In a meeting with the management team of a growing company, one figure kept coming up all the time and seemed to have got the maximum attention- growth in revenues. It seemed the leaders were determined to blast their way to a stage where they could think of an IPO. For this they were working towards increasing their sales as much as possible. It looked as if they wanted to show the world how much they had grown and just “how big” they were.
It soon became clear that in this one sided drive, they were not keeping sight of other vital measures- particularly in the long term- such as Return on Equity, Return on Capital Employed and profit per employee.
During a break, when the discussions turned to other topics, it became evident that many of the leadership team were quite content to leave issues like ratios and metrices to the Finance Head. ” That’s his headache. Let him deal with it” seemed to be the name of the game. ” Our job is to grow the business” they seemed to say.
As you will agree, you don’t have to be a financial wizard or even the Head of Finance to know something about these key ratios.
- ROE or Return on Equity tracks the firm’s profitability by showing how much profit a firm generates with the money invested by the shareholders. It is calculated as Net Income divided by Shareholder’s Equity. ROE helps compare your firm with your competitors.
- EBIT : Earnings Before Interest & Tax refers to operating profit and is really revenues less operating expenses. This means how much have you earned before paying interest and taxes due. This again is a indicator of profitability.
- ROCE: Return on Capital Employed measures the efficiency and profitability of a company’s capital investments. It is calculated as Earnings Before Interest & Tax divided by Total Assets less Current Liabilities. If your ROCE is not higher than the rate at which the company borrows, any increase in borrowing will reduce shareholders’ earnings.
- Sales per Employee: The sales-per-employee ratio indicates how expensive the firm is to run. “People businesses” lend themselves to the sales per employee ratio. Firms with higher sales-per-employee figures are considered more efficient than those with lower figures. A higher sales-per-employee ratio indicates that the company can operate on low overhead costs, and therefore do more with less employees, which often translates into healthy profit.
- Profit per Employee: Calculated by dividing the firm’s Gross profit by the Number of Employees, profit per employee gives a more accurate picture. Your objective is to generate higher profits with the same or less number of employees.
Employee costs will only increase. In India today, in many industries the profitability has been impacted by the steep rise in employee costs.
Now is the time to ask what you are doing to improve employee productivity. Over time what matters most is not the size of the firm but it’s profitability.
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This is the 96 th of the “A Step A Day” series : To provide perspective and provoke thought to facilitate self-development across a wide spectrum of issues- big and small- crucial for executive success.