Operating Profitability Flashcards
What are some key ratios for Profitability?
- Profit
- Profit margin
- Return on Assets
- Return on Capital Employed
- Return on Equity
Alternative for certain industries, for example:
- Profit per employee
How can we related stakeholders to the income statement?
- Operating income = customers
- External purchases = suppliers
- Personnel expenses = employees
- Interest expenses = Lenders
- Tax expenses = State
- Net profit = Owners
What is value added in the income statement?
Sales - Purchases
What is a typical depreciation for a manufacturing company (Atlas Copco)?
around 4-5% of sales
What is often a large item for telecommunications companies?
High depreciation/amortization/writedowns (impairment of goodwill)
What are characteristics of food retailers?
Low value added and low personnel expenses
What are characteristics of service companies?
Low purchases and high personnel expense
What is the net margin?
Net profit / Revenues
What is a margin?
A measure of how efficiently resources are used to make revenues (income statement)
Does not include investments/capital.Two firms can have the same profit margin but have differences in financing.
What is the formula for Return on Assets?
ROA = EBIE / Total Assets
What is the formula for Return on Capital Employed?
ROCE = EBIE / Capital employed
Why do we use EBIE as a profit measure in ROA and ROCE?
The returns should not be affected by how capital is financed
What are similarities between ROA and ROCE?
- They measure operating profitability
- The profit number is EBIE, unaffected by compensation to capital providers
- The capital measure in the denominator should be opening capital in this course
What is the formula for EBIE?
EBIE = Operating profit + Financial income
What are differences between ROA and ROCE?
The capital measure is different:
- ROA: capital measure includes all assets used in operations to generate profits
- ROCE: only assets that are financed by owners and lenders are included
What is the final formula for ROA in the DuPont analysis?
ROA = PM * TOA
What is the formula for the profit margin?
PM = EBIE / Sales
What is the formula for Turnover of Assets?
TOA = Sales / Total assets
What is the formula for Turnover of Capital Employed?
TOCE = Sales / Capital employed
What are on the axes of the DuPont graph?
Vertical: Profit margin
Horizontal: Asset turnover
What does the position in the DuPont analysis/graph indicate?
- industry
- strategy
- value creation
What does movements in the DuPont analysis/graph indicate?
- Changed efficiency (cost savings, capital efficiency)
- Change in strategy (new product mix, outsourcing, divestments)
- Change in business cycle (demand, prices, exchange rate)
- New competition situation (new entrants, deregulations)
- Accounting based reasons (goodwill, accounting changed, asset age)
What does business risk depend on?
Uncertainty on the earnings capacity. More movement in the dupont graph implies more business risk
If the firm has enough equity, they may live with it. If not, may do something about it, for example increase the proportion of variable costs).
Which firms tend to be on the left side of the DuPont graph?
Those in capital intensive industries (energy companies)
Which firms tend to be on the right side of the DuPont graph?
Retailers / organically growing service&consulting companies
What does the movements of a steel company typically look like in the DuPont graph?
Like a circle
How can a firm improve its profit margin?
- Growth = increase in sales (new markets, products, services, distribution channels, customer segments, market share increase, acquisition, change prices)
- Margin improvements (purchase from low cost suppliers, close unprofitable businesses, decrease number of products, outsource, everyday efficiency improvements)
How can a firm increase its turnover of capital (employed)?
- Non-current assets (internal efficient use, external cooperation with customers/suppliers, sharing with competitors)
- Working capital management (inventory, acc rec and acc pay)
What are changes in ROA/ROCE most often linked to?
Changes in profit margin (why it is in focus in media)
Which companies tend to be in the middle of the DuPont graph?
Manufacturing industrial companies
What is capital intensity?
The inverse of capital turnover:
Assets / Sales
How are interest-bearing liabilities incurred?
As a consequence of purely financial decisions and negotiations with lenders on the terms of the payment of interest, amortization, etc.
How do non-interest-bearing liabilities normally arise?
As a consequence of decisions in the ongoing activity of buying materials and services, employing personnel, etc, in combination with the traditional payment terms which apply to various types of resource acquisition.
How can a firm decrease business risk?
By shifting to more variable costs
