Accounting Mechanics Using Financial Statements to Assess Performance

Return on Sales (ROS) 2 Net Income Sales Revenue ROS = = $39,700 $305,000 = 13.0%  A profitability measure  Cup-A-Jo generates 13 cents of bottom line profit for every dollar of sales revenue.

Return on Assets (ROA) 3 [Net income + Interest expense × (1 – Tax rate)] Total assets ROA = = $39,700 + [$6,300 × (62.3%)] $472,450 = 9.2%  Another profitability measure  Cup-A-Jo has earnings of 9.2% available for its business capital providers. *Effective Tax rate = $24,000/$63,700 = 37.7%

Return on Equity (ROE) 4 Net income Shareholders’ equity ROE == $39,700 $371,700 = 10.7%  Another profitability measure  Cup-A-Jo is expected to generate about 10.7 cents of profit for every dollar of shareholders’ investment in the company.

Asset Turnover 5 Sales revenue Total assets Asset Turnover = $305,000 $472,450 =  Asset utilization measure (productivity)  For every dollar invested in the company’s assets. Cup-A-Jo generated 64.6 cents of sales. =

Financial Leverage 6 Total assets Shareholders’ equity Financial Leverage = $472,450 $371,700 = 1.27  Measures mix of debt versus equity financing  Cup-A-Jo’s assets are about 1.27 times the amount of shareholders’ equity invested =

Return on Equity Paradigm Four ways to improve ROE 1.Improve return on sales 2.Improve asset turnover 3.Improve use of financial leverage 4.Some combination of 1, 2, and 3 7 Return on Shareholders’ Equity Return on SalesAsset Turnover Financial Leverage

Return on Equity Breakdown 8 Total assets Shareholders’ equity × $472,450 $371, = ROE = Return on Sales × Assets Turnover × Financial Leverage Sales revenue Total assets $305,000 $472, Net income Sales revenue = $39,700 $305,000 = 13.0% ×× × × × = 10.7% Also called DuPont Analysis

Summary Profitability measures – ROS – ROA – ROE Productivity measure – Asset turnover Leverage measure – Financial leverage DuPont Analysis