This week’s focus: This is a first – and probably a last – but this week’s focus is about accounting! Specifically, I want to talk about Return on Capital, which measures how well you turn the overall cash that’s been invested in your business into a stream of profit. The key equation is this:

Return on Capital = Profit Margin (Profit/Sales) x Asset Turnover (Sales/Capital Employed)

Critically, there are two parts to the equation – profit margin and asset turnover. Yet most business leaders focus predominantly on the former and pay far less attention to the latter. As a result they fail to maximize their returns and their cash flow.

Some CEOs do get it, though, and manage their business accordingly. Amazon, for example, generates relatively low profit margins – about 3 or 4% – but has market-leading Return on Capital performance as a result of creating a business model that has no need for capital-hungry stores and its strict stock and cash flow management.

How often are you critically reviewing your capital employed, identifying underutilized and unproductive assets and driving up your Return on Capital?

Off The Record: Money (That’s What I Want) by Barrett Strong

Money don’t get everything, it’s true

But what it don’t get I can’t use.

© Stuart Cross 2012. All rights reserved.