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When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Beta Systems Software (FRA:BSS), so let's see why.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Beta Systems Software, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = €2.2m ÷ (€86m - €35m) (Based on the trailing twelve months to March 2024).
Thus, Beta Systems Software has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Software industry average of 15%.
Check out our latest analysis for Beta Systems Software
In the above chart we have measured Beta Systems Software's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Beta Systems Software .
The Trend Of ROCE
In terms of Beta Systems Software's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 9.2%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Beta Systems Software to turn into a multi-bagger.
On a side note, Beta Systems Software's current liabilities have increased over the last five years to 41% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Key Takeaway
In summary, it's unfortunate that Beta Systems Software is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 60% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.