Online financial courses - The best source of advice comes from the Short Courses


Online Financial Courses - Evaluating Financial Performance

Provided by : Matt H. Evans
Adress: 6903 29th St N ; Arlington, VA 22213
Phone number : 1-877-689-4097
Email: matt@exinfm.com

Course 1: Evaluating Financial Performance

Chapter 1: Return on Equity

Why use ratios?

It has been said that you must measure what you expect to manage and accomplish. Without measurement, you have no reference to work with and thus, you tend to operate in the dark. One way of establishing references and managing the financial affairs of an organization is to use ratios. Ratios are simply relationships between two financial balances or financial calculations. These relationships establish our references so we can understand how well we are performing financially. Ratios also extend our traditional way of measuring financial performance; i.e. relying on financial statements. By applying ratios to a set of financial statements, we can better understand financial performance.
sitemap | top

Calculating Return on Equity

For publicly traded companies, the relationship of earnings to equity or Return on Equity is of prime importance since management must provide a return for the money invested by shareholders. Return on Equity is a measure of how well management has used the capital invested by shareholders. Return on Equity tells us the percent returned for each dollar (or other monetary unit) invested by shareholders. Return on Equity is calculated by dividing Net Income by Average Shareholders Equity (including Retained Earnings).

EXAMPLE - Net Income for the year was $ 60,000, total shareholder equity at the beginning of the year was $ 315,000 and ending shareholder equity for the year was $ 285,000. Return on Equity is calculated by dividing $ 60,000 by $ 300,000 (average shareholders equity which is $ 315,000 + $ 285,000 / 2). This gives us a Return on Equity of 20%. For each dollar invested by shareholders, 20% was returned in the form of earnings.
SUMMARY - Return on Equity is one of the most widely used ratios for publicly traded companies. It measures how much return management was able to generate for the shareholders. The formula for calculating Return on Equity is: Net Income / Average Shareholders Equity
sitemap | top

Components of Return on Equity

Return on Equity has three ratio components. The three ratios that make up Return on Equity are: 1. Profit Margin = Net Income / Sales 2. Asset Turnover = Sales / Assets 3. Financial Leverage = Assets / Equity Profit Margin measures the percent of profits you generate for each dollar of sales. Profit Margin reflects your ability to control costs and make a return on your sales. Profit Margin is calculated by dividing Net Income by Sales. Management is interested in having high profit margins.

EXAMPLE - Net Income for the year was $ 60,000 and Sales were $ 480,000. Profit Margin is $ 60,000 / $ 480,000 or 12.5%. For each dollar of sales, we generated $ .125 of profits.

Asset Turnover measures the percent of sales you are able to generate from your assets. Asset Turnover reflects the level of capital we have tied-up in assets and how much sales we can squeeze out of our assets. Asset Turnover is calculated by dividing Sales by Average Assets. A high asset turnover rate implies that we can generate strong sales from a relatively low level of capital. Low turnover would imply a very capital-intensive organization.

EXAMPLE - Sales for the year were $ 480,000, beginning total assets was $ 505,000 and year-end total assets are $ 495,000. The Asset Turnover Rate is $ 480,000 / $ 500,000 (average total assets which is $ 505,000 + $ 495,000 / 2) or .96. For every $ 1.00 of assets, we were able to generate $ .96 of sales.

Financial Leverage is the third and final component of Return on Equity. Financial Leverage is a measure of how much we use equity and debt to finance our assets. As debt increases, we financial leverage increases. Generally, management tends to prefer equity financing over debt since it carries less risk. The Financial Leverage Ratio is calculated by dividing Assets by Shareholder Equity.

EXAMPLE - Average assets are $ 500,000 and average shareholder equity is $ 320,000. Financial Leverage Ratio is $ 500,000 / $ 320,000 or 1.56. For each $ 1.56 in assets, we are using $ 1.00 in equity financing.

Now let us compare our Return on Equity to a combination of the three component ratios: From our example, Return on Equity = $ 60,000 / $ 320,000 or 18.75% or we can combine the three components of Return on Equity from our examples: Profit Margin x Asset Turnover x Financial Leverage = Return on Equity or .125 x .96 x 1.56 = 18.75%. Now that we understand the basic ratio structure, we can move down to a more detail analysis with ratios. Four common groups of detail ratios are: Liquidity, Asset Management, Profitability and Leverage. We will also look at market value ratios.
sitemap | top

Chapter 1: Return on Equity
Chapter 2: Liquidity Ratios
Chapter 3: Asset Management Ratios
Chapter 4: Profitability Ratios
Chapter 5: Leverage Ratios
Chapter 6: Market Value Ratios
Chapter 7: Comparing Financial Statements
Chapter 1 points
Why use ratios?
Calculating Return on Equity
Components of Return on Equity


10 Upcoming learning videos : in all categories



Selected learning videos for today


learn video about : Explaination about the theory of plate techtonics in geologyExplaination about the theory of plate techtonics in geology
learn video about : Differentes types of rocks in geologyDifferentes types of rocks in geology
learn video about : Geology lecture titled Macro evolution in the deep sea by SeilacherGeology lecture titled Macro evolution in the deep sea by Seilacher
learn video about : Geological evidence of Darwin theory of evolution that still mattersGeological evidence of Darwin theory of evolution that still matters
learn video about : The meaning of Limestone and shale cycles in the upper ordovicianThe meaning of Limestone and shale cycles in the upper ordovician
learn video about : Geologic carbon sequestration and mitigating climate change by inection of CO2Geologic carbon sequestration and mitigating climate change by inection of CO2
learn video about : Geology and mineral resources of oclahoma by Ken JohnsonGeology and mineral resources of oclahoma by Ken Johnson
learn video about : How to calculate the budget line and prices if you know incomeHow to calculate the budget line and prices if you know income
learn video about : Ecuador geology and volcanology given by Dr throfilosEcuador geology and volcanology given by Dr throfilos
learn video about : This video is about Mexico volcanos and Mexico Geological phenomenonThis video is about Mexico volcanos and Mexico Geological phenomenon
learn video about : Explanation about the 3 type of rocks and the relationship between themExplanation about the 3 type of rocks and the relationship between them
learn video about : Learning english vocab for ESL - project managementLearning english vocab for ESL - project management
learn video about : How to pronunciate words starting with BHow to pronunciate words starting with B
  1. What happens when we pull on a pulley and the pulley is pulling on other things?


  2. Tension in an accelerating system and pie in the face


  3. A more complicated friction/inclin ed plane problem


  4. Calculating the acceleration of on object sliding down an inclined plane


  5. Phisics cours - Introduction to friction


  6. Physics explanation about Mass on Inclined Plane


  7. Learning physics - A slightly more difficult tension problem


  8. Learning physics-An introduction to tension


  9. Physics topic explaining Force with Vectors


  10. Explanation about Newton's Laws and vectors