SW Group is one of the largest food retail chains in Europe. As well as having a significant market share for groceries SW Group has also increased its sales of clothes in recent years.
The aim of a company is to maximize profit for its shareholders. That is why its top priority is the ROE (the return on equity) ratio. In 2012 the company managed to increase this ratio by 3.2%, thanks both to an improvement of its Return on Capital Employed ratio (ROCE) and of its Financial Leverage Effect (FLE). Indeed the ratios mentioned above are linked by the formula: ROE = ROCE + FLE. We will first focus on the ROCE ratio by analyzing SW Group’s profitability and then analyze in further details the role of FLE.
Is the Company Healthy?
SW Group’s financial statements show an improvement in the financial position of the company. This could be mainly justified by an increased profit, knowing that gross, operating and net profit all increased. Indeed, the overall revenues increased more than the sales costs did.
What’s important to observe is that ROCE is function of Operating Profit Margin and the SRCE, or Sales Revenue ratio to Capital Employed. This relation can be written as follows: ROCE= OPM + SRCE. Thus, we have to analyze both ratios to fully understand the reasons for an increase in the ROCE.
OPM is defined by the relation between the Gross Profit Margin (GPM) and the Operating Expenses to Sales ratio (OES). The Gross Profit Margin shows that SW converted a larger part of sales revenue into gross profit than the year before, proving a basic improvement of the activity’s profitability (from 13.8% in 2011 to 14.1% in 2012).On the other hand, the operating expenses increased less than the sales revenue. The Operating Expenses to Sales Ratio indeed decreased between 2011 and 2012 (from 8.3% to 8.1%). Therefore, since OPM = GPM – OES, OPM follows the same trend with an improvement of 0.5% from 5.5% in 2011 to 6% in 2012. If OPM can...