Analysis of Low Return on Funds Employed through Conceptual Ideas

Analysis of Low Return on Funds Employed through Conceptual Ideas

Introduction

The problem states that inventory overstocking results in low return on Funds Employed. This is due to the fact that the formula involves Funds or Capital Employed, which is composed of Fixed Assets plus working capital. High Return on Funds Employed is achieved through capital efficiency, which is deploying as little fixed capital and working capital as possible without cutting corners, and operational efficiency, which meant that using as little resources and costs as possible to produce a good.

Discussion

Before commenting on the Return on Funds Employed or Return on Capital Employed, it is imperative to shed some light on the financial ratio. The ROCE is a widely used measure and is used both for internal management, as well as, stakeholders seeking capital market information pertaining to a specific company.

For the calculation of ROCE, the formula incorporates and compares earnings after interest and taxes or NOPAT - net operating profit after taxes to capital employed.

In addition to assessing the relative success of business operations of an enterprise, ROCE is additionally used as a central planning scale. ROCE also provides a suitable reference for the performance-based compensation of management. If the manager is rewarded for achieving the highest possible total return, managers are compelled to make investments which help him or her to increase the bottom line. This phenomenon compels managers to focus on the profitability and ignore the long term prospects of projects which might be strategically beneficial for the future of the company (Drucker & Maciariello 2008).

A company with inadequate Return on Funds Employed might cause its management to come under pressure from shareholders; hence resorting to imprudent actions such as use of increased leverage or under stocking inventory to boost ...