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The Analysis of Profitability

After reading this chapter you should understand:
  • How ratios aggregate to explain return on common equity (ROCE).
  • How financial leverage affects ROCE.
  • How operating liability leverage affects ROCE.
  • The difference between return on net operating assets (RNOA) and return on assets (ROA).
  • How profit margins, asset turnovers, and their composite ratios drive RNOA.
  • How borrowing costs are analyzed.
  • How profitability analysis can be used to ask penetrating questions regarding the firm's activities.
After reading this chapter you should be able to:
  • Calculate ratios that drive ROCE.
  • Demonstrate how ratios combine to yield the ROCE.
  • Perform a complete profitability analysis on reformulated financial statements.
  • Prepare a spreadsheet program based on the design in this chapter. See the BYOAP feature on the text's Web site.
  • Answer "what-if" questions about a firm using the analysis in this chapter.

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