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 durability, such as the rate of return.

If you want to know the secret of successful companies, click here! 👉

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What is a company's rate of return?

For a business to succeed, it needs customers, of course, 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 financial performance) is its profitability, or its rate of return when expressed as a percentage.

Rate of return: definition

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

This ratio is used to assess :

• an organization'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 ratios for assessing a company's health and viability:

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 financial debt).

This indicator measures current business performance to determine whether the organization is succeeding in properly exploiting its resources 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 return on sales corresponds to the net margin generated by sales operations. It assesses 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)

Also known as the rate of return, ROI measures the performance of a company' s investments.

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

👉 Its calculation formula is as follows:

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

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

Why is calculating the rate of return so important?

Calculating a company's rate of return is important for determining 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 its financial health and longevity. It helps you to steer your business in the right direction.

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

The benefits of calculating a company's rate of return

Calculating a company's rate of return has many advantages. Thanks to this indicator, you can :

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

What about disadvantages?

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

• the formula does not take into account possible cost variations (fixed and variable costs) 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 a company's economic and financial health, it is in your interest to supplement this analysis with other indicators.

3 strategies to improve your rate of return

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

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

Strategy 1 - Optimize costs

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

The solution to reducing these costs is to first analyze all your expenses, with the aim of identifying potential savings, for example :

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

To achieve these savings, you can raise your employees' awareness of the challenges of more frugal practices, renegotiate contracts with your suppliers, or develop your processes through the digitization of management operations and artificial intelligence.

Strategy 2 - Increase your rates

Another solution is to optimize your pricing policy.

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

Strategy 3 - Increase your sales volume

We also advise you to improve your revenues by increasing your sales volume. This strategy often requires investment, with a view to developing your teams, increasing your production capacity and optimizing your distribution processes.

💡 And to achieve an even higher rate of profitability, be smart and combine these different strategies: reduce your costs, increase your volume sales 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 make the right decisions by comparing different investment opportunities.

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

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

• it can be used to assess a 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 company's long-term viability;
• It is a useful benchmark for positioning your business in relation to the competition.

How to 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;
• optimize your cash management...

... and, of course, combine these different strategies!

Your priorities for action will depend on a number of other parameters to be taken 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 simple calculation gives you precise indicators of your company's economic, financial and commercial performance, as well as its investment potential. It enables you to identify ways to act on different levers when the ratio is low, or even negative, or on the contrary to consolidate a strategy by optimizing 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 business. That's why you need to include complementary indicators in your analysis, such as :

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