Chapter 4 Flashcards
Define ROE
Relates net income to average total stockholders’ equity from the BS
Net income / Average stockholders’ equity
What are the 2 methods for ROE disaggreation
- The traditional DuPont analysis - disaggregates return equity in components of profitability, productivity, and leverage
- Extends Duppont analysis by tanking an ROE analysis with an operating focus that separates operating and nonoperating activities. Operating activities are the drivers of shareholder value.
ROE = Net income / Average stockholders’ equity
=
(ROA) Net income / average total assets x
(FL)Average total assets / Average stockholders’ equity
FL = Financial Leverage
What are Return on Assets
ROA measures return fromt eh perspective of the entire company. Includes both profitabliity (numberator) and total company assets (denominator)
What is Financial Leverage
FL, the second component of ROE, measures the degree to which the company finances its assets with debt versus equity
In DuPont analysis, FL = Avg Total Assets / Avg stockholers’ equity
Disaggregation of ROA
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The two drivers of ROA
- Profit Margin (PM)
- Asset Turnover (AT)

Analysis of Profitability and Productivity
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Review the Disaggregation of ROE and its margins
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What is Profit Margin
Net Income / Sales
What is Operating Expense Margin
SG&A
SG&A expanse / Sales
Analysis of Working Capital Components (Turnover Ratios)
- Accounts receivable turnover = Sales / Average accounts receivable
- Inventory turnover = Cogs / Average inventories
- Accounts payable turnover = Gogs / Average accounts payable
Define the “Days” measures for working captial accounts
Days sales outstanding (DSO) 365 / Accounts rec. turnover
+ Days invenetory outstanding (DIO) 365 / Inventory turnover
- Days payables outstanding (DPO) 365 / Accts payable turnover
= Cash Conversion Cycle (CCC) DSO + DIO - DPO
What does the CCC measure
The average time (in days) to sell inventories, collect the receivables from the sale, pay the payables incurred for the inventory purchase, and return to cash
Lower is better
Define ROE
Return on Equity
ROE = Operating return + Nonoperating return
Define RNOA
Return on Net Operating Assets
RNOA = Net operating profit after taxes (NOPAT)
Average net operating assets (NOA)
NOPAT / NOA
Define Net Operating Assets
Net operating assets = Operating assets - Operating liabilities
To do this, you must partition the BS into Opetating Assets and Operating Liabilities
Operating Assets Operating Liabilities
Accounts receivable Accounts payable
Inventories Accrued expenses
Prepaid expenses and supplies Unearned or deferred revenue
PPE Income taxes payable
Intangible assets and Goodwill Deferred income tax liabilities
Deferred income tax assets Pensino and other post-employ
Equitey method investments obligatinos
Define Net Nonoperating Obligations (NNO)
Assets and Liabilities that are not used as part fo the core business activities of the company
Nonoperating Liabilities Nonoperating Assets
Short and long term debt Cash adn cash equivalents
Lease obligations Marketable securities
Interest payable Discontinued assets
Dividends payable Derivative assets
Discontinued liabilities
Derivative liabilities
Operating Line Items on the Income Statement (IS)
- Revenues
- Cogs
- SG&A (including wages, advertising, occupancy, insurance, depreciation and amoritization, liquidating, and restructuring
- R&D - often part of SG&A
- Impairments of operating asets such as goodwill
- Income from strategic investments
- Gains and losses on disposals of operating assets such as PPE and strategic investments
- “Other” op ex or income
Nonoperating Line Items on the Income Statement
- interest expenses on debt and lease obligations
- Loss or income relating to discontinued operations
- Debt issuance and retirement costs
- Interest and dividend income on nonstrategic investments
- Gains or losses on the sale of nonstrategic investments
- “Other” income or expense if reported separately from operating income
Define Tax on operating profit
= Tax expense + (Pretax net nonoperating expense x Statutory tax rate)
(Pretax net nonoperating expense x Statutory tax rate) = “Tax Shield”
Define Net Nonoperating Expense (NNE)
NOPAT = Net income + NNE
Define Net Operating Profit Margin
Reveals how much operating profit the company earns from each sales dollar. It’s affected by:
- Gross profit (revenues - cogs)
- Other operating expenses and all overhead costs that the cmopany incurs to support its operating activities
NOPS =
Net operating profit after tax / Sales
Define Net Operating Asset Turnover
Measures the productivity of the company’s net operating assets. Higher NOAT is preferrable
NOAT =
Sales / Average net operating assets