FOUNDATION
BUSINESS SIMULATION
Success Measures
Success Measures
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Profits
Market Share
ROS
Asset Turnover
ROA
ROE
Stock Price
Market Capitalization
Select 3 – 4 that
you want to focus on
Introduction to Ratios
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• ROS
• Asset Turnover
• ROA
• ROE
A financial ratio shows the relationship between two
financial measures
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Developed by dividing one measure into another
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Provide insights into company’s operations and strategy
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Four categories: liquidity, solvency, market value,
profitability
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Used internally to evaluate performance and set goals
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Used externally to make investment decisions
Ratio Information
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ROS – Return on Sales
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ROA – Return on Assets
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ROE – Return on Equity
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Leverage
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Turnover
Net profit divided by total sales for the same period.
Net profit divided by the value of the total assets for the same period.
Net profit divided by the value of the owners’ equity for the same period.
Total assets divided by owners’ equity.
Sales 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
“ROA measures a company’s ability to use
all its assets to generate earnings.”
net profit
Return on Assets =
assets
Return on Assets
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What Does Return On Assets Tell You?
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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
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Typical Range:
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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
Return on Sales
“ROS indicates the percentage of each sales
dollar that results in net income.”
net profit
Return on Sales =
net sales
Return On Sales
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What Does Return On Sales Tell You?
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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.
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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
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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
generating sales revenue.”
sales
Asset Turnover =
assets
Asset Turnover
What Does Asset Turnover Tell You?
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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.
2.
Increase sales without increasing assets – for example increase
awareness and easy accessibility
Hold sales constant while reducing assets – eliminate idle plant
or excess working capital
Asset Turnover
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Typical Range:
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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 shows the debt level of the
organization.”
assets
Leverage =
equity
Leverage
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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
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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
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Typical Range:
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Leverage typically ranges between 1/5
and 3.0
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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 highlights for the
stockholders the return on their investment.”
net profit
Return on Equity =
equity
Return on Equity
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What Does Return On Equity Tell You?
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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
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Typical Range:
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ROE is relatively easy to manipulate –
issue stock, retire stock
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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
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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
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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
Value Chain
net profit
sales
Return on
Sales
x
sales
assets
Asset
Turnover
x
assets
equity
Leverage
Du Pont Formula
net profit
sales
Return on
Sales
x
sales
assets
x
assets
equity
Asset
Leverage
Turnover
net profit
Return on Equity =
equity