If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing 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. So after glancing at the trends within Sylogist (TSE:SYZ), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Sylogist is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = CA$5.0m ÷ (CA$92m - CA$46m) (Based on the trailing twelve months to June 2024).

Therefore, Sylogist has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Software industry average of 13%.

View our latest analysis for Sylogist

In the above chart we have measured Sylogist's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sylogist for free.

What The Trend Of ROCE Can Tell Us

The trend of ROCE at Sylogist is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 11% we see today. On top of that, the business is utilizing 24% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Sylogist's current liabilities have increased over the last five years to 50% 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

To see Sylogist reducing the capital employed in the business in tandem with diminishing returns, is concerning. In spite of that, the stock has delivered a 20% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.