b2 - du pont and other ratios
TRANSCRIPT
© Institu
to I
nte
rnacio
nal
San T
elm
o,
2012
DU PONT AND OTHER RATIOS
PROFITABILITY RATIOS
Profit and Loss account ratios
How can we compare net profit?
– We can compare it with Sales: Return on Sales (ROS)
– We can compare it with Assets: Return on Assets (ROA)
– We can compare it with Equity: Return on Equity (ROE)
Return on Sales is the ratio between Profit and Sales or, in otherwords, the percentage of each sale finally obtained as profit.
PROFITABILITY RATIOS - ROS
• ROS can be considered as a good approximation of average return.
• ROS shows us how far/close we are to losing money, i.e. if small deviations in income or expenses can take the company to a net loss position.
Why is it useful?
• The most common formula is to use Net profit over sales
• ROS = Net profit / Sales
• Another option would be to use Profit Before Interest and Taxes if we want to focus on the business without taking into consideration the cost of debt and taxes.
How do we calculate it?
• There are no fixed rules. It will depend on the risk of the business; the higher the risk, the higher the targeted ROS.
What should our targeted ROS be?
It is very common to compare the company’s ROSwith that of its competitors or benchmark.
P&L account:
Sales-COGSMargin- Operating ExpensesEBITDAAmortizationEBITInterestEBTTaxesNet Profit
Total Assets
Equity
Assets Liabilities
Ret
urn
on
Sal
esR
OS
= B
N /
Ven
tas
PROFITABILITY RATIOS - ROS
This is the Return that the company obtains for each Euro invested in Assets. It provides a good picture of the relationshipbetween how much shareholders have invested in the company and how much those investments give back to investors.From this standpoint, it is a critical ratio for shareholders and banks, which help investors to fund assets.
PROFITABILITY RATIOS - ROA
• It reflects the return of the business considered as an investment. It does not take into consideration howthe investments have been financed. It is the best financial ratio for determining the quality of thebusiness.
Why is it useful?
• It can be calculated in different ways. The easiest way: Net Profit divided by Total Assets.
•ROA = Net Income / Total Assets
•To isolate the investment from financing costs, use instead Net Income (or Net Earnings or Net Profit), Earnings before Interest and Tax (EBIT):
•ROA = EBIT / Net Assets.
•We can also use Net Assets at the beginning of the year, at the end of the year or the average for the year.
How do we calculate it?
• Again there is no hard and fast rule in this respect. Targeted ROA can be compared with alternative investments, such as sovereign debt, etc.
What is our targeted ROA?
Other names: ROI: Return on investment.ROCE: Return on capital employed.ROIC: Return on invested capital.
It will depend on the business itself, but in any case ROA must be higher that the cost of the resources that we use to finance our investments.
P&L account:
Sales-COGSMargin- Operating ExpensesEBITDAAmortizationEBITInterestEBTTaxesNet Profit
Total Assets
Equity
Assets Liabilities
Return on Assets
ROA = NP / Assets
PROFITABILITY RATIOS - ROA
PROFITABILITY RATIOS - ROE
Return on Equity tells us about the return obtained by shareholders on each Euroinvested in the company. The ratio considers not only shareholders’ disbursementsbut also the retained earnings reinvested in the company.
• Since ROA tells us about the return on investments without considering how the investments have been financed, ROE shows us how much shareholders make on the investments made in the company.
Why is it useful?
• Few options
• ROE = Net Profit / Equity
• Again, we can use Equity at the beginning of the year (very reasonable), at the end of the year or the average of both figures.
How do we calculate it?
• This is a shareholder decision. A great deal of information is available in finance literature on the so-called cost of equity. It is generally accepted that the higher the risk of the company, the higher the targeted return on equity.
What is our targeted ROE?
P&L account:
Sales-COGSMargin- Operating ExpensesEBITDAAmortizationEBITInterestEBTTaxesNet Profit
Total Assets
Equity
Assets Liabilities
Return on Equity
ROE = NP / Equity
PROFITABILITY RATIOS - ROE
P&L account:
Sales-COGSMargin- Operating ExpensesEBITDAAmortizationEBITInterestEBTTaxesNet Profit
Total Assets
Equity
Assets Liabilities
Ret
urn
on
Sal
esR
OS
= B
N /
Ven
tas
Return on Assets
ROA = NP / Assets
Return on Equity
ROE = NP / Equity
PROFITABILITY RATIOS – ROS, ROA, ROE
DUPONT MODEL
Equity
Assetsx
Assets
Salesx
Sales
NetprofitROE
Margin Rotation Leverage
© Institu
to I
nte
rnacio
nal
San T
elm
o,
2012