ACCT 447 Module 3 - Lecture notes 3 PDF

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Lecture notes related to Module 3...

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Identify balance sheet operating items and compute net operating assets ● Separate operating and non-operating components of a business to improve analysis of a company ○ Companies create value mainly through core operations of the business ● ROE consists of 2 returns ○ Operating return + non operating return ● Traditional DuPont equation skews operating vs. non operating ○ Difference between borrowed money and operating liabilities (such as a/p) ○ A/P and accruals are interest free and are self liquidating as part of cash conversion cycle ● Operating returns are reflected in the return on net operating assets (RNOA) ○ NOPAT/NOA ● Net operating assets = operating assets - operating liabilities ○ Operating Assets ■ Current: A/R, inventories, prepaid expenses, deferred income tax assets, other current assets ■ LT: PPE net, capitalized lease assets, natural resources, equity method investments, goodwill and intangible assets, deferred income tax assets, other long-term assets ○ Operating Liab ■ Current: A/P, accrued liab, unearned/deferred revenue, deferred income tax liab ■ LT: pension and other post-employment liabilities, deferred income tax liab ○ “Other” current and LT assets - generally treated as operating unless footnotes indicate otherwise ○ Cash and cash equiv are non operating! Mostly ST marketable securities in reality → non operating assets Identify income statement operating items and compute net operating profit after tax ● Only financial related income and expense are non operating ● Many companies have an operating profit total ○ This is the company’s definition → need to examine what has been included ● Income taxes relate to both operating and non operating ● Net operating profit after tax (NOPAT) = net operating profit before tax - tax on operating profit (our estimate) ○ Tax on operating profit = tax expense + (pretax net nonoperating expense* Statutory rate) ■ The amount in parentheses is called the tax shield ■ Interest exp (non op exp) is deductible for tax purposes ■ Isolate income tax by elim the reduction caused by interest expense (by adding back the shield) ■ Taxes saved by tax shield do not relate to operating profits

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Basically just trying to isolate tax on operating profit Also possible that you will need to reduce tax expense if interest income exceeds interest expense (therefore it made tax expense greater due to a non operating item)

Compute and interpret return on net operating assets (RNOA) ● Return on net operating assets (RNOA) = net operating profit after tax (NOPAT) /Average net operating assets ○ Compute same way as ROA in dupont model, but now focusing on operating profit/assets to better focus on operating activities of company ○ ROA computed under traditional dupont approach is actually a weighted average of the return on operating assets and the return on net non operating assets Disaggregate RNOA into net operating profitability and net operating asset turnover ● RNOA = net operating profit margin (NOPM) * net operating asset turnover (NOAT) ○ NOPM = NOPAT/Sales ○ NOAT = Sales/Avg NOA ● Net operating profit margin (NOPM) reveals how much operating profit the company earns from each sales dollar ○ NOPM is affected by: the level of gross profit, operating expenses, and competition ● Net operating asset turnover (NOAT) measures the productivity of the company’s net operating assets ○ NOAT can be increased by: (need high without affecting rev and profitability) inc by inc sales for a given level of inv in op assets or reducing the number of op assets req to gen a dollar of sales (or both) ○ Reducing operating working capital is usually easier than reducing LT NOA ○ LT op assets are more difficult to reduce (but it can be done) ● Low NOA turnover = capital intensive ● Some companies need really high profit margin to achieve sufficient RNOA ○ Shows you can’t compare these across industries because there are different needs...