Question

discuss how the Return on Equity presentation can facilitate the integration of the financial plan and the management control process. Also, what three relationships does the return on equity analysis presentation provide to the strategic planning process?

Answer 1

The development of a financial plan is not of much use till the time the plan is integrated with the management control process. ROE facilitates integration of financial plans with the management control process. Financial ratios provide the structure of integration. The ROE is a combination of the operating margin ratio, total asset turnover ratio, equity financing ratio and non operating revenue percentage. Hence the ROE by itself can show the varinaces in the financial plan. For instance the ROE will be lower if the Operating margin is lower than what was planned by the management. If the management focuses on the 4 relationships provided by the ROE, its direction of controls will improve automatically.

The ROE provides the following three relationships which are vital to the strategic planning process:

ROE= (Net Profit Margin) (Asset Turnover) (Equity Multiplier).

The Net profit margin is the core and most important objective of every business. Asset turnover determines how effectively a business converts its assets to revenues. The equity multiplier allows stakeholders to understand which portion of the return is due to debt. Thus ROE allows the management to make strategic decisions such as which areas of business will yield higher returns, how much debt to be used, etc.