We cannot assess profits or profit growth properly without relating to the

We cannot assess profits or profit growth properly

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We cannot assess profits or profit growth properly without relating to the amount of funds (the capital) employed in making the profits. The most important profitability ratio is return on capital employed (ROCE) , also called return on investment (ROI) . ROCE measures how efficiently a business using its funds available. It measures how much is earned per $1 invested. When assess profits or profit growth, it relate with the amounts of funds(capital) employed in making profits. The most important profitability ratio is return on investment (ROI ). Return on investment = PBIT Capital employed Capital employed = Shareholders’ fund + payables: Amounts falling due after more than one year’ + any long -term provisions for liabilities and charges. = Total assets less current liabilities
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___________________________________________________________________________________________________________________ Page 9 of 21 IPK COLLEGE 1664, JALAN KULIM, 14202 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by Susan Lim Email : [email protected] Important : Capital employed is not just shareholders’ fund . There are 3 comparisons can be made what does ROCE tell us: The change in ROCE from one year to the next. The ROCE being earned by other companies , if this information is available. A comparison of the ROCE with current market borrowing rates (i) What would be the cost of extra borrowing to the company if it needed more loans, and is it earning a ROCE that suggests it could make high enough profits to make such borrowing worthwhile? (ii) Is the company making a ROCE which suggests that it is making profitable use of its current borrowing? Profit margin and asset turnover explain the ROCE. Disadvantages of ROCE: uses profits which is not directly linked to the objectives of maximising shareholder wealth. Profit margin X asset turnover = ROCE PBIT X Sales revenue = PBIT Sales revenue Capital employed Capital employed
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___________________________________________________________________________________________________________________ Page 10 of 21 IPK COLLEGE 1664, JALAN KULIM, 14202 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by Susan Lim Email : [email protected] Return on equity Return on equity measure firm’s overall performance. Return on equity: will compare net profit after tax with the equity that shareholders have invested in the firm. The ratio will shows the earning power of the shareholders’ book investment and can be used to compare two firms in the same industry. A high return on equity could reflect the firm’s good management of expenses and ability to invest in profitable projects. However, it could also reflect a higher level of debt finance (gearing) with associated higher risk. Gross profit margin, net profit margin and profit analysis Depending on the format of income statement, you may be able to calculate the gross and net profit margin.
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  • Spring '17
  • JANE KDAL

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