Factor analysis of return on equity

One of the important aspects of the company's performance evaluation 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 the indicator of profitability. However, a simple calculation may not be sufficient and it will be necessary to supplement it with an analysis. The most popular method is, perhaps, factor analysis of return on equity. Let us dwell in more detail on the methodology of its conduct and the main features.

Factor analysis of return on equity is usually associated with DuPont formulas that allow you to quickly make all the necessary calculations. It is important to understand the way in which these formulas have turned out, besides, there is nothing complicated in this. The profitability of the owner's capital is obviously determined by the ratio of the net profit received to the value of this capital. The factor model is obtained from this relation by elementary transformations. Their essence consists in multiplying the numerator and denominator by revenue and assets. After this, it is easy to see that the efficiency of the use of 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 assets (assets) and the level of profitability of sales. After the compilation of the mathematical model, it is directly analyzed. 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 effect of each factor in isolation, regardless of the others.

It should be noted that in the same way, factor analysis of economic profitability is carried out. It is the ratio of profit to assets. After small changes, this figure can be represented by the product turnover of the firm's property on the profitability of sales. The subsequent analysis follows the same way.

It is necessary to pay special attention to what indicators should be used for calculations. Obviously, it is necessary to use the information for at least two periods so that you can observe the changes. Data that are taken from the income statement are cumulative, since they represent a certain amount for a particular period. In the balance sheet, the data is presented on a specific date, so it's 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, a factor analysis of the current liquidity ratio can be carried out extremely simply. For greater detail, it is advisable to disclose the formula for this coefficient, reflecting the components of current assets in the numerator, and the short-term liabilities in the denominator. Then it is required to calculate the influence of each of the factors identified. It should be pointed out 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 kind of analysis is difficult to overestimate, and the factor analysis of return on equity and other indicators is one of the best methods that facilitate the adoption of correct management decisions. The identification of a strong negative influence of one or another factor clearly indicates where the impact should be directed. On the other hand, a positive influence can be seen, for example, on the existence of certain reserves of profit growth.