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Financial Statement Analysis Assignment

Essay by   •  October 9, 2016  •  Coursework  •  1,181 Words (5 Pages)  •  2,064 Views

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Individual assignment

Financial statement analysis

  1. How is return on invested capital investment used as a management tool?

Return on invested capital (ROIC) comes under profitability ratio. Its primary use is to measure the return that an investment generates on the capital invested by the stakeholder i.e. stockholders and bondholder and others. It basically tells how good a company is in turning capital into profits. It is the best way to measure that company has a MOAT or no. MOAT is an economic term introduced by well-known business man warren buffet which means ability of an organization to maintain a competitive advantage over its competitors to protect its long term profits and market share from other competing firms, ROIC is a financial performance forecasting tool that management uses to see their long term investment are going to be fruitful will they have a competitive advantage in the industry. And will they be able to secure their market share reason being it gives the clear picture of how exactly the company is using its capital.

ROIC is calculated with the following equation ROIC = (net income-dividends)/ (debt+equity) lets solve an example to have a clear understanding. a company makes 100,000 MYR as net income and 500,000 MYR in total debt and 100,000 in shareholder equity ROIC = 16.7% , for some companies , net income may not be the profitability measure used in calculating ROIC so the numerator should be used according to the information needed . It shouldn’t be based on short time results based on onetime events so while calculating ROIC the consideration of income should be related to core business. Lastly ROIC can be an excellent indicator for a company’s MOAT, if a company is able to generate 15 -20 % yearly means it has developed a good method for turning capital into profit.

  1. Why is return on invested capital one of the most relevant measures of company performance? How do we use this measure in analysis of our financial statements?

ROIC is one of the most relevant measures of a company performance because it is used to measure, evaluate the efficiency of the company to in investing the capital in its control to a number of different profitable investments. The return on invested capital generally provides an idea about how the company is using the stakeholder’s money to generate returns. Which is done by making a comparison between the return on invested capital and cost of capital. The result of which gives a picture on whether the invested capital was used effectively or not, invested capital can be in the form investment in building projects machinery or buying other companies

More over ROIC gives the investors the management overview of company management performance, because management performing well hikes the stock prices thus yielding a higher income for the investors. Along with the return on capital invested can be used in several areas of analysis. It is an important indicator of a company long term financial strength and is uses key measures from both income statement and balance sheet to access profitability. It can also be used as a tool for planning and control. It can help the management in budgeting coordinating evaluating and controlling the business activities to the asses the returns or losses for company segments or divisions

It can be used as a measure for analysis of the financial statements because it provides information about the return  generated by the company on each ringgit of capital invested if the returns generated are higher than investors will be attracted to the company it can be used as a tool to check the efficiency of operations . The operation will be considered efficient when the return is greater than the cost of capital thus it acts as automatic check for the internal management of the company

  1. Why is interest expense ignored when computing return on net operating assets (RNOA)?

Firstly let’s see what is RONA is a comparison of net income with net assets It is a measure of financial performance calculated by dividing net income by net assets and net working capital it is used to show how well a company is performing in comparison with its industrial rivals and how its management are they deploying assets in economically valuable ways or not. Now breaking down the formulae net income is revenue less the expenses related to making and selling company’s products so expenses like management salaries utilities interest related to debt are not included in its calculation.

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