Lecture4 - Financial Ratio Analysis Lecture 4 Outline 1....

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Financial Ratio Analysis Lecture 4
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Outline 1. Profitability Analysis Using financial ratios Cross-sectional vs. time-series 2. Profitability Ratios Return on Assets (ROA) Decomposing into Profit Margin (PM) and Asset Turnover (ATO) Return on Net Operating Assets (RONA) Return on Equity (ROE) Decomposing ROE Applications to SBUX 3. Cross Section and Time Series Analysis 4. Some Key Takeaways from Profitability Analysis
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Profitability Analysis Ratio analysis provides a framework for analyzing a company in an organized and systematic way. What are the main advantages of using ratios? Two basic types of ratio analysis: Cross-sectional approach – compare the firm to industry peers on a number of dimensions. Time series approach – use the historic performance of a firm as the benchmark.
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Basic Profitability Ratios Profitability ratios measure the return on invested capital. We will discuss two basic profitability ratios: Return on Assets Return on Equity The numerator of each ratio includes a measure of performance (income) for the relevant period and the denominator shows the capital base that generates this income . It is important to make sure that the numerator and the denominator agree.
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Return on Equity Basic Profitability Ratios (cont’d.) Return on Assets Profit Margin Asset Turnover Financing Activities (Debt Policy) Operating Activities Investing Activities Equity rs Shareholde Average Income Net ROE = Assets Total Average t Expense Interest NI ROA ) 1 ( + = Sales t IntExp NI ) 1 ( + = Sales Average Total Assets = Note: For tax rate use either effective (preferred) or statutory rate.
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Basic Profitability Ratios (cont’d.) We have two main claimholders for the firm – the debt holders and the equity holders: We have to match the correct resource with the correct income for each group. EBI - Earnings before interest (or NOPAT - Net Operating Profit after taxes) is the income generated by total assets while net income is the income generated by the shareholders’ equity. The difference is interest expense. Another way to think about it – earnings before interest is income for which both the equity and debt holders are entitled. Net income is the income for which the equity holders only are entitled. Why don’t we consider interest income as well? Tot al Assets Total liabilities The firm Debt holders Equity holders Shareholders’ equity EBI or NOPAT Interest expense Net income
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Return on Assets (ROA) What is a reasonable absolute benchmark for ROA? What is “normal” ROA (in large samples, averaged over time)? Assets Total Average EBI Assets Total Average t Expense Interest NI ROA ) 1 ( = + =
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Decomposing ROA into Profit Margin and Asset Turnovers Disaggregating ROA: Decomposing Profit Margin – simply divide each net income line item by sales: Sales: COGS: Selling & Admin: Depreciation & Amortization: Other Revenue: Income Taxes (add back tax on interest expense): EBI: Turnover Asset x Margin Profit ROA = Sales t) Int. Exp(1 NI + = tal Assets Average To Sales x
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This note was uploaded on 04/09/2010 for the course NBA 5090 taught by Professor Yehuda,nir during the Fall '10 term at Cornell University (Engineering School).

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Lecture4 - Financial Ratio Analysis Lecture 4 Outline 1....

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