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    ROE and ROA Ratios For Accounting Summary

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    myzevel
    1) The document discusses key return on equity (ROE) and return on assets (ROA) ratios. 2) ROE can be calculated using the DuPont formula as net profit margin x total asset turnover x financial leverage. 3) There are three drivers of ROE: return on assets, leverage, and the spread between return on assets and the after-tax interest rate.

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    ROE and ROA Ratios For Accounting Summary

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    myzevel
    756 views3 pages
    1) The document discusses key return on equity (ROE) and return on assets (ROA) ratios. 2) ROE can be calculated using the DuPont formula as net profit margin x total asset turnover x financial leverage. 3) There are three drivers of ROE: return on assets, leverage, and the spread between return on assets and the after-tax interest rate.

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    ROE and ROA Ratios for Accounting Summary

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    1) The document discusses key return on equity (ROE) and return on assets (ROA) ratios. 2) ROE can be calculated using the DuPont formula as net profit margin x total asset turnover x financial leverage. 3) There are three drivers of ROE: return on assets, leverage, and the spread between return on assets and the after-tax interest rate.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    756 views3 pages

    ROE and ROA Ratios For Accounting Summary

    Uploaded by

    myzevel
    1) The document discusses key return on equity (ROE) and return on assets (ROA) ratios. 2) ROE can be calculated using the DuPont formula as net profit margin x total asset turnover x financial leverage. 3) There are three drivers of ROE: return on assets, leverage, and the spread between return on assets and the after-tax interest rate.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    RATIOS FOR ACCOUNTING – ROE SUMMARY

    Return on = Net
    Equity Income
    Average
    Stockholders’
    Equity

    DuPont Formula: ROE= ¿ = ¿ × Sales × Assets < -- > ROE = net profit margin ratio X total assets turnover X financial leverage
    Equity Sales Assets Equity

    [A=L+E A/E = (L+E)/E = L/E +1; if L=E  A/E = 2; if L=0  A/E = 1]

    Return = Expense(1-tax
    Net Income + Interest
    rate)
    on Average Total
    Assets
    Assets
    *Interest expense added back because it was the denominator is also due to investor and they received the interest
    ** Corporate tax rate

    From DuPont: ROE= ¿ =ROA ×


    Equity
    ¿ ×
    Assets
    ¿+∫ (1−t ) Equity
    =ROA +
    Debt
    Equity [
    × ROA−
    Debt )]
    ∫ ( 1−t ) = ROA+ [ LEVERAGE × SPREAD ]
    (
    Financial Leverage % = ROE – ROA (≠Financial Leverage of the DuPont formula).
    When positive borrow at one rate and invest at a higher rate of return (ROA).
    ROA needs to be greater than after tax interest expense.

    LEVERAGE: a measure of how much debt the firm has relative to equity;
    SPREAD: the difference between ROA and the after‐tax interest rate on the firm's debt

    Three drivers of ROE are:


    1. Return on Assets (ROA)
    2. Leverage (the amount of debt relative to equity)
    3. Spread (the excess of ROA over the after‐tax interest rate)
    RATIOS FOR ACCOUNTING – ROA SUMMARY
    ¿+∫ (1−t) ¿+∫ (1−t) Sales
    ROA= = × =Profit Margin × Asset Turnover
    Assets Sales Assets

    Profit Margin (PM): how profitable are the firm’s products. Net profit per dollar of sales

    Asset Turnover (ATO): is a measure of how efficiently the firm is using its assets to generate sales Net sales per dollar of assets

    Profit Margin can be thought of as the following term where all figures are % of sales (Common Size Income Statement Items):

    Gross Profit SG∧ AExpense Other Expense Tax Expense


    Profit Margin= − − −
    Sales Sales Sales Sales

    Asset turnover can be disaggregated into:

    ( net credit ) Sales


     Accounts Receivable Turnover: [Sales/AR]
    Avarage Accounts Receivable

    Cost of Googs Sold


     Inventory Turnover: [CoGS/INV]
    Avarage Inventory

    ( net credit ) Sales


     Fixed Asset Turnover: Assets ¿ [Sales/Fixed Assets]
    Avarage Net ¿

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