Sunday, 26 February 2006 22:25
Return on Capital Employed on Stock
Stock circulation coefficient and customer service level are the main basic indicators of the success of stock management. Capital employed on stock shall be reduced by means of an increase in stock circulation coefficient whereas customer loyalty, bearing vital importance for the company, shall be risen by means of an increase in service level. As I have mentioned in my previous article, there are three basic functions of operations: manufacturing, marketing&sales and finance. Satisfactory financial results shall be obtained for a successful operation. Financial achievement is directly related to whether capital employed on stock is used successfully or not. Briefly, a company which is able to increase customer service level while reducing capital employed on stock.
Return on capital employed on stock shall be measured by ROCE formulation. ROCE (Return On Capital Employed) is calculated with following formula:
Interest and Profit before Taxes
ROCE = ----------------------------------------- x 100 (%)
Stock Amount
ROCE = ----------------------------------------- x 100 (%)
Stock Amount
ROCE is defined as relative profit rate against capital employed on stock. Relative profit rate is a different concept from profit on sale. The example below shall help a better understanding of this matter:
Let’s assume that ABC company has obtained 150 TL net profit over 1000 TL total sales turnover within last six months, whereas XYZ company has assumed 200 TL net profit over 1000 TL total sales turnover for the same period. In this case, profit rate of ABS has been accrued 15% (150 / 1.000), whereas profit rate of XYZ has accrued 20 % (200 / 1.000). In other words, XYZ has obtained a higher profit rate than ABC. However, we should also consider the stocks, in other words, capital employed on stocks for the total operation profit. Let’s also assume that stock value of ABC is 1.000 TL and stock value of XYZ is 2.000 TL. ROCE of ABC and XYZ companies are
150
ROCE ABC = --------------- x 100 = %15
1.000
ROCE ABC = --------------- x 100 = %15
1.000
200
ROCE XYZ = --------------- x 100 = %10
2.000
ROCE XYZ = --------------- x 100 = %10
2.000
According to the calculations above, ROCE of ABC is higher than ROCE of XYZ since capital employed on stock of ABC is less than capital employed on stock of XYZ. In other words, the profit of ABC’s capital employes on stock is higher than XYZ.
ROCE should constantly be compared with current borrowing costs within the market. For instance, let’s assume that ABC has obtained 5% interest yield for its 1000 TL deposit in the bank. In this case, ABC shall try to have a ROCE value over 5% interest yield. As a common trend, it is expected that ROCE shall be accrued double of borrowing cost. It is accepted that, the companies, whose ROCE is double of their borrowing costs, shall use their capitals efficiently. On the other hand, follow-up of ROCE’s change over years is so crucial since it shows capital utilization trend.
