1. Profitability Chapter 8 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2. Chapter 8, Slide #2 Profitability Measures Exclude items of income not arising from normal operations –Discontinued operations –Extraordinary items © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

3. Chapter 8, Slide #3 Net Profit Margin Also referred to as return on sales Reflects net income dollars generated by each dollar of sales Potential distortion –Net “other” income or loss © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

4. Chapter 8, Slide #4 Total Asset Turnover Measures the activity of the assets and the ability of the firm to generate sales through the use of the assets Potential distortion –Investments –Construction in progress –Other assets that do not relate to net sales © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

5. Chapter 8, Slide #5 Return on Assets Measures the ability to utilize assets to create profits Average total assets –Internal analysis: month-end amounts –External analysis: beginning and ending amounts –If necessary, consistent use of end-of-year amounts © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6. Chapter 8, Slide #6 DuPont Return on Assets © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

7. Chapter 8, Slide #7 DuPont Return on Assets (cont’d) DuPont analysis separates return on assets into net profit margin and total asset turnover Separating the ratio into the two elements allows evaluation of the causes for the change in return on assets © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8. Chapter 8, Slide #8 DuPont Analysis Variation Consider only operating assets and income –Operating assets exclude Construction in progress Long-term investments Intangibles ‘Other’ assets –Operating income includes only Net sales Operating expenses May give significantly different results Reflective of ROA from primary business © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

9. Chapter 8, Slide #9 Operating Income Margin Use operating income in the numerator © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

10. Chapter 8, Slide #10 Operating Asset Turnover Measures the ability of operating assets to generate sales dollars © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

11. Chapter 8, Slide #11 Return on Operating Assets Measures the ability of operating assets to generate operating income DuPont analysis of the return on operating assets: © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

12. Chapter 8, Slide #12 Sales to Fixed Assets Measures the ability to make productive use of property, plant, and equipment by generating sales dollars –Exclude construction in progress Possible distortions –Old fixed assets –Labor-intensive industry © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

13. Chapter 8, Slide #13 Return on Investment (ROI) Measures income earned on investment and how well the firm utilizes its asset base Evaluates enterprise performance © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

14. Chapter 8, Slide #14 Return on Investment (ROI) (cont’d) Measures ability to reward investors and to attract providers of future funds Evaluates the earnings performance without regard to financing sources © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

15. Chapter 8, Slide #15 Return on Total Equity Measures the return to common and preferred stockholders Adjustments for redeemable preferred stock –Deduct dividends from net income (numerator) –Deduct stock value from total equity (denominator) © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

16. Chapter 8, Slide #16 Return on Common Equity Measures the return to the common stockholder Common equity: Total stockholders’ equity lesspreferred capital lessminority interest reported as equity © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

17. Chapter 8, Slide #17 The Relationship Between Profitability Ratios Rate of return on Measures return to providers ofTypical result AssetsAll fundsLowest (includes all assets) InvestmentLong-term fundsHigher than ROA (relative small amount of short-term funds) Total equityEquityHigher than ROI (measures return only to shareholders) Common equity Highest Common shareholders absorb greatest degree of risk Requires that return to preferred shareholders exceed funds paid to preferred shareholders © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

18. Chapter 8, Slide #18 Gross Profit Margin Sales –Cost of Goods Sold =Gross Profit Beginning Inventory +Purchases of Inventory –Ending Inventory © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

19. Chapter 8, Slide #19 Gross Profit Margin Analysis Analysis helps the following ways: –Managers budget gross profit levels in projections –Cost control –Estimate inventory levels for interim financials and insurance losses in merchandising industries –Used by auditor and IRS to judge accuracy of accounting systems © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

20. Chapter 8, Slide #20 Segment Reporting Operating segments –Separate financial information is available –Evaluated by the chief decision making officer Geographical information –Revenues earned –Asset concentration Major customers Products and services © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

21. Chapter 8, Slide #21 Gains and Losses from Prior Period Adjustments Charged directly to retained earnings –Changes in accounting principles –Realization of net operating loss carryforward tax benefits from purchased subsidiaries –Changes in accounting entity –Correction of errors originating in prior periods © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

22. Chapter 8, Slide #22 Comprehensive Income Items not included in net income Reported as a separate component of stockholders’ equity –Foreign currency translation adjustments –Unrealized holding gains and losses from available- for-sale marketable securities –Changes to stockholders’ equity resulting from additional minimum pension liability adjustments –Unrealized gains and losses from derivative instruments © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

23. Chapter 8, Slide #23 Comprehensive Income (cont’d) Traditional profitability analysis utilizes net income –Items of accumulated other comprehensive income are excluded from analysis Consider supplemental analysis including other comprehensive income items for –Return on assets –Return on investment –Return on total equity –Return on common equity © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

24. Chapter 8, Slide #24 Pro Forma Financial Information Non-GAAP-based financial information Release timed to coincide with release of GAAP financial results Sarbanes-Oxley Act of 2002 requires –Reconciling of pro forma data to GAAP financial condition and results of operations –Pro forma data is not misleading or untrue © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

25. Chapter 8, Slide #25 Interim Reports Unaudited financial reports covering fiscal periods of less than one year –Interim reports are an integral part of the annual report –Quarterly information is disclosed in the annual report SEC requires quarterly information be filed on Form 10-Q Produced quickly; rely on more estimates © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.