Is profit the best performance indicator for my business?
As an owner of a small business in the building and construction industry, it is important to know how your business is performing. Many people in this position look to profit as the key indicator of how their business is performing.
While calculating and understanding your profit is important, it is only part of the story of your business performance.
To understand the whole picture, you need to look at the ‘Return on Capital Employed’
This metric is more useful to assess your business performance as it considers the opportunity cost of the money you have invested in your business. The money you have invested in your business could have been used in other ways.
By calculating the Return on Capital Employed of your business, you can assess the performance of your business against other investment opportunities that you could have invested your funds in.
Return on Capital Employed (ROCE) is calculated by dividing your Earnings Before Interest & Tax (EBIT) by the Capital Employed in the business.
Company A and Company B both generate an EBIT of $250,000 (On this metric, both have performed at the same level).
Company A has $2,000,000 capital invested into it, while Company B has $3,000,000.
The ROCE for Company A is $250,000 ÷ $2,000,000 = 0.125 or 12.5%.
The ROCE for Company B is $250,000 ÷ $3,000,000 = 0.083 or 8.3%.
Based on the Return on Capital Employed metric, Company A performed better than Company B, as their ROCE is higher.
This information is not to be relied upon without speaking to your accountant, tax agent or financial adviser depending on the advice.