Chapter 08, financial statment analysis

7/21/2019 Chapter 08, financial statment analysis

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Copyright 2009 by The McGraw-Hill Companies, Inc. All rights resere!.McGraw-Hill"Irwin

Financial

Statement

Analysis

K R Subramanyam

John J Wild


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8-2

8CHAPTER

Return on Invested Capital and

Profitability Analysis


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Return on Invested Capital

Joint analysis is where one measure is

assessed relative to another

Return on invested capital (ROIC) orReturn on Investment (ROI) is an important

joint analysis

Joint analysis is where one measure is

assessed relative to another

Return on invested capital (ROIC) orReturn on Investment (ROI) is an important

joint analysis

Importance of Joint Analysis


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ROI Relation

ROI relates income, or other performance measure,

to a companys level and source of financin

ROI allows comparisons with alternative investmentopportunities

Ris!ier investments e"pected to yield a hiher ROI

ROI impacts a companys a#ility

to succeed, attract financin,

repay creditors,and reward owners

ROI relates income, or other performance measure,

to a companys level and source of financin

ROI allows comparisons with alternative investmentopportunities

Ris!ier investments e"pected to yield a hiher ROI

ROI impacts a companys a#ility

to succeed, attract financin,

repay creditors,and reward owners


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Application of ROI

($)measurin

profita#ility

(%)&easure for

plannin and

control

(')measurin

manaerial

effectiveness

($)measurin

rofita#ility

(%)measure for

plannin and

control

ROI is applica#le to


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&easurin &anaerial *ffectiveness

&anaement isresponsi#le for allcompany activities

ROI is a measure of manaerialeffectiveness in #usiness activities

ROI depends on the s!ill, resourcefulness,

inenuity, and motivation of manaement

&anaement isresponsi#le for allcompany activities

ROI is a measure of manaerialeffectiveness in #usiness activities

ROI depends on the s!ill, resourcefulness,

inenuity, and motivation of manaement


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&easurin rofita#ility

ROI is an indicator of companyprofita#ility

ROI relates !ey summary

measures profits with financin

ROI conveys return on invested

capital from different financin perspectives

ROI is an indicator of companyprofita#ility

ROI relates !ey summarymeasures profits with financin

ROI conveys return on invested

capital from different financin perspectives


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&easurin for lannin and Control

ROI assists manaers with

lannin+udetin

Coordinatin activities*valuatin opportunities

Control

ROI assists manaers with

lannin+udetin

Coordinatin activities*valuatin opportunities

Control


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Components of ROI

Return on invested #apital is defined as$

Income

Invested Capital


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Components of ROI

Invested Capital efined

- .o universal measure

of invested capital

- ifferent measures of

invested capital reflect

user/s differentperspectives


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Components of ROI

Alternative &easures of Invested Capital

Common &easures

- .et Operatin Assets

- Stoc!holders/ *0uity


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Components of ROI

erspective is that of the companyas a whole

Called etu n on net ope atingassets (RNOA)

R.OA

measures operatin efficiency1performance reflects return on net operatin

assets (e"cludin financialassets1lia#ilities)

erspective is that of the companyas a whole

Called etu n on net ope atingassets (RNOA)

R.OAmeasures operatin efficiency1

performance reflects return on net operatin

assets (e"cludin financialassets1lia#ilities)

.et Operatin Assets

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Components of ROI

Common *0uity Capital

- erspective is that of common

e0uity holders- Captures the effect of leverae(de#t) capital on e0uity holderreturn

- *"cludes all de#t financin andpreferred e0uity

- erspective is that of commone0uity holders

- Captures the effect of leverae(de#t) capital on e0uity holderreturn

- *"cludes all de#t financin and

preferred e0uity

net in#ome less preferred dividends

avera'e #ommon e(uity

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Components of ROI

Computin Invested Capital

- 2sually computed usin ave agecapital availa#le for the period- 3ypically add #einnin andendin invested capital amountsand divide #y $

- &ore accurate computation is to

averae interim amounts4 0uarterly or monthly

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Components of ROI

Ad5ustments to Invested Capital and Income .um#ers

&any accountin num#ers re0uire

analytical ad5ustment4see prior chapters

Some num#ers not reported in financial

statements need to #e included

Such ad5ustments are necessary for

effective analysis of return on invested

capital

&any accountin num#ers re0uire

analytical ad5ustment4see prior chapters

Some num#ers not reported in financial

statements need to #e included

Such ad5ustments are necessary for

effective analysis of return on investedcapital

8 %


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8-%

Components of ROI

Return on .et Operatin Assets 66 R.OA

.OA3

(+einnin .OA 7 *ndin .OA) 1 $

.OA3

(+einnin .OA 7 *ndin .OA) 1 $

8here

.OA3 9 Operatin income " ('6 ta" rate)

.OA 9 net operatin assets

8 %!


