The Essentials of Finance and Accounting for Nonfinancial Managers By Edward Fields

1
The Essentials of Finance and Accounting for
Nonfinancial Managers By Edward Fields

• Chapter 7
• Using ROA to Measure Profit Centers

2
Measuring Profit Centers with ROA

• Profit centers are business entities dedicated to
  a specific market, distribution channel or set of
  customers
• Each Center has its own strategy and may have a
  separate business model
• Profit centers are also known as Strategic
  business units (SBU)

3
Measuring Profit Centers with ROA

• SBUs may be responsible for the asset side of the
  balance sheet
• The ROA model in this chapter is known as the
  DuPont formula, which is at least 75 years old

4
DuPont ROAREFERENCE PAGE 106
5
ROA-Its Components

• The ROA ratio is really a combination of two
  ratios
• Revenue/assets
• ATCF/revenue
• Revenue/assets is Asset Turnover
• ATCF/revenue is known as margin
• Multiplying asset turnover by margin yields ROA
• Many business decisions cause the two ratios to
  move in opposite directions

6
ROA and SBU Decisions

• Example
• Outsourcing improves turnover, but reduces margin
  as profit that was kept in house now must be paid
  to the vendor
• REFERENCE
• Revenue/assets is Asset Turnover
• ATCF/revenue is known as margin

7
Compare 3 SBUs
Line One Revenue. All three SBUs achieved
significant revenue gains in the most recent
year. The Eisen Company is the largest of the
three, with 50 million in annual revenues, while
the Norelli Company is the smallest, with
revenues amounting to 10 million.
8
Compare 3 SBUs
Line Two After Tax cash flow. This is each
businesss net income plus depreciation expense,
which is added back to calculate the cash flows
generated
9
Compare 3 SBUs
Line Three Total Assets. This identifies the
total assets dedicated to each business.
Ideally, common property is excluded from this
measure and no overhead expenses are allocated to
the individual.
10
Compare 3 SBUs
Line Four Margin. This is ATCF/revenue. This
measures the efficiency and reflects all of the
operating decisions made by the SBU management
team. Notice Wilson has the highest (not
necessarily the best) margin.
11
Compare 3 SBUs
Line Five Asset Turnover. All three SBUs are
quite asset intensive. Any asset turnover ratio
below 2.0 indicates a considerable investment in
assets relative to the amount of revenue earned
with those assets.
12
Compare 3 SBUs
Line Six Return on assets. This is line 4 x
line 5. It can also be calculated by dividing
line 2 by line 3. Wilson has the highest margin
(line 4) and an asset turnover of 1.33. Its
asset intensiveness is compensated for by the
higher margin.
13
(No Transcript)
14
BACK-UP SLIDES
15
1 and 6 Assets

• Cash
• Size depends on the managers ability to predict
  and manage cash inflows and outflows
• Some SBU do not manage cash balances
• Accounts Receivable
• The question is what are the credit terms has the
  SBU determined

16
1 and 6 Assets

• Inventory
• A multitude of SBU decisions can effect inventory
  such as supply chain management
• Degree of vertical and/or horizontal integration
• Fixed Assets
• Vertical and horizontal integration
• Business type effects investment in fixed assets
• A three shift operation requires less equipment
  than a one shift operation

BACK
17
2 and 3 Revenue

• Issue is efficiency
• How much business can it generate?
• How much value is built into the product?
• How much of it is outsourced?
• Significant outsourcing reduces the need for
  fixed assets
• Only inventory and accounts receivable will need
  to be increased

BACK
18
4 and 5. After Tax Cash Flow (ATCF)

• Given the revenue generated by the SBU, how much
  profit can be achieved?
• Profit achieved is related to the type of
  business, economies of scale, capacity,
  utilization, etc.
• Greatly affected by the degree of vertical
  integration

BACK