Financial Ratio Analysis - Capital Employed Turnover

Capital Employed Turnover

We know that the ROCE (return on capital employed) ratio gives us a good idea of how the profit the business is earning relates to the capital the shareholders have invested in their business. Here is another ratio that's not exactly the same as the ROCE ratio, but it does enhance our view of a business.

The capital employed turnover ratio tells us the state of the relationship between the shareholders' investment in the business and the turnover that the management of the business have been able to generate from it.

Capital Employed Turnover =     Turnover    
Equity Shareholders' Funds

As with all financial ratios, there is no ideal value to this ratio, so we should find out what the Carphone Warehouse has done over the latest two years and then try to interpret what we find.

Carphone Warehouse 31 March 2001 25 March 2000
  £'000 £'000
Turnover 1,110,678 697,720
Equity shareholders' funds 436,758 44,190

Capital Employed Turnover Ratio for the Carphone Warehouse
31 March 2001 1,110,678
436,758
2.54 times
25 March 2000 697,720
44,190
15.79 times

The Carphone Warehouse has gone from a capital employed turnover ratio of almost 16 to one of 2.54 in a year - a major change that suggests a problem. We need to understand why they have this problem.

The answer to our question is simple once we review the Equity Shareholders' Funds section of the balance sheet for the two years:

Capital and reserves 2001 2000
Called-up share capital 833 600
Share premium 356,235 0
Other reserves 0 0
Profit and loss account 79,690 43,590
Equity shareholders' funds 436,758 44,190

There are two changes of importance:

The profit and loss account has increased by 83%, which is a good thing.

We now have a share premium account, a massive share premium account: they have issued some shares at an enormous premium and it is this value that has distorted the capital employed turnover ratio.

If we remove the share premium value from the ratio, we can see whether the underlying trend is good or bad:

Adjusted Capital Employed Turnover Ratio for the Carphone Warehouse
31 March 2001 1,110,678
436,758 - 356,235
13.79 times
25 March 2000 697,720
44,190
15.79 times

See the difference the share premium account has made? The Carphone Warehouse has lost a bit of ground in this ratio over the two years, but not as serious as we thought before. The ground it has lost, though, to fall from 15.79 to 13.79 is explained by turnover rising at a slower rate than the capital employed.

As we have said before, we would expect this ratio to catch up over the coming year otherwise the investments it is making are not as valuable as they ought to be.

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