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Lecture Financial statement analysis (11/e): Chapter 8 - K. R. Subramanyam

Chapter 8 - Return on invested capital and profitability analysis. This chapter focuses on return with an emphasis on profitability. We emphasize return on invested capital and explain variations in its measurement. Special attention is directed at return on net operating assets and return on common shareholders’ equity. We explore disaggregations of both these return measures and describe their relevance to our analysis. Financial leverage is explained and analyzed using the return measures in this chapter. | Financial Statement Analysis K.R. Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8 CHAPTER Return on Invested Capital and Profitability Analysis Return on Invested Capital • Joint analysis is where one measure is assessed relative to another • Return on invested capital (ROIC) or Return on Investment (ROI) is an important joint analysis Importance of Joint Analysis Return on Invested Capital ROI Relation ROI relates income, or other performance measure, to a company’s level and source of financing ROI allows comparisons with alternative investment opportunities Riskier investments expected to yield a higher ROI ROI impacts a company’s ability to succeed, attract financing, repay creditors,and reward owners Return on Invested Capital Application of ROI (2) measuring profitability (3) Measure for planning and control (1) measuring managerial effectiveness (2) measuring Profitability (3) measure for planning and control ROI is applicable to: Return on Invested Capital Measuring Managerial Effectiveness • Management is responsible for all company activities • ROI is a measure of managerial effectiveness in business activities • ROI depends on the skill, resourcefulness, ingenuity, and motivation of management Return on Invested Capital Measuring Profitability • ROI is an indicator of company profitability • ROI relates key summary measures: profits with financing • ROI conveys return on invested capital from different financing perspectives Return on Invested Capital Measuring for Planning and Control ROI assists managers with: • Planning • Budgeting • Coordinating activities • Evaluating opportunities • Control Components of ROI Return on invested capital is defined as: Income Invested Capital Components of ROI Invested Capital Defined • No universal measure of invested capital • Different measures of invested . | Financial Statement Analysis K.R. Subramanyam Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 8 CHAPTER Return on Invested Capital and Profitability Analysis Return on Invested Capital • Joint analysis is where one measure is assessed relative to another • Return on invested capital (ROIC) or Return on Investment (ROI) is an important joint analysis Importance of Joint Analysis Return on Invested Capital ROI Relation ROI relates income, or other performance measure, to a company’s level and source of financing ROI allows comparisons with alternative investment opportunities Riskier investments expected to yield a higher ROI ROI impacts a company’s ability to succeed, attract financing, repay creditors,and reward owners Return on Invested Capital Application of ROI (2) measuring profitability (3) Measure for planning and control (1) measuring managerial effectiveness