A Better Way to Gauge Profitability
Return-on-equity (ROE) is the correct profit metric to evaluate the performance of a business. However, the primary emphasis on financial ratio analysis must be on operating performance. The "advanced" version of the DuPont model remedies the original model's failure to cleanly separa...
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| Veröffentlicht in: | Journal of Accountancy 2008-08, Vol.206 (2), p.38 |
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| creator | Burns, David C Sale, J Timothy Stephan, Jens A |
| description | Return-on-equity (ROE) is the correct profit metric to evaluate the performance of a business. However, the primary emphasis on financial ratio analysis must be on operating performance. The "advanced" version of the DuPont model remedies the original model's failure to cleanly separate the effects of operating and financing decisions. It introduces the concept of return on net operating assets (RNOA) as the core measure of operating performance and clearly separates the effects of leverage and operating decisions. The advanced model does not change the result of the ROE calculation. However, the elements underlying the ROE ratio are different and provide a clean separation of operating and financing decisions. RNOA is effectively insulated from financing decisions. Changing the amount of debt does not affect the operating assets or the profit before interest expense and, therefore, does not affect RNOA. It also permits straightforward computation of the impact on ROE of alternative financing decisions. Changes in the interest rate affect the spread, while changes in the amount of debt affect financial leverage in a transparent manner. |
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However, the primary emphasis on financial ratio analysis must be on operating performance. The "advanced" version of the DuPont model remedies the original model's failure to cleanly separate the effects of operating and financing decisions. It introduces the concept of return on net operating assets (RNOA) as the core measure of operating performance and clearly separates the effects of leverage and operating decisions. The advanced model does not change the result of the ROE calculation. However, the elements underlying the ROE ratio are different and provide a clean separation of operating and financing decisions. RNOA is effectively insulated from financing decisions. Changing the amount of debt does not affect the operating assets or the profit before interest expense and, therefore, does not affect RNOA. It also permits straightforward computation of the impact on ROE of alternative financing decisions. 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| ispartof | Journal of Accountancy, 2008-08, Vol.206 (2), p.38 |
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| source | EBSCOhost Business Source Complete; EZB-FREE-00999 freely available EZB journals |
| subjects | Auditing procedures Balance sheets Capital structure Cost control Equity Financial analysis Financial leverage Financial ratios Financial statements Interest rates Inventory Net income Profitability Profits Public accountants Ratios Retailing industry Return on assets Return on equity |
| title | A Better Way to Gauge Profitability |
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