Key ratios for corporate performance

Evaluation of corporate performance generally relies on ratios, usually relating some measure of output to a measure of input. Although there are many ratios to choose from, managers and analysts tend to concentrate on a relatively small number of criteria, since a plethora of measures can be often confusing. Three prominent performance ratios found in the literature, and recommended by many management consultants concerned with the field of corporate strategy, are: 1. (1) ROCE (return on capital employed);2. (2) net profit margin (ratio of net profit to revenue);3. (3) asset turn (ratio of sales to capital employed). Improving all the three ratios is regarded as a highly desirable objective, and it is generally assumed that these measures move in unison for any given company. In fact, as this paper demonstrates, circumstances may well arise when they do not, so that it is possible for ROCE to increase, even when one of the other two ratios declines. Similarly, the net and gross profit margins (the latter is the ratio of operating profit to revenue, where the operating profit does not account for fixed cost overheads) are two popular criteria in many industrial sectors. They are often assumed to be so interdependent, that an improvement in the one must result in an improvement in the other, and similarly that a deterioration in the value of either must lead to a fall in the other. This paper shows that these ratios need not always change in the same direction and that the gross profit margin can improve even when the net margin, revenue and profit all decline. Examples to illustrate these results are given and these provide some insight into the relationships between the various criteria discussed.