2: Financial Statement and Cash Flow Analysis
the company’s ROE will exceed its ROA. Conversely, if the company’s earnings fall short of the amount
it must pay to lenders and preferred shareholders, the ROE will be less than ROA. For GPC, the return
on ordinary equity for 2016 was 22.1%, substantially above GPC’s return on total assets:
=
===
Returnoncommonequity
Earningsavailableforordinary shareholders
Ordinary shares
$946
$4,278
0.221 22.1%
DuPont System of Analysis
Financial analysts sometimes conduct a deeper analysis of the ROA and ROE ratios using the DuPont
system. This approach uses both income statement and balance sheet information to break the ROA and
ROE ratios into component pieces, or ‘drivers’ of their values. It highlights the influence of both the net
profit margin and the total asset turnover on a company’s profitability. In the DuPont system, the return
on total assets equals the product of the net profit margin and total asset turnover:
ROA = Net profit margin × Total assets turnover
By definition, the net profit margin equals earnings available for ordinary shareholders divided by
sales, and total asset turnover equals sales divided by total assets. When we multiply these two ratios
together, the sales figure cancels, resulting in the familiar ROA measure:
=×
=×=×==
ROA
Earningsavailableforordinary shareholders
Sales
Sales
Totalassets
$946
$12,843
$12,843
$9,589
0.074 1. 340.099 9.9%
ROA====
Earningsavailableforordinary shareholders
Totalassets
$946
$9,589
0.099 9.9%
DuPont system
An analysis that uses both
income statement and balance
sheet information to break
the ROA and ROE ratios into
component pieces
John Graham, Duke
University
‘We asked companies,
“Do you manage your
earnings?”’
See the entire interview on
the CourseMate website.
Source: Cengage Learning
COurSEMATE
SMArT VIDEO
ANALYSING YOUR PERSONAL FINANCIAL STATEMENTS
Imagine that in early 2017, you prepare an
abbreviated personal balance sheet and income
statement for the year just ended, 30 June 2016.
You also prepare a list of ‘Notes’ and then analyse
the statements using some popular personal
finance ratios, which are shown below. A review of
the statements and ratios should disclose great
similarity between personal and corporate financial
statements and ratios.
BALANCE SHEET AT, 30 JUNE 2016
Assets Liabilities and Equity
Total liquid assets $ 2,225 Total current liabilities $ 905
Total investments $ 5,750 Total long-term liabilities $104,850
Total real and pers. prop. $139,200 (2) Total liabilities $105,755
(1) Total assets $147,175 Net worth [(1)–(2)] $ 41,420
Total liab. and net worth $147,175
finance in practice