Lanager efforts to reduce assets often initially

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_lanager efforts to reduce assets often initially focus on working capital (current assets and liabilities). Receiv- - can be reduced by better credit-granting policies and better monitoring of outstanding receivables. Inventories be reduced through just-in-time delivery of raw materials, elimination of bottlenecks in production to reduce -in-process inventories, and producing to order rather than to estimated demand to reduce finished goods in- ies. Companies can also delay payment of accounts payable to generate needed cash. Payables management re art than science, and reductions must be managed with care so as not to threaten valuable supply channels. _tanager efforts to reduce long-term assets are more difficult. Recent years have witnessed an increase in use rporate alliances, joint ventures, and activities that seek joint ownership of assets such as manufacturing, dis- ion, service facilities, and information technology (IT). Another strategy is to outsource production to reduce ufacturing assets. Outsourcing is effective provided the benefits from eliminating manufacturing assets more offset the increased costs of purchasing goods from outsourced producers. nancial Leverage third term in the DuPont model is financial leverage, the relative proportion of debt versus equity in the com- _-- capital structure. Financial leverage in the DuPont model is measured by the ratio of average total assets to ge stockholders' equity. An increase in this ratio implies an increase in the relative use of debt. This is evident the accounting equation: assets = liabilities + equity. For example, assume that assets are financed equally debt and equity. The accounting equation, expressed in percentage terms, follows: 100% = 50% + 50%, and financial leverage of the company is 2.0 (100%/50%). If we increase the proportion of debt to 75% (decrease proportion of equity to 25%), the financial leverage increases to 4.0 (100%/25%). The measure of financial .erage is important because debt is a contractual obligation (dividends are not), and a company's failure to make ired debt payments can result in legal repercussions and even bankruptcy. As financial leverage increases, so the required debt payments, along with the probability that the company is unable to meet its debt obligations a business downturn. OA Adjustment in the Basic DuPont Model basic DuPont model is not entirely accurate, and adjusting the return on assets for the effect of interest ad- ses the inaccuracy. Return on assets typically focuses on the operating side of the business (profit margin and asset turnover). '=':rrther,ROA is typically under the control of operating managers while the capital structure decision (the rela- - .e proportion of debt and equity) is not. Accordingly, an adjustment is often made to the numerator of ROA, and
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RatioComponent Definition Computation 3-29 Module 3 I Profitability Analysis and Interpretation sometimes to the denominator. The numerator adjustment adds back the after-tax net interest expense (net of any other nonoperating revenues or expenses) and is computed as follows: ROA = Net income + [Interest expense (1 - Statutory tax rate) 1 Average total assets
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