ACCA FR Syllabus C. Analysing And Interpreting The Financial Statements - Profitability - Notes ^{1 / 6}

ROCE

This is a measure of management’s overall efficiency in using the finance/assets

• ROCE will increase if less PPE is in the accounts

  So old PPE will give a higher than usual ROCE

  ROCE will decrease if more PPE is in the accounts

  So, Revaluations upwards will give a lower than usual ROCE

• ROCE will increase if less expenses (except interest and tax) are in the accounts

• ROCE will decrease if more loans / share issues are made that year - especially near the year end

ROCE can be broken down (explained by) 2 more ratios:

Operating Margin
Asset Turnover

So if Operating Margin is up and ROCE is down - Net Asset Turnover must be down a lot

(The assets aren't producing the amount of sales they used to)

Operating Margin

= Operating Profit (PBIT) / Sales

Asset Turnover

= Sales / Capital Employed

Inventory Turnover

= cost of sales / average inventory

Average inventory is calculated as (opening inventory + closing inventory) / 2

Gross Margin is affected by..

An increase in the sales PRICE or decrease in COS PRICE

An increase in gross profit as a whole doesn't necessarily mean an increase in the margin - as it could be due to more volume and nothing to do with the price

• Inventory measured in different ways (as this affects "price")

• Inventory write downs due to damage/obsolescence (You've reduced its 'price')

• A change in the Sales Mix - different items sell at different prices

• New (different margin) products - have different prices and hence margins

• New suppliers with different prices

• Discounts offered - reducing the sales price

• More or less Import duties - changing COS price

• Exchange rate fluctuations

• Change in cost classification: 

  eg. Some costs included as operating expenses now in cost of sales