ECON 435: Financial Ratios

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ECON 435 > ECON 435: Financial Ratios

Finding ratios within ratios

The Du Pont Identity

• ROE = Net Income / Total equity

= (Net Income / total assets) x (Total assets / Total equity)

= ROA x Equity multiplier

= Profit margin x total asset turnover x equity multiplier

• ROA = Net income / total assets

= (Net income / sales) x (Sales / Total assets)

= Profit margin x total asset turnover

• ROE (and profitability) has three parts - definations of them:
  • Profit margin illustrates operating effciency, determined by production management
  • Total asset turnover relfects efficiency by which company uses assets, determined by capital budgeting
  • Equity multiplier reflects financial leverage, determined by the long-term financial decisions by the company
    • Equity multiplier = Total assets / total equity

Lecutre slides

• Get lecture slides here.