I n t e r a c t I v e t e X t foundations in Accountancy/ acca financial accounting (ffa/FA) bpp learning Media is an acca approved Content Provider

PART H: INTERPRETATION OF FINANCIAL STATEMENTS 

 

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In our example, ROE is calculated as follows. 

 

20X8 20X7 

ROE  = 

$267,930

$888,899

   =  30.1% 

$193,830

$651,969

  =  29.7% 

ROE is not a widely used ratio, however, because there are more useful ratios that give an indication of 

the return to shareholders, such as earnings per share, dividend per share, dividend yield and earnings 

yield, but these are beyond the scope of the FFA/FA syllabus.  

3.3 Analysing profitability and return in more detail: the secondary 

 ratios 

We often sub-analyse ROCE, to find out more about why the ROCE is high or low, or better or worse than 

last year. There are two factors that contribute towards a return on capital employed, both related to 

sales revenue. 

(a) 

Profit margin. A company might make a high or low profit margin on its sales. For example, a 

company that makes a profit of 25c per $1 of sales is making a bigger return on its revenue than 

another company making a profit of only 10c per $1 of sales. 

(b) 

Asset turnover. Asset turnover is a measure of how well the assets of a business are being used to 

generate sales. For example, if two companies each have capital employed of $100,000 and 

Company A makes sales of $400,000 per annum whereas Company B makes sales of only 

$200,000 per annum, Company A is making a higher revenue from the same amount of assets 

(twice as much asset turnover as Company B) and this will help A to make a higher return on 

capital employed than B. Asset turnover is expressed as 'x times' so that assets generate x times 

their value in annual turnover. Here, Company A's asset turnover is four times and B's is two 

times. 

Profit margin and asset turnover together explain the ROCE and if the ROCE is the primary profitability 

ratio, these other two are the secondary ratios. The relationship between the three ratios can be shown 

mathematically.