Lecture 10 - Recitation 3 Flashcards
How to calculate Return on Equity (ROE)? (3)
Return on Equity (ROE) = (Net Income / Average Shareholders Equity) × 100
- Net Income: Total profit after deducting expenses, taxes, and interest.
- Average Shareholders’ Equity: The average of shareholders’ equity at the beginning and end of a period.
INTERPRETATION
ROE measures a company’s profitability in relation to shareholders’ equity. A higher ROE indicates better efficiency in using equity to generate profits.
How to calculate Return on Assets (ROA)? (4)
Return on Assets (ROA) = (Net Income / Average Total Assets) × 100 | → | AT × PM
- Net Income: Total profit after deducting expenses, taxes, and interest.
- Average Total Assets: The average of total assets at the beginning and end of a period.
INTERPRETATION
ROA measures a company’s efficiency in generating profits from its assets. A higher ROA indicates better asset utilization and profitability.
How to calculate Return on Financial Leverage (ROFL)? (2)
Financial Leverage (ROFL) = ROE ‒ ROA
- ROE = Return on Equity
- ROA = Return on Assets
INTERPRETATION
Financial leverage is the use of debt to increase the return on equity.
Return on Assets (ROA) can be disaggregated into two components:
- Profit Margin (PM) Formular
- Asset Turnover (AT) Formular
to determine which factor drives ROA. (4)
- Interpretation
ROA = ProfitMargin × AssetTurnover
Profit Margin (PM)
= (Net Income / Total Revenue) × 100
-
Net Income:
Total profit after deducting expenses, taxes, and interest. -
Total Revenue:
The total income generated from all business activities.
Asset Turnover (AT)
= Total Revenue / AverageTotalAssets
-
Total Revenue:
The total income generated from all business activities. -
Average Total Assets:
The average of total assets at the beginning and end of a period.
INTERPRETATION
This indicates whicht factor drives the ability to generate profit of overall performance:
sales compared to using assets
How to compute Gross Profit Margin (GPM)?
Gross Profit Margin (%) = (Gross Profit / Revenue) × 100
→ | Gross Profit = Total Revenue − COGS
How to compute Expense to Sales Ratio (%)?
Expense to Sales Ratio (%) = (Operating Expenses / Net Sales or Revenue) × 100
From the Income Statement:
-
Total Operating Expenses:
This includes costs such as salaries, rent, utilities, marketing, and other day-to-day operational costs. -
Net Sales or Revenue:
Total income generated by the business after deducting returns, allowances, and discounts.
INTERPRETATION
Measures the efficiency of a company in managing its operating expenses
How to compute Accounts Receivable Turnover (ART)? (3)
Accounts Receivable Turnover =
Net Credit Sales / Average Accounts Receivable
-
Income Statement:
Find the Net Credit Sales -
Balance Sheet:
Find the Average Accounts Receivable
How to compute Inventory Turnover (INVT) ?
Inventory Turnover = COGS / Average Inventory
- Income Statement | → |COGS
Find the Cost of Goods Sold (COGS), this represents the cost of producing or purchasing the goods that were sold. - Balance Sheet | → |Average Inventory
Find the Average Inventory, this is calculated as Beginning Inventory + Ending Inventory / 2
How to compute Property, Plant
(PPE Turnover)? (3)
PPE Turnover =
Net Sales / Average PPE
Income Statement
- Find Net Sales,
- this is the total revenue from sales
after deducting returns and allowances (Zulagen)
Balance Sheet
- Find the Average PPE,
- this is calculated as Beginning PPE + Ending PPE / 2
How do these turnover measures compare?
- PPET (Property, Plant Turnover)
- ART (Accounts Receivable Turnover)
- INVT (Inventory Turnover)
a higher, turnover ratio indicates better efficiency in managing resources.
- ART implies faster collections,
- INVT suggests efficient inventory management.
How to calculate
- current ratio
- quick ratio? (2)
What is it used for? (4)
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio (Acid-Test Ratio) = Current Assets - Inventory / Current Liabilities
The current ratio and quick ratio are
- liquidity ratios
- measure ability to meet its short-term obligations.
- use figures from the balance sheet:.
- Quick Ratio is a more stringent measure of a company’s liquidity. It excludes inventory from current assets since inventory may take time to convert to cash.
What Metrics relate to Return on Investment (ROI)? (4)
- ROE (Return on Equity)
- ROA (Return on Assets)
- ROFL (Return on Financial Leverage), measures use of debt / Leverage of ROE
DuPont Analysis of ROA
- PM (Profit Margin), proftability
- AT (Asset Turnover), effiziency
Give relevant Ratios / Metrics
and categorize them
by the main focus areas (5)
🌊📈🌍
Liquidity Ratio
- Inventory Turnover (INVT)
Efficiency Ratios
- Expense to Sales Revenue (ETS)
- Accounts Receivable Turnover (ART)
- PP&E Turnover (PPET)
Market Ratio
- Gross Profit Margin (GPM)
Liquidity and Solvency Ratios (4)
Liquidity Ratios
- Current Ratio
- Quick Ratio (Acid-Test Ratio)
Solvency Ratios:
- Debt to Equity Ratio,
-
Times interest earned
(Interest Coverage Ratio)
How to calculate net income from revenues? | → | EBITDA (8)
Return on Investment Metrics (3)
Ratios that divide some measure of performance (typically
income statement measures) by the average amount of
investment as reported in the balance sheet
Return on Equity (ROE)
ROE is the primary summary measure
of company performance
Return on Assets (ROA)
EWI measures the income generated by the firm
before taking into account any of its financing costs.
Components of ROA (Dupont Analysis)
- Definition (2)
- Formular (2)
- Disaggregated into profit margin (PM) and asset turnover (AT)
- Captures both profitability and efficiency.
Gross Profit Margin (GPM)
Expense-to-Sales (ETS)
Measures the percentage of each sales dollar that goes to cover a specific expense item
Total selling and administrative expenxe (SG&S) ; COGS is not part of it
PP&E Turnover (PPET)
Provides insights into asset utilization and a company’s operating
efficiency given its productive technology
Inventory Turnover (INVT)
Measures the flow of goods out of inventory relative to the
balance that is held in inventory
Accounts Receivable Turnover (ART)
Measures how many times receivables have been collected
during the period
