Having a clear profitability model is very important. It explains how a company makes money while creating value for the client at the same time. The business model should not only help you to serve your client distinctively, but it must also pursue that the company gains a high return for shareholders.
The DuPont formula helps you to make decisions on strategy and the business model because it combines the three components for creating value: margin, efficiency (asset rotation), and indebtedness (balance structure).
- ROE = Margin * Asset Rotation * Balance Structure
This translates into:
- ROE = (Profit / Sales) * (Sales/Assets) * (Assets/Equity)
3 elements of a clear profitability model
You must understand which of these three elements is your true engine for creating value, and know-how you must compete. You must identify your profitability model and be coherent with it. Some companies compete through their high sales margins (Google). Others, through asset rotation (Walmart) or leverage, by using little capital and substantial debt (Banks).
Margin (Profit / Sales): tells how much money I make as profit for each dollar I earn. It’s the result of income minus expenses. Anything that lowers costs and increases income improves the margin.
Efficiency (Asset rotation): allows you to know how much money you make for each dollar in your balance. Some companies make money by rotating merchandise several times a year. If you have a low margin for each product unit you sell but sell it many times, you end up making a lot of money. This is what happens in supermarkets.
Balance structure (Assets/Equity): allows you to make money with a smaller investment since the cost of debt is lower to the cost of capital.
Return on equity (ROE) is the result of the income model (how much it charges and how it charges it), the cost structure, the margin per customer, and the speed of use of resources.
Does it end with having a clear profitability model?
Having a solid business model is just one of the eight blocks of the success puzzle, according to the book FIT: Strategy, Value, and Prize written by our Chairman, Enrique Quemada.
If you want to know how to build an excellent strategy for successfully managing your company, be sure to get into the following topics:
- Having a solid mission, vision, and set of values.
- How to design a leadership strategy for your company.
- Create the right working culture in your business.
- How to execute your strategy.
These topics and more are all available in the downloadable e-book below.
How to build a more profitable company through the FIT strategy and may other elements.
Discover the eight elements of the business puzzle, and all they contain, to build a valuable company.
Learn how to execute your strategy and maximize the price of your company as never before.