Page 202 - Calculating Agriculture Cover 20191124 STUDENT - A

21-14 Profitability & Performance Measures CH 21]

Net Income
(b) Return on Assets Ratio % = —————————— x 100%
Average Total Assets
37,500,000
= ——————————————— x 100%
($2,000,000 + $3,000,000) ÷ 2
37,500,000
= ———————— x 100%
($5,000,000) ÷ 2
37,500,000
= —————— x 100%
$2,500,000

= 15.000 x 100%

Return on Assets Ratio % = 1,500.0%

From this ratio we know that for every dollar Roberta invested in assets during the year
produced $15.00 of net income. Lenders and potential investors would need to compare
this return with other manufacturers in her industry to have a complete understanding of
how well Roberta is managing her assets.

Return on Capital Employed. Return on Capital Employed (ROCE) is a profitability
ratio that measures how efficiently a company generates profits from its capital employed by
comparing net operating profit to capital employed. The ROCE shows investors how many
dollars in profits each dollar of capital employed generates.
The equation for Return on Capital Employed is:

Net Operating Profit
Return on Capital Employed (ROCE) = ————————————————
Total Assets – Current Liabilities

ROCE is a long-term profitability ratio that shows how effectively assets are performing
while allowing for long-term financing. ROCE is very effective to evaluate the longevity of a
firm. The ratio is based on two calculations: Net operating profit and Capital employed. Net
operating is calculated before interest and taxes are incorporated in an Income Statement.
The denominator in this equation is Total Asset less Current Liabilities.

Example: Osage Farms is a diversified farming operation. During the year the firm
had a net operating profit of $225,000. On its Balance Sheet Osage reports
$200,000 for total Assets and $65,000 for current liabilities. What is Osage
Farms Return on Capital Employed?

Solution algorithm:

Net Operating Profit
Return on Capital Employed = ————————————————
Total Assets – Current Liabilities
$225,000
ROCE = ——————————
$200,000 – $65,000
$225,000
ROCE = —————
$135,000

Return on Capital Employed = 1.67:1

From this analysis Osage has a return of 1.67. This means that for every dollar invested
in employed capital, Osage earns $1.67. This return could be the result of low asset value.
Should asset values rise then the ROCE will decline. Further, companies with large cash
reserves usually skew the ROCE ratio because cash is included in the employed capital
computation even though cash available is not invested and working; merely sitting in the
cash account.

Return on Equity (ROE) Ratio. This ROE ratio is a profitability ratio that measures
a firm’s ability to generate profits from the owners’ investment(s) in the company. The return
on equity ratio calculates how much profit each dollar of owners’ equity generates. When
employed for a corporation where the owners are the stockholders, the measurement
calculates the amount of profit for each dollar of common stockholders’ equity.

INSTRUCTOR Copyrighted Material