5 agibson 13e ch08 (topic 5) profitability
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Financial Statement
Analysis
C%ARL&' %. ()*'+
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Chapter
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ro"itability
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• /he pri#ary "inancial analysis o" pro"it ratios
should include only those ite#s o" inco#e
arising "ro# nor#al operations
• &!cludes – iscontinued operations
– &!traordinary ite#s
ro"itability Measures
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• Also re"erred to as return on sales
• Re"lects net inco#e dollars generated by each
dollar o" sales
• otential distortion can be caused by other
inco#e and other e!pense ite#s "ro# net
inco#e, as these do not relate to net sales
et ro"it Margin
et )nco#e *e"ore oncontrolling )nterest,
&uity )nco#e, and onrecurring )te#set ro"it Margin 4
et 'ales
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• Measures the activity o" the assets and the
ability o" the "ir# to generate sales through the
use o" the assets
• otential distortion – )nvest#ents
– Construction in progress
– +ther assets that do not relate to net sales
/otal Asset /urnover
et 'ales/otal Asset /urnover 4
Average /otal Assets
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the ability to utili5e assets to create
pro"its
• Average total assets – 6or internal analysis use #onth$end a#ounts
– 6or e!ternal analysis use beginning and ending
a#ounts
– )" necessary, consistent use o" end$o"$year a#ounts,
instead o" averages
Return on Assets
et )nco#e *e"ore oncontrolling
)nterest and onrecurring )te#sReturn on Assets 4
Average /otal Assets
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• uont analysis separates return on assets into
net pro"it #argin and total asset turnover
• 'eparating the ratio into the to ele#ents allos
"or i#proved analysis o" the causes "or thechange in the percentage o" return on assets
uont Return on Assets
Return on Assets 4 et ro"it Margin /otal Asset /urnover ×
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uont Return on Assets7Continued
et )nco#e *e"ore et )nco#e *e"ore
oncontrolling )nterest oncontrolling )nterest
and onrecurring )te#s and onrecurring )te#s et 'ales4 8
Average /otal Assets et sales Average /otal Assets
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Consider only operating assets and inco#e – +perating assets e!clude
• Construction in progress
•
Long$ter# invest#ents• )ntangibles
• 9+ther: assets
– +perating inco#e includes only• et sales less the cost o" sales
• +perating e!penses
• May give signi"icantly di""erent results
• Re"lective o" R+A "ro# pri#ary business
uont Analysis ;ariation
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• )ncludes only operating inco#e in the nu#erator
+perating )nco#e Margin
+perating )nco#e+perating )nco#e Margin 4et 'ales
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the ability o" operating assets to
generate sales dollars
+perating Asset /urnover
,et 'ales+perating Asset /urnover 4
Average +perating Assets
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the ability o" operating assets to
generate operating inco#e
Return on +perating Assets
• uont analysis o" the return on operating
assets<
Return on +perating assets 4+perating )nco#e
Average +perating Assets
uont Return +perating +perating+n 4 )nco#e 8 Asset
+perating Assets Margin /urnover
÷ ÷ ÷ ÷ ÷ ÷ ÷ ÷ ÷
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the ability to #a=e productive use o"
property, plant, and euip#ent by generating
sales dollars
– &!clude construction in progress "ro# net "i!ed assets• ossible distortions
– +ld "i!ed assets
– Labor$intensive industry
'ales to 6i!ed Assets
et 'ales'ales to 6i!ed Assets 4
Average et 6i!ed Assets
>&!clude Construction in rogress?
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures inco#e earned on invested capital
and ho ell the "ir# utili5es its asset base
• &valuates enterprise per"or#ance ithout regard
to "inancing sources
Return on )nvest#ent >R+)?
et )nco#e *e"ore oncontrolling
)nterest and onrecurring )te#s @>)nterest &!pense? 8 >1 /a! Rate?B
Return on )nvest#ent 4 Average >Long$/er# Liabilities @ &uity?
−
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the return to co##on and pre"erred
stoc=holders
Return on /otal &uity
• Adust#ents "or redee#able pre"erred stoc= – educt dividends "ro# net inco#e >nu#erator?
