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Ratio Analysis Profitability and Turnover Ratios

This document discusses various profitability and turnover ratios used in ratio analysis. It introduces the DuPont ratio analysis framework that breaks return on equity into return on assets, asset turnover, and financial leverage. It then discusses various profit margin, asset turnover, and days outstanding ratios that can be analyzed to evaluate different aspects of a company's profitability, efficiency, and cash flow management. The ratios decompose financial statements to gain deeper insights into business performance.

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Vaibhav Khokhar
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101 views6 pages

Ratio Analysis Profitability and Turnover Ratios

This document discusses various profitability and turnover ratios used in ratio analysis. It introduces the DuPont ratio analysis framework that breaks return on equity into return on assets, asset turnover, and financial leverage. It then discusses various profit margin, asset turnover, and days outstanding ratios that can be analyzed to evaluate different aspects of a company's profitability, efficiency, and cash flow management. The ratios decompose financial statements to gain deeper insights into business performance.

Uploaded by

Vaibhav Khokhar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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RATIO ANALYSIS: PROFITABILITY AND

TURNOVER RATIOS
Professor Brian Bushee

WHARTON ONLINE
DuPont Ratio Analysis Framework

Return on Equity (ROE)

Return on Assets (ROA) X Financial Leverage

Return on Sales (ROS) X Asset Turnover

Gross Margin Accts Rec Turnover


Expense Ratios Inventory Turnover
Accts Pay Turnover

ROE = Net Income/Sales x Sales/Assets x Assets/Equity


= Profitability x Efficiency x Leverage

WHARTON ONLINE
Profit Margin Ratios

• What are the drivers of profitability?


– Decompose Return on Sales by income statement line item
• Gross Margin = (Sales - Cost of Goods Sold) / Sales
• SG&A-to-Sales = SG&A Expense / Sales
• Operating Margin = Operating Income / Sales
• Interest Expense-to-Sales = Interest Expense / Sales
• Effective Tax Rate = Income Taxes / Pre-tax Income

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Asset Turnover Ratios

• How many times per year do we cycle through accounts?


– Example: Inventory Turnover of 8 means that we build and sell Inventory 8 times
per year, on average.
• Accounts Receivable Turnover = Sales / Average A/R
• Inventory Turnover = Cost of Goods Sold / Average Inventory
• Accounts Payable Turnover = Purchases / Average Accounts Payable
– (Purchases = Ending Inventory + COGS – Beginning Inventory)
• Fixed Asset Turnover = Sales / Avg. Net PP&E

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Days Outstanding Ratios

• How many days, on average, are accounts outstanding?


– Example: Days Inventory of 45 means that it takes 45 days, on average, from the
time we start building Inventory until we sell it
• Days Receivable (Sales) Outstanding = 365 * (Average A/R / Sales)
• Days Inventory = 365 * (Average Inventory / Cost of Goods Sold)
• Days Payable = 365 * (Average Accounts Payable / Purchases)
• Net Trade Cycle = Days Receivable + Days Inventory - Days Payable
– Net Trade Cycle represents the gap between cash outflows and cash inflows that
we have to bridge with short-term borrowing
Raw Materials Sales Cash In
Days Inventory 50 days Days Receivable 30 days
Days Payable 35 days Net Trade Cycle 45 days
Accts. Payable Cash Out

WHARTON ONLINE
WHARTON ONLINE

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