Profitability: Interpretations and Considerations
Profitability has many interpretations, often competing with other metrics as a means of measuring corporate performance. The DuPont ratio spread is explored in this chapter as useful in identifying meaningful interpretations across a range of interests: strategic effectiveness, investment strategy, operating efficiency, and shareholder returns. However, there are differing views on what comprises “profit.” It has been argued that while organizations appraise success by size of sales, or share price performance, market share, return on a measure of investment, or perhaps sales or growth rate, a realistic measure of corporate success is value added, a derivative of economic profit. To be of use as a performance metric, added value requires to be quantified. Operating margins are one indication of value that is added at each stage of production. However, this has problems. One problem concerns the charge made for the use of capital in the production process. Here the concept of economic profit can be used. Economic value added (EVA) is a financial management technique developed by Stern Stewart Inc, a financial consultancy that built upon earlier conceptual work. Other topics having an influence on profitability include cost driver analysis, total cost of ownership, and the importance of cross business network synergies. This chapter uses relevant finance and investment applications together with Industrié 4.0 and Value Chain Network 2.0 characteristics to demonstrate how finance and investment management can deliver successful stakeholder value management and introduces the notion of value contribution. Volkswagen uses value contribution as “a key measure of operating efficiency” and is calculated based on the operating result after tax and the opportunity cost of invested capital. The operating result shows the economic performance of the organization.
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