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Return on Assets, Margins and Velocity

Posted in Business Strategy, and Leadership

Ram Charan, in What the CEO Wants You to Know, shares that:

Return on assets = Margin x Velocity

The things you are invested in are assets (plant, office, etc.) Some of these assets are big items that are not expected to be sold are sometimes called fixed assets (e.g. building).

Margin is the net profit (including after tax), meaning this is the true profit.

Velocity is basically how fast you are making that money.

If you sell shoes, how long does it take for you to sell all of your shoes in a single shoe rack in your store? Is your shoe rack empty by the end of the day? Or does it take you a whole month to empty that rack? And that’s velocity, the measure of how fast you sell stuff. The faster you move your shoes off the racks, the better.

Return on assets is increased when you increase Margin or Velocity.

Some people would rather talk about return on investment or return on equity (equity is the money shareholders have invested in the business). How much money are you making with your investments or with the money shareholders invested in the company?

Some people use the term inventory turns to describe inventory velocity. Whatever the assets, figuring out asset velocity requires some simple arithmetic: your total sales for say, a year divided by total assets.

Inventory velocity = divide total sales by total inventories

The faster the velocity, the higher the return. In fact return on assets is nothing more than profit margin multiplied by asset velocity.

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