– educt stoc= value "ro# total euity >deno#inator?
et )nco#e *e"ore onrecurring )te#s
ividends on Redee#able re"erred 'toc=Return on &uity 4 Average /otal &uity
−
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Measures the return to the co##on stoc=holder
Return on Co##on &uity
Co##on euity 4 /otal 'toc=holders: &uity
D re"erred Capital D
oncontrolling )nterest
et inco#e *e"ore onrecurring
)te#s re"erred ividendsReturn on Co##on &uity 4
Average Co##on &uity
−
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• )ncludes the return to all suppliers o" "unds, both
long$ and short$ter#, by both creditors and
investors
Return on /otal Asset ;ariation
• i""ers "ro# the return on assets ratio and return
on invest#ent• )t does not lend itsel" to uont Analysis
et )nco#e @ )nterest &!penseReturn on /otal Asset ;ariation 4
Average /otal Assets
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Rate of return on
Measuresreturn to
providers of Typical result
Assets All "unds Loest >includes all assets?)nvest#ent Long$ter# "unds %igher than R+A >relative s#all
a#ount o" short$ter# "unds?
/otal euity &uity %igher than R+) >#easures returnonly to shareholders?
/he Relationship *eteen ro"itabilityRatios
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/he Relationship *eteen ro"itabilityRatios7Continued
Rate of return on
Measuresreturn to
providers of Typical result
Co##oneuity Co##on euity %ighest• Co##on shareholders absorbgreatest degree o" ris=
• Reuires that return to pre"erredshareholders e!ceed "unds paid topre"erred shareholders
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Co#paring gross pro"it ith net sales is ter#ed
the gross pro"it #argin
(ross ro"it Margin
et 'ales Revenue
D Cost o" (oods 'old
4 (ross ro"it
*eginning )nventory
@ urchases o" )nventory
− &nding )nventory
(ross ro"it(ross ro"it Margin 4
et 'ales
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• Analysis helps the "olloing ays< – Managers budget gross pro"it levels into their
predictions o" pro"itability
–
Esed in cost control – &sti#ate inventory levels "or interi# "inancial
state#ents and insured losses in #erchandising
industries
–
Esed by auditor and )nternal Revenue 'ervice to udge accuracy o" accounting syste#s
(ross ro"it Margin Analysis
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• +perating seg#ents – 'eparate "inancial in"or#ation is available
– &valuated by the chie" operating decision #a=er
–Reuires in"or#ation about
• Countries in hich the "ir# earns revenues and holds assets
• Maor custo#ers
'eg#ent Reporting
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• isclosures – /he ay the operating seg#ents are deter#ined
– roducts and services by the operating seg#ents
–i""erences beteen the #easure#ents used inreporting seg#ent and "ir#:s general$purpose
"inancial in"or#ation
• ro"itability trends can also be shon as
revenues by #aor product lines
'eg#ent Reporting7Continued
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• Charged directly to retained earnings – Changes in accounting principles
– Reali5ation o" inco#e ta! bene"its o" preacuisition
operating loss carry"orards o" purchasedsubsidiaries
– Changes in accounting entity
– Correction o" errors in prior periods
(ains and Losses "ro# rior eriod
Adust#ents
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• )te#s not included in net inco#e
• Reported as a separate co#ponent o"
shareholders: euity
– 6oreign currency translation adust#ents – Enreali5ed holding gains and losses "ro# available$
"or$sale #ar=etable securities
– Changes to stoc=holders: euity resulting "ro#
additional #ini#u# pension liability adust#ents – Enreali5ed gains and losses "ro# derivative
instru#ents
Co#prehensive )nco#e
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• /raditional pro"itability analysis includes ite#s
related to net inco#e – )te#s o" accu#ulated other co#prehensive inco#e
are e!cluded "ro# analysis• Consider supple#ental analysis including other
co#prehensive inco#e ite#s "or – Return on assets
– Return on invest#ent
– Return on total euity
– Return on co##on euity
Co#prehensive )nco#e7Continued
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product or service or otherise on a passord$protected ebsite "or classroo# use.
• )t is a hypothetical or proected a#ount
• Release ti#ed to coincide ith release o" (AA
"inancial results
• 'arbanes$+!ley Act o" 2002 reuires – Reconciling o" pro "or#a data to (AA "inancial
condition and results o" operations
ro$6or#a 6inancial )n"or#ation
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• Enaudited "inancial reports covering "iscal
periods o" less than one year – '&C reuires li#ited "inancial data be provided on
6or# 10$F – Certain uarterly in"or#ation is disclosed in notes to
the annual report
– )nteri# reports are an integral part o" the annual
report• Less reliable than annual reports as contain
#ore esti#ates
)nteri# Reports