Topic 7: Profitability analysis Ana M Arias Alvarez University of - - PowerPoint PPT Presentation

Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Topic 7: Profitability analysis

Ana Mª Arias Alvarez University of Oviedo Department of Accounting amarias@uniovi.es

School of Business Administration Course: Financial Statement Analysis and Management Control Bachelor’s Degree in Economics

Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

7.1. Analysis of the Income Statement. 7.2. Profitability ratios. 7.3. Financial leverage (gearing).

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

7.1: ANALYSIS OF THE INCOME STATEMENT.

1 201X sales from Revenue 201X sales from Revenue 

Sales growth

sales from revenue s Industry' sales from revenue s Company'

Market share

sales from revenues Total products new

• f

sales from Revenues

Innovation

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

7.2: PROFITABILITY RATIOS.

Companies exist with the primary purpose of creating wealth for their

• wners. Profitability ratios provide information about the degree of success in

achieving this purpose. They express the profit made in relation to other figures in the financial statements or to some business resource:

Resources Profit ity Profitabil 

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Return on assets (ROA)

It measures how efficient management is at using its assets to generate earnings. It is also referred to as ROI (Return on Investment).

assets Average tax and interest before Profit tax) (before ROA 

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Breaking down “Return on Assets”

• Net profit margin measures the percentage of each euro of

sales that results in net profit.

• Asset turnover measures how efficiently a company uses its

assets to generate sales.

turnover x Asset margin profit Net assets Average revenue Sales x revenue Sales tax and interest before Profit assets Average tax and interest before Profit ROA     

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Residual Income

Residual income is net profit less a deduction for shareholders’ opportunity cost in generating net profit. It is the remaining profit after considering the costs of all of a company’s capital.

Net Profit – (Equity x Required return or cost of capital)

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Task: try to solve problem 7.1.

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

RETURN ON EQUITY (ROE)

Equity Average profit Net ROE 

ROE represents the amount of profit that is attributable to the

• wners.

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

7.3: FINANCIAL LEVERAGE (GEARING).

Borrowing can be used to increase the returns to owners (if the returns from borrowed funds > the cost of paying interest):

equity Average s liabilitie Average x rate) interest

• (ROA'

ROA' ROE  

Financial leverage (gearing)

Taxation rate

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Ana Mª Arias Alvarez (University of Oviedo) Profitability analysis OpenCourseWare

Task: try to solve problem 7.2.

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