Acca financial Accounting (FA) Study Text ac ca (FA)

 

 

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Interpretation of financial statements 

386

 

KAPLAN PUBLISHING

 

Relationship between ratios 

ROCE can be subdivided into operating profit margin and asset turnover. 

Operating margin 

× 

asset turnover 

= 

ROCE 

 

 

 

 

 

Operating profit 

 

Sales revenue 

 

Operating profit 

–––––––––––––––– × ––––––––––––––– = 

–––––––––––––––– 

Sales revenue 

 

Capital employed 

 

Capital employed 

 

 

Further explanation of the relationship 

 

Profit margin is often seen as an indication of the quality of products or 

services supplied (top-of-range products usually have higher margins). 

Asset turnover is often seen as a measure of how intensively the assets 

are worked or how efficiently they are used to generate revenue. 

A trade-off often exists between margin and asset turnover that means 

different businesses can actually achieve the same ROCE: 

•

 

Low-margin businesses (e.g. food retailers) often have intensive 

asset usage (i.e. they produce a high volume of goods to sell but 

sell them at low prices). 

•

 

Higher margin businesses (e.g. luxury jewellery items) produce less 

goods but sell them at a high price. Many of these businesses still 

use very labour intensive, rather than machine intensive, methods of 

production. Such crafts are highly valued and consumers are willing 

to pay a premium for them.