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  Relationship Profitability and Efficiency

Introduction to Relationship between Profitability and Efficiency

In our previous discussions concerning profitability ratios, we observe that return on capital employed (ROCE) is considered as a key ratio through many businesses.

The ratio is expressed as follow:

ROCE =( Operating profit/Long term capital employed) x 100

In which long-term capital contains share capital as well as reserves as well as long-term borrowings. This ratio can be broken down into two elements, as displayed in Figure below. The 1st ratio is the operating profit margin ratio and the 2nd is the sales revenue to capital employed (net asset turnover) ratio.

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Diagram: the main elements of ROCE ratio

By breaking down the ROCE ratio in this way, we emphasize the fact that the overall return on funds used within the business will be determined both through the profitability of sales and through efficiency in the use of capital.

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