Return on Assets Dissected and the Diminishing Effect of Capital Spending against Core Business Profitability

This is Part 3 of a Series. Go to Part 2: Dissecting that Process which Drives Business Profitability

Magnified Mark-up Profitability diminished. The impact of the
working capital's profitable turnover can only go insofar as to
how much it weighs against overall operating assets
in which Capex Assets may take a large portion of.

So in this example of ours, what is the Return on Assets (ROA)? We would have to divide the $20,000 in profits by the total asset base we have laid out for this venture, which is $70,000 ($50,000 in working capital plus the $20,000 in transportation vehicle capital spending) to arrive at a 28.57% return. This 28.57% ROA, in itself, however, doesn't give us much insight, and for sure you would agree with me in saying that as an entrepreneur and businessman, we are interested to know what has driven this 28.57% return. Observe the following as we dissect ROA into its finer elements:

$20,000 in operating income / $100,000 in operating costs = 20% Mark-Up

$100,000 in operating costs / $50,000 in working capital = 2x Turnover of working capital

$50,000 in working capital/ $70,000 worth of operating assets = 71.43% Weight of working capital against overall operating assets

20% mark-up x 2x turnover x 71.43% weight = 28.57% ROA

Mark-up is most basic and easily deduced by us entrepreneurs. We have costs, and we need to put a mark-up to earn money, to profit (i.e. the Mark-up). And if we're able to repeat this mark-up many times given the working capital we have, we are able to magnify and multiply this mark-up (i.e. the Turnover). Nonetheless, the impact of this profitable activity by the working capital (i.e. mark-up x turnover) can only go insofar as to how much it weighs against overall operating assets (i.e. working capital / operating assets); thus generally, the more capital intensive the business is, the lesser impact this magnified mark-up profitability has.

In summary, as a businessman investor, we are interested in our mark-up, our money's turnover, and how much capital is tied on fixed assets (i.e. capex assets). This three-step ROA dissection would reveal what's driving profitability.