Return on capital measures how well a company invests funds in its business. It’s important for determining financial strength and growth potential. A common approach is to divide net income by average capital for a period. Decreasing returns may signal the need for changes to expenses or operations. Lower returns may be due to unforeseen events.
A return on capital is a means of measuring how well a given company invests funds in its basic business operation. While there are various formulas used to determine this particular relationship between funds invested and the returns generated as a result of those funds, many companies find that identifying return on capital is very important in determining the financial strength of the business and finding ways to help the company to achieve additional growth over time. Typically, the means of determining a return on capital will focus on the pre-tax income generated versus the amount of funds the company invests in the business.
A common approach to determining a return on capital involves identifying the amount of net income that is generated during a given period of time, after excluding any amount of after-tax interest expense that may have occurred during that period. The resulting figure is divided by the relevant average capital for the period. The amount of that return on capital may be used as part of the evaluation of the overall business operation and may form the basis for changes if the return is not deemed sufficient for the amount of funds invested in the operation.
A return on capital that decreases with each successive period of time may be a sign that the company needs to take a close look at operating and other expenses and make some changes to the way it operates the business. The changes may involve strengthening the sales and marketing effort as a means of attracting more customers and increasing sales. At the same time, a poor return on capital can trigger an investigation into the operating structure that results in changes to policies and procedures for the business to reduce costs and generally operate more efficiently. This in turn can have a positive impact on net earnings and cause the downward trend in returns on capital to cease and allow the fortunes of the business to begin to rise once more.
There is no single reason why a return on capital would be less than anticipated. Sometimes the original projections of the return may have been more hopeful than factual. Even if those projections are realistic, lower returns may be due to some event or series of events that were not anticipated when the capital was originally invested in the trade. For this reason, it is important to take the time to determine what led to the return on equity, both from the perspective of capitalizing on those positive factors in the future and minimizing the impact of any negative factors in subsequent periods.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
