Financial profit

In finance, financial profitability, shareholder return or "ROE" (for its initials in English, Return on equity ) relates economic benefit to resources own necessary to obtain that profit. For a company, ROE indicates the return obtained by shareholders (the only capital providers who do not have a guaranteed return) on the capital they have invested, excluding third-party resources, such as financial debt.

Financial profitability can be understood as a measure of the benefit a company obtains in relation to the funds invested by shareholders. It is usually expressed as a percentage.

The financial profitability, ROE, is calculated:

ROE=BeneficiornetorPatrimorniorNetor{displaystyle ROE={frac {Beneficio net}{Patrimony Neto}}

For example, if one million is placed in an account and the interest generated is one hundred thousand, the return is 10%. Account profitability is calculated by dividing the amount generated by the amount it took to generate it.

Adding to the numerator of the above ratio the amount of the tax levied on the income of the company, the financial return before taxes is obtained. When the economic profitability is greater than the cost of the debt (now expressed as a percentage, to be able to compare, and not in absolute value as before), the greater the degree of indebtedness, the greater the value of the financial profitability or profitability of the shareholders, by virtue of the so-called leverage effect. On the contrary, when the economic profitability is lower than the cost of the debts (other people's capital yields less in the company than it costs) the opposite effect occurs: the debt erodes or reduces the profitability of the own capital.

Decomposition: DuPont Formula

In order to carry out a more detailed analysis of the causes that generate profitability, at the beginning of the century the company DuPont developed XX the DuPont formula that breaks down the previous formula into three terms:

There are companies that follow a strategy of cost leaders that base their profitability on a high rotation with a low margin. That is to say they sell a lot but with little margin on each sale. While other companies base their profitability on high margins, but a low rotation..

It allows the company to divide its return into the components of profit on sales and efficiency on use of assets.

Other variables that affect financial profitability can be introduced into the expression: sales and assets.

ROE=BeneficiornetorRecursorsprorpiors× × VentasVentas× × ActivorActivor{displaystyle ROE={frac {Beneficio net}{Recursos own}}{times {frac {Ventas}{Ventas}}}times {frac {Activa}{Activa}}}}}}

By decomposing and extending the expression, we obtain:

ROE=BeneficiornetorVentas× × VentasActivor× × ActivorRecursorsprorpiors=Margen× × Rortacior♪ ♪ n× × Apalancamientor{displaystyle ROE={frac {Beneficio net}{Ventas}}}times {frac {Ventas}{Activo}}times {frac {Activa}{Recursos themselves}}}={Margen}times {Rotaci{acute {o}}n}times {palancamiento},}

The first two components are shown in the previous section, margin and rotation. The third component is leverage, which is defined as the relationship between investments (assets) and the company's own resources. The first two components are derived from business operations, while the third is the financial aggregate. An ROE that increases from Margin or Turnover growth is an ROE that grows for business reasons, while an ROE that grows from increased leverage shows a company that has increased financial risk.

One of the great advantages of the ROE decomposition using Dupont is that it allows us to identify the "drivers" of profitability and follow its evolution over time. In this way it is possible to follow the evolution of the Margin, Turnover and leverage over time and to be able to identify the causes of a drop in profitability and take corrective measures on time. It is useful to create a "Margin x Turnover" It helps to see the combined contribution of business components to profitability.