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ROCE is an important Financial Ratio that is used for measuring the combined effect of Profitability of the Business and the Productivity of the Business.
Profitability is measured in terms of Return on Sales and Productivity is measured in terms of how well the Assets of the Business are put to use by looking at Assets Turnover.
(1)The formula used for calculating Return on sales is PBIT less Tax/Net Sales.
(2)The formula for calculating Return on Assets is Net Sales/(Net Fixed Assets+Net Current Assets)
(3) the formula for calculating Return on Capital Employed(ROCE) is obtained by Multiplying (1)X(2)-(calculated for each year separately in the example given below)
The following is a real example of a trend of ROCE of a Business over the years ,that has three Verticals:
Belts, Oilseals and Engineering.The composite business is called Polymer.
Now for this Business ,an analysis is done and the ways of how to improve the ROCE of this Business have been identified. This is as follows:
How to Improve ROCE of the Business
This ROCE improvement Plan can be built through Balanced Scorecard Methodology.
EVA Ratio-"Economic Value Add" of the Business, which is the Economic Profit of the Business can also be considered as the Ultimate Financial goal of a Business . The EVA is NOPAT(Net Operating Profit After Tax)- (Invested Capital*WACC) where Invested Capital includes both Equity & Debt and WACC is Weighted Average Cost of Invested Capital. In this WACC, the cost of Debt i.e Borrowed capital is calculated Net of Taxes, where the local Income/Corporate Tax policies allow deduction for the Interest paid on Borrowed Capital and the Dividend payable/expected by Shareholders is considered as the Cost of Equity.
A sample of Strategy Map developed with EVA &ROCE Ratios ,under Balanced Scorecard Methodology for a Co. in India is given below:
The benefits of drawing out a Strategy Map like this on
Financial perspective built on Financial Ratios at the pinnacle, and Customer ,Operational
and Learning & Growth perspectives are many due to interplay of
cross-functional interactions and improvements flowing through the entire
organisation. When this happens the organisation functions as a one whole being
with all its parts working in Sync & Synergy.
On an external environment, it is like all the players of a
Team planning a carefully laid out Strategy in a tournament for winning a World
cup in Soccer or Cricket!!
RBI's recent Monetary Policy announcement after MPC considered the latest economic factors, CPI etc , came out with no repo rate cut. Primarily because CPI is elevated and at an uncomfortable level as far as RBI is concerned.since the mandated and stated objective of RBI is now inflation control, RBI has decided to hold the rate this time despite the economic slowdown calling for a steep rate cut.RBI also mentioned that this year would see real GDP contraction after more than four decades, but still decided to save the powder for a more rainy day or for a day when the bang will be worth its buck.
India is facing rising prices also esp. food prices, fuel prices and therefore is experiencing a cost push inflation. There is a school of economists who say the inflation is fueled by easy liquidity floating in the economy and the stock exchange boom , gold price rise all indicate to easy money into areas where some quick money can be made.Even RBI is predicting a rise in inflation levels in Q2 but has refrained from an inflation forecast.
Gold price,as Ruchir Sharma in today's TOI blog(link )puts it, rises due to uptick in demand whenever interest rate is lower than the inflation rate. But Gold being a safe haven investment booms when the rest of the economy sees more volatility elsewhere esp. in stable investments. There is a rush of outflow from equity MFs in July but is it going to Debt MFs or to stock market or to gold is anybody's guess.But there is greater desperation driving up buying Gold rather than preference as an investment.
All this paint a confusing story but with tinges of liquidity bulge which may become an inflation down the road, unless the productive resources are used for assets and jobs creation. But the silverlinings are shallow oil prices, decent monsoon, burgeoning foreign exchange reserves and surplus in current account balance. So, cost push factors in inflation are slightly mitigated in the near to short term.
CII 's recent 111th Business Outlook survey,July 2020, which was released last month revealed that out of three indeces Current situation index, Expectation index, Business confidence index, the Current Situation Index of Q1 of Fy 20-21 is similar to the levels of Q4 of Fy 19-20! Only the Expectations and Business Confidence levels in the economy have deteriorated during Q1 of Fy 20-21 as compared to earlier quarter.
Dr.Manmohan Singh in his BBC interview has also clearly said that this human crisis created by the pandemic calls for greater spending and greater borrowings by the GOI, even upto another 10% of GDP for tackling health, military and economic challenges of the country. His wise words would be worthy of listening now.(link)
But this borrowing must have a clear exit clause linking it to FRBM Act requirement of glided fiscal deficit path to 3% of GDP eventually in the short to medium term of 3/4 years. Only this can bring back investors into the country. Otherwise Fiscal profligacy is the scourge of the growing economies like India.
There are no simple answers but quick actions,as outlined by PM in his speech on the occasion of Ram janmasthan Temple laying foundation,have to be taken by the Govt. Quoting from Kamba Ramayana he said "காலம் தாழ ஈண்டு இனும் இருத்தி போலாம்" என்றான் இராமன்" which essentially means we should not procrastinate taking actions to rectify the situation. A well focused fiscal stimulus, vaccine or no vaccine, is an urgent imperative.
