One of the important aspects of evaluating the activities of the company is the study of its effectiveness from the point of view of the owner. Efficiency in this case, as in many others, can be assessed by determining a profitability indicator. However, a simple calculation may not be enough and it will be necessary to supplement it with analysis. The most popular method is, perhaps, a factor analysis of return on equity. Let us dwell in more detail on the methodology and its main features.
Factor analysis of return on equity is usually associated with DuPont's formulas, which allow you to quickly make all the necessary calculations. It is important to understand how these formulas came about, and there is nothing complicated about it. The return on equity of the owner is obviously determined by the ratio of the net profit received to the value of this capital. The factor model is obtained from this relationship by elementary transformations. Their essence is to multiply the numerator and denominator by revenue and assets. After that, it is easy to notice that the efficiency of using this part of the capital, its profitability, is determined by the product of the indicator of the degree of financial dependence on the turnover of property (assets) and the level of profitability of sales. After compiling the mathematical model , its analysis is performed directly. It can be carried out in any way suitable for deterministic models. Factor analysis of return on equity using DuPont formulas is one of the variations of the method of absolute differences. It, in turn, is also a special case of the method of chain substitutions. The main principle of this method lies in the alternate determination of the impact of each factor in isolation, regardless of the others.
It is worth noting that a factor analysis of economic profitability is carried out in a similar way. It is a ratio of profits to assets. After small transformations, this indicator can be represented as the product of the turnover of the property of the company on the profitability of sales. Subsequent analysis goes the same way.
Particular attention should be paid to what indicators should be used in the calculations. Obviously, it is necessary to use information for at least two periods in order to be able to observe the changes. The data that are taken from the income statement are accumulative in nature, as they represent a certain amount for a given period. In the balance sheet, the data are presented for a specific date, so it is best to calculate their average value.
The above methods, that is, the method of chain substitutions and its modifications, can be used to analyze almost any deterministic factor model. For example, factor analysis of the current ratio can be carried out very simply. For greater detail, it is advisable to disclose the formula for this coefficient, reflecting the components of current assets in the numerator, and short-term liabilities in the denominator. Then it is required to calculate the influence of each of the identified factors. It should be noted that for this model it is impossible to apply absolute differences and the method of the same name, since it has a multiple character.
The value of any type of analysis can hardly be overestimated, and the factor analysis of the return on equity and other indicators is one of the best methods that contribute to the adoption of sound management decisions. Identifying the strong negative impact of a factor clearly indicates where the impact should be directed. On the other hand, a positive influence may indicate, for example, the presence of certain reserves for profit growth.