Topic list Syllabus reference

Formula to learn
„„ Profit after tax and preference dividend ._лпя/
ROE = x 100%
Equity shareholders funds




In our example, ROE is calculated as follows.
ROE

20X8 $267,930 _ oq до/ $909^899

20X7
$193,830 _ 29%
$668,769

ROE is not a widely used ratio, however, because there are more useful ratios that give an indication of the return to shareholders, such as earnings per share, dividend per share, dividend yield and earnings yield, which are described later.

3. 
   Analysing profitability and return in more detail: the secondary ratios
   

We often sub-analyse ROCE, to find out more about why the ROCE is high or low, or better or worse than last year. There are two factors that contribute towards a return on capital employed, both related to sales revenue.

1. 
   Profit margin. A company might make a high or low profit margin on its sales. For example, a company that makes a profit of 25c per $1 of sales is making a bigger return on its revenue than another company making a profit of only 10c per $1 of sales.
   
2. 
   Asset turnover. Asset turnover is a measure of how well the assets of a business are being used to generate sales. For example, if two companies each have capital employed of $100,000 and Company A makes sales of $400,000 per annum whereas Company В makes sales of only $200,000 per annum, Company A is making a higher revenue from the same amount of assets (twice as much asset turnover as Company B) and this will help A to make a higher return on capital employed than B. Asset turnover is expressed as x times' so that assets generate x times their value in annual sales. Here, Company A's asset turnover is four times and B's is two times.
   

Profit margin and asset turnover together explain the ROCE and if the ROCE is the primary profitability ratio, these other two are the secondary ratios. The relationship between the three ratios can be shown mathematically.