The secret of successful companies? Controlling their rate of return

A company's success is the result of a combination of factors: a good product, quality services and positioning in line with its target market. It's also the personality and know-how of an entrepreneur and a committed team.

But from an accounting and financial point of view, there are other criteria to consider, which determine its health and sustainability, such as the rate of return.

If you want to know the secret of successful businesses, look no further! 👉

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What is a company's rate of return?

For a business to succeed, of course, it needs customers, but that's not enough.

If you generate a high volume of sales, but your turnover is too low to cover your fixed costs (rent, salaries, electricity, telephony, etc.) and variable costs (purchase of raw materials, transport costs on sales and purchases, etc.), then you can quickly run into difficulties.

The indicator that will enable you to assess the health and sustainability of your business (also known as its financial performance) is its profitability, or its rate of return when expressed as a percentage.

Profitability rate: definition

A company's rate of return is a key financial indicator.

This ratio is used to assess :

• an organisation's ability to generate profits;
• or, on the contrary, losses, when it is below the break-even point.

The different profitability ratios

There are several types of profitability rate for assessing the health and viability of a business, such as :

The economic rate of return (Return On Capital Employed - ROCE)

This rate assesses the company's ability to generate profits from the capital invested (equity or debt).

This indicator measures the performance of the current activity in order to determine whether the organisation manages to exploit its resources correctly to create wealth.

👉 Its calculation formula is as follows:

Return on equity (ROE)

This rate of return, also known as the rate of return on equity, measures a company's ability to generate profits from the equity provided by investors (owners, shareholders, etc.).

This indicator is of particular interest to investors, as it helps them to accurately assess the profitability of their investment.

👉 Its calculation formula is as follows:

Return on sales (ROS)

The rate of return on sales corresponds to the net margin generated by commercial operations. It measures the company's ability to generate profits from sales.

It is an important indicator for assessing a company's overall performance.

👉 Its calculation formula is as follows:

Return on investment (ROI)

This rate of return, also known as the rate of return, measures the performance of investments made by a company.

This financial ratio is used to compare the financial gains in relation to the sums invested in an operation.

👉 It is calculated as follows:

As a bonus, find below the formula for calculating the break-even point (BEP). As a reminder, this is the sales figure you need to generate to break even.

💡 Tip: to help you with your various calculations, there are management software packages that automatically provide you with the various KPIs you need to steer your business and your investments. One example is Sage Active, a solution for small businesses that combines accounting, invoicing and sales management. Thanks in particular to Sage Copilot, its AI assistant, you benefit from powerful financial reports that are updated in real time.

Why is calculating the rate of return so important?

Calculating the rate of return is important for assessing the viability of a business, the performance of an investment, and for identifying the most profitable projects.

This assessment is based on the fact that a company's value depends on its profitability, which is a guarantee of good financial health and long-term viability. It helps you to manage your business in an informed way.

At the same time, the rate of return reassures investors (or not) about the potential profits to be made.

The advantages of calculating a company's rate of return

There are many advantages to calculating a company's rate of return. Using this indicator, you can :

• accurately assess the company's current, and probably future, economic and financial performance;
• make a rapid financial diagnosis, highlighting potential problems such as margins that are too low using the commercial profitability ratio, or costs that are too high using the economic profitability ratio;
• make strategic decisions based on the ratios obtained and the room for manoeuvre available. This may involve new investment in existing operations, investment in new developments, or downsizing loss-making operations and redirecting existing investment;
• compare these ratios with those of other companies in the same sector, to get a better idea of where you stand.

What about the disadvantages?

As with all ratios, calculating the rate of return also has its drawbacks:

• the formula does not take into account possible variations in costs (fixed and variable charges) and unforeseen events;
• interpretations based on assumptions, particularly for medium- and long-term investments;
• failure to assess potential risks and the impact of external factors such as market fluctuations, inflation, regulatory constraints, etc.

While calculating the rate of return provides relevant indicators of the company's economic and financial health, it is in your interest to supplement this analysis with other indicators.

3 strategies for improving your rate of return

There are several levers you can use to improve your profitability rate.

Here, it's not a question of changing the calculation rules, but of changing your operational strategy.

Strategy 1 - Optimise costs

A low profitability rate may be linked to a level of fixed and variable costs that is proportionately too high in relation to the sales generated.

The solution to reducing these costs is to begin by analysing all your costs, with the aim of identifying potential savings, for example :

• on administrative costs ;
• the purchase of raw materials
• energy costs.

To make these savings, you can raise awareness among your staff of the importance of more frugal practices, renegotiate contracts with your suppliers, or develop your processes by digitalising management operations and using artificial intelligence.

Strategy 2 - Increase your prices

Another solution is to optimise your pricing policy.

Depending on market trends and your competitors, you may consider increasing your prices. So why not divide your offer into different product and service ranges, to improve your unit and overall profitability?

Strategy 3 - Increase your sales volume

You are also advised to improve your revenue by increasing your sales volume. This strategy often requires investment, with a view to developing your teams, increasing your production capacity and optimising your distribution processes.

💡 And to achieve an even higher rate of profitability, be clever and combine these different strategies: reduce your costs, increase your sales volume and your prices!

FAQ

What is the purpose of calculating the rate of return?

The rate of return, a key indicator of a company's financial health and viability, measures the capacity of a project or activity to generate profits.

Although it is important to cross-reference this ratio with other data, particularly market data, it remains a criterion for assessing the relevance of the choices to be made.

It also helps investors to make the right decisions by comparing different investment opportunities.

What are the benefits of using the rate of return to manage your business?

There are many advantages to taking the rate of return into account when managing a business:

• it can be used to assess the company's economic performance;
• It is a financial diagnostic tool;
• it provides precise information for strategic decision-making;
• it helps determine the viability of a project and the long-term viability of the business;
• It is a useful benchmark for positioning a business in relation to its competitors.

How can you improve your company's profitability?

To improve your company's profitability, you can :

• reduce your fixed and variable costs
• increase your sales volume
• increase your prices to the extent that your target market will accept;
• optimise your cash management...

... and of course combine these different strategies!

Your priorities for action will depend on many other parameters that you need to take into account when choosing your angle of attack.

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Rate of return: what you need to remember

Mastering the rate of return is one of the little secrets of a successful business. A fairly simple calculation gives you precise indicators of your company's economic, financial and commercial performance and its investment potential. It enables you to identify ways of acting on different levers when the ratio is low, or even negative, or on the contrary to consolidate a strategy by optimising costs and increasing profits.

While the profitability ratio is a good indicator of a company's performance, on its own it provides a partial view of the company. That's why you need to include additional indicators in your analysis, such as :

• gross margin and net margin;
• sales margin;
• working capital requirements
• projected cash flow;
• deviations from forecast sales, etc.