Reasons for Falling ROCE

From the data given, ROCE has fallen from 14.9 per cent to 10.5 per cent, a fall of 4.4 per cent. The first step is to break the ROCE into its two component parts, capital employed turnover and operating profit. The operating profit is given in the question however capital employed turnover must be calculated.

                                     Calculation of capital employed turnover

The capital employed turnover ratios have fallen from 1.242 in 2004 to 1.05 in 2005. Thus the business is generating less sales per € invested in the business. This is also reflected in the reduced number of tourists which fell by 4.76% (100/2100). This is despite the average price per tour falling by 10%.

The operating profit margin fell from 12 per cent to 10 per cent. From the data given, the main reasons for this fall are:

o       The company not maintaining its average price per tour of €550. This price fell by 10% to €500. Management must ascertain why this has occurred and assess how to rectify the situation. Also the average price per seat fell by 20.5% suggesting that the volume of tours did not increase in reaction to the reduced price per tour.

o       Direct costs as a percentage of sales increased by 2%. As sales volume falls it is expected that there would be some fall in direct costs. Management must investigate this increase and ascertain is it due to the reduced sales or a lack of control over costs.

o       Labour costs as a percentage of sales has increased by 2%. This is also in conjunction with an increase in the number of employees of 7.2% (20/280). Management must ascertain what category of labour has increase and question the value from this increase especially in the light of falling sales. Again falling sales can ensure an increased labour costs to sales %. Management must ascertain whether this is a significant part of this increase.

o       The overheads to sales percentage has decreased from 12% to 10%. Management must investigate this reduction and ascertain what category of overhead has fallen. Overheads are mainly fixed costs and thus they are not expected to fall as sales volume falls. Thus this 2% represents a real saving and management must assess where this saving has occurred and assess its long-term impact.