Interpreting ROE

ROE is an important indicator of a company’s profitability and potential growth. Any decision that affects the product price, unit cost, volume or efficiency will have an impact on profitability or turnover ratios. Likewise, any decision that affects the debt/ equity ratio will have an impact on the financial structure and the cost of capital. Hence ROE is important for every business as it competes for limited resources.

ROE can help in inter firm comparison and analyse changes over time. It shows the impact on various components on profitability and is particularly useful in the financial analysis of industries with high margin, turnover and high leverage.

Business that tend to maintain high level of ROE for the long periods are rated higher by the stock market. But, then again not all companies with a high ROE are good investments and therefore looking at the returns over long time periods complemented with Du Pont will help you assess the quality of companies.

Generally a low or failing ROE is a pointer to the existence of some weakness. The DuPont analysis help to find out where this weakness lies. For example software services companies in India still boast of a very high ROE but the trend has been declining. A DuPont analysis will show the chief reason for this is the failing profit margins.

This model may be useful in the case of industries like investment banking and retailing because of the nature of these businesses. Perhaps the biggest drawback of the DuPont model is that it relies heavily on numbers. And number could be fudged and also it does not take into account the cost of capital. Besides it does not take into account cash flows and time value for money.

Best Practices for a Cost-Effective Internal Audit

1. Determining and Utilizing the Right Resourcing Model
Determining what the resource needs of the company are and choosing the best model for meeting those resourcing needs is an important practice. While insourcing can often be the desired solution if the time or financial constraints do not support it, choosing this model can be to the detriment of the overall organization. Making sure you use the right model for each business’s needs is critical.

2. Focusing on the Core

To have a highly cost-effective audit, the first step is to concentrate on the crucial foundations of assets and functions that directly affect the internal auditing process. After this, you can disseminate the efforts across the company’s workflows. This can be time-saving and will also help streamline the necessary changes.
The key is in reducing the scope during the initial stages. This helps the internal audit team concentrate on the highly-valuable attributes of the organization. It allows both management and the board some flexibility to set their policy and goals for the audit function, as well as deciding how to appropriately balance and manage the cost versus effectiveness of the audit. One way to analyze what functions need to be included is by conducting a BIA (Business Impact Analysis).

3. Utilizing Enterprise Risk Management

After finding the core functions and assets, organizations should utilize an effective Enterprise Risk Management strategy that will be applied to the entire company’s workflows. This is to further identify which domains need to be included in the scope of the internal audit, as well as to know how to move forward after identifying and addressing the issues found after focusing on the core functions and assets.
Creating a strategy that supplements the initial efforts of restructuring the internal audit systems helps an organization to focus on the critical functions affected by the issues and will provide a clearer perspective on which parts are problematic for the company from top to bottom. This eases the process of identifying the most susceptible assets that can be adversely exploited. This will also help the internal audit team to further concentrate on the high-risk areas and balance their resources cost efficiently.

4. Focusing on Time Management

One of the most important aspects of reducing the cost of the internal audit is appropriate time management. A well-defined timeline should be in place to restrict longer engagements, allowing time to be utilized most effectively. This can be achieved by allocating time durations to complete the entire audit, as well as each subtask in the entire process. By emphasizing time management, allocation of employee time and company resources are balanced with meeting the desired deadline.

Choosing a Project Finance

Before examining how projects are structured and financed, it is worth asking why sponsors choose project finance to fund their projects. Project finance is invariably more expensive than raising corporate funding. Also, and importantly, it takes considerably more time to organise and involves a considerable dedication of management time and expertise in implementing, monitoring and administering the loan during the life of the project. There must, therefore, be compelling reasons for sponsors to choose this route for financing a particular project.

The following are some of the more obvious reasons why project finance might be chosen: . The sponsors may want to insulate themselves from both the project debt and the risk of any failure of the project. A desire on the part of sponsors not to have to consolidate the project’s debt on to their own balance sheets. This will, of course, depend on the particular accounting and/or legal requirements applicable to each sponsor.

However, with the trend these days in many countries for a company’s balance sheet to reflect substance over form, this is likely to become less of a reason for sponsors to select project finance (the implementation in the UK of the recent accounting standard on “Reporting the Substance of Transactions” (FRS 5) is an example of this trend) There may be a genuine desire on the part of the sponsors to share some of the risk in a large project with others. It may be that in the case of some smaller companies their balance sheets are simply not strong enough to raise the necessary finance to invest in a project on their own and the only way in which they can raise the necessary finance is on a project financing basis A sponsor may be constrained in its ability to borrow the necessary funds for the project, either through financial covenants in its corporate loan documentation or borrowing restrictions in its statutes.

Real Estate Investing

Rental solutions have been key to addressing India’s housing challenges, and the country’s rental real estate holds immense potential. In 2017, the rental real estate market was pegged at one crore units and was valued at $22 billion (Rs 1.53 lakh crore). By 2023, its volume is expected to be 1.8 crore and valuation $41 billion (Rs 2.85 lakh crore).

However, maximising rental yields has been a challenge for the rental real estate market. Low rental yield and poor capital appreciation, especially in the past two-three years, have hurt investors.

However, smart choice of investments, value-added services and a host of online rental disrupters can be a game-changing recipe for India’s rental real estate market and investors. You can earn a higher rental yield, if you keep the following factors in mind:

• Invest in affordable homes

Magicbricks data suggests that yields in the affordable homes segment are higher compared to the mid-level or luxury segment. There is also a significant variation between yields based on their capital values(Rs/sq. ft). We have observed across cities that properties priced below Rs 6,000/sqft have an average rental yield of more than 3%. On the other hand, properties priced at Rs 6,000 per sq ft or more had rental yields between 2.4% and 3%. Hence, from a rental income perspective, it makes more sense to invest in affordable properties. This trend holds across most cities.

• Invest in affordable real estate markets

Homebuyers must keep in mind that while the broader real estate market has remained flat, there are some micro-markets across metros and large cities where property prices are reasonable and investors can expect good returns. On a pan-India level, the average yield per sqft stands at 3%, but there are some micro-markets where the rental yield can go up to almost 4.5%.

• Invest in co-living solutions

There is a huge latent demand from India’s millennials, be it the student community or the migrant working professionals, in the 18-35 age bracket, for co-living options. Given that millennials make up around 30% of the population, co-living players have an opportunity to service this upcoming demand. These new models have the capacity to push effective rental yield to 8%.