Factor analysis of profitability - one of the most useful methods of analysis

Calculation of profitability of firm is very important step in the evaluation of the financial condition. These indicators allow to judge about efficiency. However, in order to draw any conclusions, a simple calculation of these indicators is not enough. After the calculation of the indicators need to be analyzed by a particular method. One of the most popular techniques is factor analysis of profitability of the enterprise, therefore on it we and will stop.

As you can tell by the name, this type of analysis is to determine the influence on the resulting index, in this case – the profitability of certain factors. A great contribution to the development of this method made by the firm DuPont, which experts have developed a special formula that allows for easy analysis of profitability of assets and own capital. These formulas are based on the method of absolute differences applied to some transformed mathematical models. Consider the transformation to be performed to produce a factor analysis of profitability of these formulas.

Let's Start with return on assets, which is determined by the ratio of net profit to average over the period value of these assets. Multiply the numerator and denominator of this formula to the revenue. Now you may notice that the resulting fraction can be represented as the product of two fractions, each of which is an economically significant indicator: the asset turnover and return on sales. Thus we can conclude that this combination of factors affects return on assets.

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In terms of return on capital of the owner of transformations is to do a little more. Calculation formula of this indicator, multiply and divide by the revenues and assets. After a series of simple transformations can be concluded that the degree of efficiency of use of capital of the owner is dependent on the same factors that affect the return on assets (a measure of their turnover and profitability of sales), as well as from the indicator of financial dependence.

Factor analysis of profitability is made in a slightly different way. The model can be converted, opening and laying out the specifics of the rate of profit in the numerator and cost in the denominator. After this procedure to the obtained mathematical model can be applied the method of chain substitutions. To use the method of absolute differences in this case is impossible, as the mathematical model will have a multiple character.

Obviously, the ability to make a factor analysis of profitability, depends on the availability of information about factors over multiple periods, at least two. The preferred source data, intermediate and final results to present in tables. Of course, if possible, is to use automation tools, i.e. computers and special software. The analysis should be concluded which factors had the greatest positive and negative impact, and what factors can be neglected. Subsequent management decisions should contribute to strengthening the positive effects and weaken the negative.

This type of analysis is not the only one, which are indicators of profitability. More often for analysis using the method of comparisons. Comparisons can be made with indicators of the same enterprise for the previous periods (horizontal analysis, analysis in time), as well as similar indicators from other companies (analysis space) with the average levels.