How To Increase ROE in Capsim
ROE is among the top performance measures that contribute to your capsim score. Unfortunately, students are sometimes incapable of improving it as it comprises multiple elements.
Our guide takes you through effective tips on how to increase ROE in capsim. And if you get stuck applying any of these steps, don’t hesitate to ask for help.
What Is ROE?
Return on equity is a ratio measuring shareholders’ return from their shares. ROE is significant as it informs investors how good your management is in generating revenue from the assets or cash you hold.
How do you compute return on equity?
ROE is a company’s net income divided by the shareholders’ equity. This gives you a ratio that is multiplied by 100 to express the value as a percentage.
Here is the ROE formula
Return on Equity = Net Income/Shareholders Equity * 100
You can obtain the net income from the income statement and the shareholder’s equity from the balance sheet.
For example, if your company generates $50,000 in profits in a year and holds a shareholders’ equity of $400,000, your return on equity will be:
ROE = 50000/400000
= 0.125
You’re bound to worry about your ROE as it impacts your score in capsim raking. However, there’s no definite number to aim for, as the industry has its standards. Depending on the normal for your industry, you can develop a strategy that will generate a better ROE than your competitors.
How To Increase ROE in Capsim
The return on equity formula is made up of two parts;
- Net income
- Shareholders equity
Adjusting either or both of these elements will change the ROE by definition.
The balance sheet calculates shareholders’ equity by subtracting the total liabilities from the total assets. Any shift in your assets(inventory and cash) or liabilities (equipment loans and tax liabilities) brings an ROE change automatically.
Here’s how to improve your ROE
Adjust Your Leverage
Leverage is key in ROE value; therefore, you should handle it appropriately. Rising debt increases the interest payments on loans. Consequently, if you finance your company with debts, you will make less profit after taxes than a company operating on equity.
Borrowing aggressively boosts your ROE artificially; however, it does not reflect the actual performance of your company. Leverage gives you a better view of the financial structure of your company, and when handled properly, it can result in a significant ROE increase.
However, there’s an exception to this direct leverage-ROE relationship. Typically, when the interest payments exceed the asset turnover, the leverage’s positive effect no longer applies to the ROE.
Increase Your Profit Margins
The second part of your return on equity formula is net income, the equivalent of profits. Increasing your retained earnings will improve your return on equity as long as the shareholders’ equity remains constant.
In our previous example, your company had a $50,000 net income and $400,000 shareholders’ equity. If the net income increases to $60,000 and the shareholders’ equity remains the same, your return on equity will be
= 60,000/400000
ROE = 0.15
There are multiple ways to increase caspim profits, including
- Increasing the market share
- Reducing the operating cost
- Raising the price of your products
- Lowering labor costs
- Reducing production costs like packaging
Deploy Idle Cash
Having too much cash at hand than you need for your operations? This may sound like a favorable condition in business. However, withholding too much money means you’re not maximizing your profitability. This affects your ROE negatively as it increases the shareholders’ equity.
To solve this, your team should allocate the extra cash to profitable ventures like building capacity or increasing automation. This will help you generate more income and leverage the return on equity. If you already have enough funds for all the departments, you can decide to pay dividends instead.
In the case where we have a net income of $60,000 and shareholders’ equity of $400,000, assuming that $120,000 is the cash at hand and $280000 is inventory. You can pay $100,000 cash out as a dividend and remain with $20,000.
This amount, plus the inventory of $280,000, gives you $300,0000 equity.
This will change your return on equity to:
= 60,000/300000
ROE = 0.2
That’s a 5% increase.
Reduce Your Inventory
What’s your capsim inventory?
Is it affecting your return on equity value positively or negatively?
In our example, we have an inventory of $280,000 which adds to the shareholder’s equity. If it’s way above the market demands, the company is constantly faced with additional storage charges.
As a result, you have extremely high total equity and less profit after deducting the storage fees. Suppose you reduce the inventory to match your market share demands to a figure like $140,000; you will have an equity of (cash reserve) of $20,000 + (inventory) of $140,000, giving you an equity of $160,000.
The new shareholders’ equity of $160,000 gives an ROE of;
60,0000/160000
= 0.375
= 37.5 %, which gives you a 32.5% increase from the initial value.
Is Your ROE Dropping Consistently?
Not sure what is causing a constant decrease in your ROE? Our team of caspim professionals can help you assess the involved elements to identify what could be the cause and provide you with suitable solutions.
Please Check out our Guide on How Increase Profits in Capsim
Visit our site to get expert help!