Financial Management: Asset Effectiveness & Efficiency & Working Capital Management Flashcards
Return on Investment ROI Formula
Income/ Investment Capital
Investment Capital (D+E)
OR
Investment Capital = Net Income/ Avg. Assets
Return on Total Assets Ratio
Net Income/ Average total assets
Debt-to Asset ratio
Total Debts/ Total assets
Debt to Equity Ratio
Total Debt/ Total Shareholder’s Equity
Definition of Net Working Capital
CA-CL
Current Ratio
Current Assets/ Current Liabilities
Quick Ratio
Cash + MS+ A/R / CL
APR of quick payment discount
(360/Pay Period- Discount Period) X (Discount/100-Discount %)
Cash Conversion Cycle
ICP+ RCP- PDP
Inventory Turnover
Cogs/Average Inventory
Inventory Conversion Period (ICP)
365/ Inventory Turnover
A/R Turnover
Sales/ Avg. A/R
Receivable Conversion Period (RCP)
365/ A/R Turnover
A/P Turnover
COGS/ Average A/P
AP Deferral Period
365/ AP Turnover
Reorder Point
Safety Stock + (Lead Time X Sales during lead time)
Economic Order Quantity
(2X Annual Sales Order X Order Cost )/ Carrying cost per unit
Return on Investment *2nd type of formula)
Profit Margin X Investment turnover
ROI
is ideal performance measure for investment in strategic business units
Return on Assets
Net Income/ Average Total Assets
Limitations of Return on Investment
- Residual Income may be superior
- inadvertently focus managers purelt on maximizing short-term returns
- Disincentive to Invest ( Takes time for asset to produce sales)
Return on Equity
Net Income/ Total Equity
ROE Goal
ROE> Cost of Equity (CAPM)
Net Profit Margin is a measure of operating efficiency
Net Income/ Sales
Asset Turnover is a measure of the degree of efficiency with which a company is using its assets
Sales/Avg. Total Assets
Financial Leverage amplifies both risk assumed and potential return
FL= Avg. Total Assets/ Equity
-Must be within risk appetite
Residual Income and Economic Value Added in dollars for investors
RI =Net Income (i/S) - Required Return $
Required return= Net Book Value X Hurdle Rate
Net Book Value of Equity = Assets - Liab.
Calculating DuPoint ROE
Net Profit Margin X Asset Turnover X Financial Leverage
NI/S X Sales/Avg Total Assets X Avg. TA/ Equity
Extended DuPoint Model
Net Profit Margin into 3 distinct components.
Net Income/Sales
a) Tax Burden: Net Income/ Pre-tax Income
b) Interest Burden: Pretax Income/ EBIT
c) Operating Income Margin= EBIT/Sales
Benefits of Residual Income Performance Measures
a) Realistic Target Rates In dollars
b) Focus on Target Return and Amount
Weakness of Residual Income Performance Measures
a) Reduces Comparability
b) Target Rates Require Judgement
Economic Value Added
EVA is WACC
The hurdle rate is WACC
EVA uses NOPAT
NOPAT
Profit before interest but after tax
EVA =
NOPAT- $WACC
Investment = D+E
NOPAT - Required Return
EBITX(1-T)
Residual Income
Looks at the return available to the stockholder
EVA
Looks at the return to all providers of capital
Positive EVA means
Performance is meeting standards.
Stock value is going to go up
Negative EVA means
Not meeting standards
Stock is going to go down.
Debt- to Asset Ratio Interpretation
Ratio indicates a long term debt paying ability. The lower the ratio, the better protection afforded to creditors
Debt-to- Equity Ratio Interpretation
the lower the ratio, the lower the risk involved
When it comes to carrying inventory
The lower the cost of inventory, the more companies are willing to carry.
Determination of Safety Stock depends on the following factors
1) Reliability of sales forecasts
2) Possibility of customer dissatisfaction resulting from back orders
3) Cost of running out of inventory
4) Lead time
5) Seasonal demands on inventory
What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers
ROI may lead to rejecting projects that yield positive cash flows
The basic objective of the residual income approach of performance measurement and evaluation is to have a division maximize its:
Income in excess of a desired minimum amount
The imputed interest rate used in the residual income approach for performance measurement and evaluation can best be characterized as the
Historical weighted average cost of capital for the company.
