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Improving Financial Performance: What Is the Payoff? Objectives Understanding determinates of operating performance (ROA) Understanding determinates of financial performance (ROE) Links between managerial decisions and financial performance Operating Profit Margin Turnover Ratio

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objectives
Objectives
  • Understanding determinates of operating performance (ROA)
  • Understanding determinates of financial performance (ROE)
  • Links between managerial decisions and financial performance
determinants of operating performance roa

Operating Profit Margin

Turnover Ratio

Return on Assets

X

=

Determinants of Operating Performance (ROA)
  • Operating profit margin
  • Asset turnover ratio
determinants of financial performance roe

Return on Assets

InterestAssets

Leverage

ROE

-

X

=

Determinants of Financial Performance (ROE)
  • Operating profit margin
  • Asset turnover ratio
  • Leverage
profitability analysis

Profitability Analysis

AKA The DuPont Model

slide6

Gross

Revenue

Fixed

Costs

Variable

Costs

Net

Income

-

-

=

Operating

Profit Margin

Net

Income

Interest

Expense

Gross

Revenue

+

÷

=

-

Interest

Assets

ROA

x

Gross

Revenue

÷

Turnover

Ratio

Total Assets

=

ROE

x

Financial Structure

Total Assets

Equity

Financial

Structure

÷

=

DuPont

Analysis

Operating Performance

implications
Implications
  • If ROE > ROA
    • Interest rate less than ROA
    • Making money on borrowed money
    • Increase ROE by borrowing more (but be careful)
implications8
Implications
  • If ROE < ROA
    • ROA less than interest rate
    • Losing money on borrowed money
    • Reduce interest cost
    • Reduce debt
    • Improve operating performance (ROA)
improving performance
Improving performance
  • Ways to enhance operating performance (ROA)
    • Increase operating profit margin
    • Increase volume per dollar invested or capital turnover
  • Ways to enhance equity return (ROE)
    • Enhance operating performance
    • Reduce financing costs
    • Leverage – more debt
data for profit analysis

Income Statement

Balance Sheet

Data for Profit Analysis
  • Gross Revenue
  • Fixed Costs
  • Variable Costs
  • Interest Costs
  • Total Assets
  • Equity
example case mbc farms
Example Case: MBC Farms
  • Operated by Mike, Betty, and Craig
  • Enterprises
    • Crops, dairy
  • Operate 3,000 acres, 250 milking cows
    • Own 1,800 acres, cash rent remainder
  • Six full-time employees
worksheet 4
Worksheet 4

Spreadsheet for MBC Farms Case

reduced interest
Reduced interest
  • Opportunity to refinance term debt at a 1% lower interest rate
  • $91,648 in intermediate debt and $799,573 term
  • Saves about $8,913
earlier soybean planting
Earlier soybean planting
  • Has been planting about half of soybeans after June 23
  • Pushing harder would result in about a 10% increase in soybean revenue
  • No change in costs
summary
Summary
  • Measurement of performance
    • Operating: ROA
    • Financial: ROE
  • Determinants of rates of return
    • Operating profit margin
    • Asset turnover ratio
    • Cost of debt
    • Leverage
  • Links among managerial decisions & rates of return
key points
Key Points?
  • What are the 2 key elements of operating performance?
  • Overall financial performance is measured by what ratio?
  • With respect to financial performance, when is debt a good thing?
references
References
  • Boehlje, Michael, Craig Dobbins, Alan Miller, Dawn Miller, & Freddie Barnard, Measuring and Analyzing Farm Financial Performance, Department of Agricultural Economics, Purdue University, EC-712, 1999 (pages 37-43),
  • Miller, Alan, Michael Boehlje, and Craig Dobbins, Key Financial Performance Measures for Farm General Managers, Department of Agricultural Economics, Purdue University, ID-243, June 2001.