How operating cycle affects the roA ?

Commercial profitability : ROS (Return on sales)

How much profit a company is generating per 100 € of sales ?

ROS = PAT x 100 Sales

Click here to see the source of data

Starworld Group	2020	2021	2022
Profit After Taxes (PAT)	305	450	715
Sales	2784	3341	4343
ROS	10.96 %	13.47 %	16.46 %

Net profit after Tax (PAT) can be affected :

• by taxes (change) and
• interest (change in financial policy).

So, it is better to take EBIT (Taxes and Interests are outside the control of operating managers)

ROS = EBIT x 100 Sales

Click here to see the source of data

Starworld Group	2020	2021	2022
EBIT	478	676	1042
Sales	2784	3341	4343
Return on Sales	17.17 %	20.23 %	23.99 %

To show how Operating Cycle affects the Economic Profitability, ROA must be decomposed into 2 elements :

Pre-tax ROA = ROS x Asset turnover

Pre-tax ROA = EBIT x Sales Sales Total Assets

Click here to see the source of data

Starworld Group	2020	2021	2022
EBIT	478	676	1042
Sales	2784	3341	4343
Assets	2250	2605	2700
Return on Sales	17.17%	20.23%	23.99%
Asset Turnover	1.237	1.283	1.609
Pre-tax ROA	21,24 %	25,95 %	38,59 %

So, Operating Managers can impact the company ROA

• either by improving the Profit margin [ EBIT / Sales]

• through Cost Control or
• Revenue increases

• or by improving the Asset turnover [ Sales / Asset ]

• through a better capacity utilization or

  a more efficient WCR management

 

The Dupont Chart is a very useful managerial tool

quick and simple way to show to the various managers, in charge of different functions (production, purchasing, administrative, marketing and sales, etc...) their impact on the overall ROA.

 

Sources :

Interpreting and using Financial Statements, 1999, Marc Bertonèche, Ph. D. in Finance from the Northwestern University, Professor at the Bordeaux University and at Sciences-PO Paris, Visiting Professor at Harvard Business School and Oxford University

Corporate Finance Course, Bernard Jaquier, Professor in Economics & Finance, Lausanne, Switzerland, 2023