FOUNDATION BUSINESS SIMULATION

Success Measures

Success Measures

Profits Market Share ROS Asset Turnover ROA ROE Stock Price Market Capitalization

Select 3 – 4 that you want to focus on

A financial ratio shows the relationship between two financial measures

Developed by dividing one measure into another Provide insights into company’s operations and

strategy Four categories: liquidity, solvency, market

value, profitability Used internally to evaluate performance and set

goals Used externally to make investment decisions

Introduction to Ratios• ROS• Asset Turnover• ROA• ROE

Ratio Information

ROS – Return on SalesNet profit divided by total sales for the same period.

ROA – Return on AssetsNet profit divided by the value of the total assets for the same period.

ROE – Return on EquityNet profit divided by the value of the owners’ equity for the same period.

LeverageTotal assets divided by owners’ equity.

TurnoverSales divided by the value of total assets for the same period.

- Information such as on the front page of FastTrack report

Ratios Report Sample from Spreadsheet Proformas

•Your spreadsheet program creates a Proforma Ratios Report based on your sales forecasts and tactical decisions.

Are your decisions maximizing the Success Measurements (ROE, ROS, ROA, Stock Price, Asset Turnover, Leverage. Market Capitalization) you chose?

Return on Assets

Return on Assets =Return on Assets =net profitnet profit

assetsassets

““ROA measures a company’s ability to use ROA measures a company’s ability to use all its assets to generate earnings.”all its assets to generate earnings.”

Return on Assets

What Does Return On Assets Tell You? Return on assets is an efficiency ratio. It

compares the profits generated with the asset base required. It answers the question, how hard are you working your assets?

There is an economic opportunity cost notion associated with this ratio. An operating manager may be challenged with how a dollar spent on assets might do compared with a dollar invested in some other area, or how the ROA compares with the interest a firm is paying on the money borrowed to pay for the asset.

Return on Assets

Typical Range: This ratio is volatile especially in early

rounds. A typical ROA in early rounds would fall

around 6% By later rounds, ROA averages around 15% An ROA between 20% – 30% must be

considered excellent

““ROS indicates the percentage of each sales ROS indicates the percentage of each sales dollar that results in net income.”dollar that results in net income.”

Return on Sales

Return on Sales =Return on Sales =net profitnet profit

net salesnet sales

Return On Sales

What Does Return On Sales Tell You? Since return on sales (ROS) gives the analyst

an idea of the profit margin on a product, this ratio can reveal a great deal about product positioning and pricing policies.

All companies, whether cost leaders or differentiators, strive to keep their margins as high as possible.

A cost leader attacks expenses, particularly the cost of goods, in he hope of maintaining margins while dropping price.

A differentiator creates demand, then raises prices to cover the increased cost while maintaining margins.

Return On Sales ROS is also a good indicator of demand and

supply within the industry. The more competitive an industry, the more pressure there is on price and subsequently ROS falls.

Typical Range: ROS in early rounds typically ranges from

2% to 8% Margins in later rounds have a potential to

increase because teams have cut expenses and right-sized their production.

ROS typically ranges from 5% to 15%

Asset Turnover

““Reveals how effective assets are at Reveals how effective assets are at generating sales revenue.”generating sales revenue.”

Asset Turnover =Asset Turnover =salessales

assetsassets

Asset Turnover

What Does Asset Turnover Tell You? Asset turnover tells an analyst more about

volume of sales than it does about profitability. Asset turnover (T/O) demonstrates how effective the asset base is in generating top line revenue.

To increase Asset Turnover, a company must either:

1. Increase sales without increasing assets – for example increase awareness and easy accessibility

2. Hold sales constant while reducing assets – eliminate idle plant or excess working capital

Asset Turnover

Typical Range: In the beginning rounds, Asset

Turnover usually ranges between 0.8 and 1.2

By later rounds it averages around 1.5 An Asset Turnover of 2.0 means you

are doing well

Leverage

Leverage =Leverage =assetsassets

equityequity

““Leverage shows the debt level of the Leverage shows the debt level of the organization.”organization.”

Leverage The amount of debt used to finance a firm's assets.

A firm with significantly more debt than equity is considered to be highly leveraged.

The degree to which an investor or business is utilizing borrowed money. In itself, Leverage is not Good or Bad

If you were absolutely certain you could borrow at 10% and make a 20% return, you would borrow all you could.

The higher your leverage the higher the risk that you will not be able to make your interest and principal payments

On the other hand, use of Equity dilutes ownership and increases the risk of take-over

Leverage

Typical Range: Leverage typically ranges between

1/5 and 3.0 Below 1.5 you have used retained

earnings to fund growth instead of giving it to stockholders as dividends, and either avoided debt or reduced it

Above 3.0 your interest payments use much of your earnings

Return on Equity

Return on Equity =Return on Equity =net profitnet profit

equityequity

““Return on Equity highlights for the Return on Equity highlights for the stockholders the return on their investment.”stockholders the return on their investment.”

Return on Equity

What Does Return On Equity Tell You? Return on equity tells you how

effectively a company is using the dollars invested in it by stockholders.

According to Forbe's Magazine, ROE is the most often quoted single statistic when describing a firm's performance. It is also one of the statistics considered to be most useful by stockholders.

Return on Equity

Typical Range: ROE is relatively easy to manipulate

– issue stock, retire stock ROE between 10% - 15% could be

considered Fair ROE between 15% - 25% - Good ROE between 25% - 50% - Excellent ROE > 50% “Worthy of Close

Inspection”

Du Pont Formula

The following diagram shows how ROI was calculated when that ratio was first created back in the early 1900s. 

As anyone can see, it is far more complex than many currently touted calculations. 

What it also illustrates is that, originally, ROI was a measure of return on the total investment in the entire business, not the ROI of a project or a product or a training course or any other isolated aspect of a business.

Du Pont Formula

DU PONT'S FORMULA FOR ROE

Financial executives at Du Pont cooked up this formula for deriving ROE.

It provides a richer way of looking at corporate profitability.

• PROFIT MARGIN X TURNOVER X LEVERAGE = ROE Profits [divided by] Sales [divided by] Assets [divided by] Equity

Du Pont Formula

net profitnet profit

salessales

salessales

assetsassets

assetsassets

equityequityxxxx xxxx

Value Chain

Return on Return on SalesSales

Asset Asset TurnoverTurnover

LeverageLeverage

Du Pont Formula

net profitnet profit

salessales

salessales

assetsassets

assetsassets

equityequityxxxx xxxx

Return on Return on SalesSales

Asset Asset TurnoverTurnover

LeverageLeverage

Return on Equity =Return on Equity =net profitnet profit

equityequity