE of your business? Is it sufficient? If not what are you going to do to look at ways to improve it?
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