The calculation of the profitability of the company is a very important step in assessing the financial condition. These indicators allow us to judge the effectiveness of activities. However, in order to draw any conclusions, a simple calculation of these indicators is not enough. After calculation, indicators must be analyzed using one method or another. One of the most popular methods is the factor analysis of the profitability of the enterprise, therefore we will dwell on it.
As the name suggests, this type of analysis consists in determining the effect on the resulting indicator, in this case, the profitability of certain factors. A significant contribution to the development of this method was made by DuPont, whose specialists developed special formulas that make it easy to analyze return on assets and equity. These formulas are based on the use of the method of absolute differences, which is applied to several transformed mathematical models. Consider the transformations that need to be implemented in order to conduct a factor analysis of profitability using these formulas.
Let's start with the return on assets, which is determined by the ratio of net profit to the average value of these assets for the period under review. Multiply the numerator and denominator of this formula by the revenue indicator. Now you can notice that the obtained fraction can be represented as the product of two fractions, each of which is an economically significant indicator: asset turnover and sales profitability. Thus, we can conclude that it is this combination of factors that affects the return on assets.
Regarding the return on equity of the owner of the transformation, a little more should be done. The calculation formula of this indicator must be multiplied and divided into revenue and assets. After a series of simple transformations, it will be possible to conclude that the degree of effectiveness of the use of ownerβs capital is dependent on the same factors that affect the return on assets (indicator of their turnover and return on sales), as well as on the indicator of financial dependence.
Factor analysis of production profitability is made in a slightly different way. The model can be transformed by revealing and detailing the indicator of profit in the numerator and cost in the denominator. After this procedure, the chain substitution method can be applied to the resulting mathematical model. It is impossible to use the method of absolute differences in this case, since the resulting mathematical model will have a multiple character.
Obviously, the availability of the ability to make a factor analysis of profitability depends on the availability of information on factors for several periods, at least two. It is most convenient to present the initial data, intermediate and final results in tables. Of course, if possible, it is worth using automation tools, that is, computers and special software. As a result of the analysis, it should be concluded which factors had the greatest positive and negative impact, and which factors can be neglected. Subsequent management decisions should contribute to strengthening the positive impact and weakening the negative.
This type of analysis is not the only one to which profitability indicators are exposed. More often, they use the method of comparison to analyze them. Comparisons can be made with the indicators of the same enterprise for previous periods (horizontal analysis, analysis over time), as well as with similar indicators of other companies (spatial analysis) and with industry average levels.