One thing can be found that the activities are limited within current assets and current liabilities which establish that the profit is the return on working capital.
It can also be observed that the outflow of cash, resultant inflow of cash and the duration of one operating cycle is not uniform.
For turnaround of a loss-making business entity, the business operation of a round of business cycle which resulted
Minimum duration of operating cycle;
Minimum outflow of cash;
Maximum inflow of cash; and
Resulted maximum amount of profit
is to be found out and the same is to be considered as bench mark for turning around of the loss making business entity into a profit making business entity and efforts are to be made for achieving the benchmark.
Now some intricacies of financial management and business management is stated to explain the relationship between competitive advantage and financial management of the business entity.
All the business organisations need to develop and maintain competitive advantage on a sustained basis to retain its existing position and to progress for climbing further heights of achievements
Competitive advantage can be either in the form of Differentiation or in the form of Cost advantage. Differentiation, acknowledged by customers, gives the business organisation a premium in price. The competitive advantage in the form of Cost, gives the business organisation an opportunity to sell its products and services at a price lower than that of competitor resulting increase in sales by way of acquiring new customers. The new customer thus acquired, can be existing customer of the competitor or a fresh customer due to generation of new demand for products emanated from economic development.
For performance analysis for a period of time, the business organisation first calculates the rate of profit represented by a ratio between the total profit and total sales. It calculated Capital turnover ratio represented by the ratio between total sales and total assets. Multiplication of both the ratio gives Return on Capital Employed. Financial leverage is the ratio between total assets and net worth. Multiplication of financial leverage with Return on Investment yields Return on Net Worth.
Though performance analysis of a business organisation is done by the above ratio analysis, actually the profit depends on the volume of business carried out by completing the number of rounds of business cycle and profit earned from each round of business cycle. Total profit earned by the business organisation in a period of time is the aggregate of difference of inflow and outflow of cash occurred for all individual rounds of operating cycle completed in a period of time. So is the total sales which is the aggregate of inflow of cash occurred for all individual rounds of operating cycle completed in a period of time.
But performance appraisal is to be done in the same way as the business is done. This will enable us to take corrective action to achieve desired results. Otherwise there will be mismatch, there will be problem in taking corrective actions.
Aggregating total sales and total profit by adding all individual sales from the operating cycles completed in a period of time and profit earned thereon and then finding a relation dilutes the performance analysis in an objective manner as the ratio is not the same for all the individual operating cycle competed in a period of time. Averaging has blurred the outcome.
Return on Capital Employed = Profit Margin X Assets Turnover
= (Total Profit / Total Sales) X (Total Sales / Total Assets)
Total Profit = Aggregate of Profit from number of rounds of Business cycle
completed in a period of time
Similarly Total Sales = Aggregate of Inflow of cash from number of rounds of Business cycle completed in a period of time.