FINANCING RATIOS – INDEBTNESS OF THE BUSINESS
|Table 1: Selected Financial Data Extracted from 2015 & 2016 Annual Reports (in RM million)|
|Cost of sales||407.1||452.9||1,836.5||1,845.8|
|Short term borrowings||–||–||399.6||616.7|
|Long term borrowings||–||–||0.6||0.3|
|*Opening inventories are the closing inventories in the previous financial year.
**Page 121 of Apex’s 2016 annual report, under notes to the accounts 20. Trade and Other Receivables
***Page 127 of Apex’s 2016 annual report, under notes to the accounts 25. Trade and Other Payables.
Return on Equity & the DuPont Model
Return on Equity, or ROE, is also a profitability ratio that measures how much profit each dollar of the shareholders’ fund the company can generate. The reason why ROE is not grouped together under the earlier profitability ratios is because I believe ROE deserves close attention as it is one of the most important determinants of performance of the management of a company.
|Return on Equity =||Net Profit||X 100%|
There are many methods to calculate Return on Equity. Some may use the opening shareholders’ fund, and some may use average shareholders’ fund (i.e. opening shareholders’ fund plus ending divided by two). In this book we are using closing to ease understanding. Once you are familiar, you can explore other calculation methods.
Table 4: Return on Equity
|Apex||=||RM35.0 m||X 100%|
|Pharmaniaga||=||RM45.6 m||X 100%|
This means that for every RM1.00 of shareholders’ fund, Apex Healthcare generated RM0.112 worth of profits whereas Pharmaniaga generated RM0.082 worth of profits.
In the 1920s, the DuPont Corporation, in the course of identifying how to improve ROE, broke down ROE into three components, being profitability (or Net Profit Margin), asset efficiency (Total Asset Turnover), and financial leverage (Equity Multiplier). These are the ratios that we have covered earlier.
Using the ratios calculated earlier:
Table 5: The DuPont Model
|Formula||=||Profit Margin X Total Assets Turnover X Equity|
|Apex||=||6.02% X 138.9% X 133.9%|
|2.09% X 130.1% X 300.9%|
Overall, Apex outperforms Pharmaniaga in Return on Equity measurement. Splitting out the drivers of the outperformance, Apex edges over Pharmaniaga in terms of profitability and efficiency, whereas Pharmaniaga edges out Apex in terms of financing leverage.
The DuPont Model is also useful in analysing the transformation of a company. Take Nestle (Malaysia) Bhd (“Nestle”) for instance. It is one stock that has been viewed as “expensive” in terms of valuation, but it is one of those stocks that has been performing for a long period. Looking at Figure 1, Nestle’s continuous improvement in its margin and financial leverage (in terms of trade payables rather than bank borrowings) have been driving the group’s Return on Equity.
This concludes Chapter 13. The next chapter will provide answer to the million dollar question: How much to pay for a business.