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Components of ROI

+A:A.C* S;**3

)peratin' assets ********************* )A+ess operatin' liabilities ******** ,)+

.et operatin' assets**************

.)A

/inan#ial liabilities ****************** /++ess finan#ial assets ************* ,/A

.et finan#ial obli'ations********* ./)

0to#1olders e(uity**************** 0

.et finan#in' **************** ./) 0

Operatin and nonoperatin activities 6 istinction

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Components of ROI

Return on Common *0uity 66 ROC*

.et income 6 referred dividends

(+einnin e0uity 7 *ndin e0uity) 1 $

.et income 6 referred dividends

(+einnin e0uity 7 *ndin e0uity) 1 $

8here

*0uity is stoc!holder/s e0uity less preferred

stoc!

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Analy6in' Return on Assets-R)A

isareatin R.OA

Return on operatin assets 9

Operatin rofit marin " Operatin Asset turnover

NOAAvg.

Sales

Sales

NOPAT

NOAAvg.

NOPAT=

Operatin rofit marin measures operatin' profitability

relative to sales

Operatin Asset turnover (utili


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ffe#t of )peratin' +evera'e on R.)A

OA 9 operatin assets

O::*= 9 operatin lia#ilities leverae ratio

(operatin lia#ilities 1 .OA)

8-2%


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Profit 7ar'in and Asset urnover

rofit marin and asset turnover are

interdependent

9 Profit mar'in is a fun#tion of sales and operatin'

e:penses ,sellin' pri#e : units sold

9 urnover is also a fun#tion of sales

,sales;assets

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Relation #etween .OA3 &arin, .OA 3urnover, and

Return on .et Operatin Assets

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.et operatin' Asset urnover v;s

.et operatin' Profit 7ar'in for 0ele#ted Industries

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isareatin rofit &arin

)peratin' profit mar'in ,)P7 < .)PA0ales

Preta: P7 < Preta: sales P7 Preta: oter P7

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=ross Profit 7ar'in$ Refle#ts te 'ross profit as

a per#ent of sales9 Refle#ts #ompanys ability to in#rease or maintainsellin' pri#e

9 >e#linin' mar'ins may indi#ate tat #ompetition asin#reased or tat te #ompanys produ#ts ave

be#ome less #ompetitive? or bot

0ellin' :penses

=eneral and Administrative :penses

isareatin rofit &arin

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isareation of Asset 3urnover

Asset turnover measures theintensity with which companies utili


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Accounts Receiva#le turnover$ Refle#ts o@ manytimes re#eivables are #olle#ted on avera'e*

9 A##ompanyin' ratio$ Avera'e #olle#tion period Inventories turnover$ Refle#ts o@ many times

inventories are #olle#ted on avera'e9 A##ompanyin' ratio$ Avera'e inventory days outstandin'

:on6term Operatin Asset turnover$ Refle#ts te

produ#tivity of lon'-term operatin' assets Accounts aya#le turnover$ Refle#ts o@ (ui#1ly

a##ounts payable are paid? on avera'e9 A##ompanyin' ratio$ Avera'e payable days outstandin'


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Analy6in' Return on Common (uity-R)C

where ROC* is e0ual to net income availa#le to common shareholders

(afte preferred dividends) divided #y the #einnin6of6period common

e0uity

3his can #e restated in terms of futu eROC*

Role in *0uity =aluation

8-3%


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isareatin ROC*

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:everaerefers to te e:tent of invested #apitalfrom oter tan #ommon sareolders

If suppliers of #apital ,oter tan #ommonsareolders re#eive less tan R)A? ten

#ommon sareolders benefit te reverseo##urs @en suppliers of #apital re#eive more

tan R)A e lar'er te differen#e in returns bet@een

#ommon e(uity and oter #apital suppliers? te

more su##essful ,or unsu##essful is te tradin'

on te e(uity

:everaerefers to te e:tent of invested #apitalfrom oter tan #ommon sareolders

If suppliers of #apital ,oter tan #ommonsareolders re#eive less tan R)A? ten

#ommon sareolders benefit te reverseo##urs @en suppliers of #apital re#eive moretan R)A

e lar'er te differen#e in returns bet@een

#ommon e(uity and oter #apital suppliers? te

more su##essful ,or unsu##essful is te tradin'

on te e(uity

:everae and ROC*

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Alternate =iew of ROC* isareation

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e0uityrs/stoc!holdecommonAveraepayoutividenddividendsreferredincome.et9raterowth*0uity

Assessin *0uity >rowth

Assumes earnins retention

anda constant dividend

payout

Assesses common e0uity

rowth rate throuh

earninsretention

Assumes earnins retention

anda constant dividend

payout

Assesses common e0uity

rowth rate throuh

earninsretention

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Assessin *0uity >rowth

Assumes internal rowth

depends on bothearnins

retention and return earned on

the earnins retained

Assumes internal rowth

depends on bothearnins

retention and return earned on

the earnins retained

rate)Payout(1ROCE=rategrowthequtyeSusta!a"l

Chapter 08, financial statment analysis

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