Profit is one way of judging the success of a business. It would be unlikely, however, that you would just look at profit without looking at other things as well. It is like looking at one piece of a jigsaw. It might give you part of the picture but not the whole picture.
We need to use a number of different measures when looking at business success - one element on its own may not give us the full picture. Copyright: Bojan Senjur, from stock.xchng.
The list below gives a number of different ways in which we might measure the success of a business.
1. Return on Capital Employed (ROCE)
This is an accounting measure of success. It looks at how a business uses its capital to generate profit. An example helps to see what we mean by this.
Consider two different but identical firms, A and B. Both have identical assets (capital - equipment, machinery, buildings etc.) worth £100,000. At the end of 2006 Firm A makes a profit of £5,000 while Firm B makes a profit of £25,000.
Which is the most successful firm? The logical answer, of course, will be Firm B. It seems to be using its assets far more effectively to generate profits compared to Firm A. In reality, though, firms producing similar goods do not have identical assets, so it is difficult to compare their success in using these assets. This is the reason why we use ROCE to help us compare.
There is a formula that we use to do this. It is:
ROCE = Profit/Capital Employed x 100
You will see different measures of profit used and slightly different ways in which the formula is written because of this but don't worry the basic principle is the same whatever measure of profit we use.
Now let us use this formula to illustrate how it helps us compare.
Assume two firms as before. Firm A has capital assets worth £10 million and makes a profit in 2006 of £ 2.5 million. Firm B is a much smaller firm with capital assets of £1.2 million. It makes a profit in 2006 of just £400,000.
Which is the most successful firm? In terms of the profit made, Firm A looks to be the favourite but if we use ROCE we might get a different picture. In each case, use the formula to calculate the ROCE for Firm A and Firm B.
Firm A
Firm B
2. Share Price
Public limited companies (PLCs) raise finance in part by selling shares. These shares can be traded on the Stock Exchange. The price of the shares on the stock exchange reflects the demand and supply of the shares. If the share price is rising then it is likely that the demand for the shares is rising faster than the available supply. If the price is falling it suggests people are trying to sell the shares.
Why might people want to buy or sell shares? Partly because of the profit that they think the firm might make in the future and by being a shareholder they will be able to get a share of those profits (the dividend). You can get more details about how the stock exchange works and how share prices change by looking at Biz/ed's resource on the London Stock Exchange.
If share prices are rising it is a sign that investors think the business is, or is going to be, successful in the future.
Task
Use a newspaper or the Internet to find the share price of the following companies:
- British Airways
- Tesco
- Nokia
- BT
- Cadbury's
Try to find out what has happened to their share price over the past year. What might the movements in the share price tell you about the success of the company over that time period?
N.B. You can get share price details from the following sites:
Productivity
Productivity is a measure of efficiency - how well the firm uses its equipment, machinery, land or labour - in production. Productivity must not be confused with production. Production refers to the total amount produced. Productivity refers to the output per worker or machine or piece of land per period of time.
An example:
A farm has 30 hectares of land on which it grows wheat. At the end of the harvest it has produced 60,000 tonnes of wheat. This is a measure of production.
The productivity would be given by the output per hectare. In this example the productivity of the land would be 60,000/30 = 2,000 tons per acre.
The diagram above shows the productivity (output per worker per year) of five of the major motor manufacturers in 2000 and 2001. You can see from this that there is a big difference between them. Nissan's Sunderland plant has a much higher level of productivity per worker than the General Motors plant in Luton. There may be a number of reasons for this (not that the workers are lazy!) but it is another way in which we might measure the success of a business.
Task
Productivity can help a firm gain some competitive advantage. In the chart above, assume that each new car produced sells for the same price (£12,000). Further assume that each worker in each firm is paid the same wage - £450 per week.
Use this information to calculate the profit for each firm per worker during one year if the workers wage was the only cost the firm had to consider. What does this tell you about the importance of productivity as a measure of business success?
Nokia has managed to increase its market share - does this mean that the firm is more successful? What might your judgement of this success depend on? Copyright: Steven Waite, stock.xchng.
Market Share
Market share refers to the proportion of total sales that one firm accounts for in a market. For example, if the total sales of crisps in a year are 2 billion packets and Walkers crisps account for 1.8 billion of those sales, then they would have a market share of 90%.
Increasing market share may well be a sign that a firm is doing well because if its market share increases, other things being equal, it means it is selling more goods or services. The data below refers to the market share of the main 5 firms who supply mobile phones.
| Firm | Market Share 2004 | Market Share 2005 |
|---|
| Nokia | 33% | 35% |
| Motorola | 16.3% | 17.8% |
| LG Electronics | 6.8% | 7.2% |
| Sony Ericsson | 6.3 | 6.9% |
| Samsung | 12.2% | 12.1% |
Source: Nokia's market share back at 35% - from BBC News.
Task
Use the data above and present it in a suitable diagrammatic or chart format. You may use a spreadsheet to help you with this.
Identify and explain TWO ways that a business like those in the table above might use to increase its market share.
