What is the difference between roe and rnoa

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Next, we reformulate the financial statements to distinguish between operating and financing activities see Exhibit 2. Note that the balance sheet calculates operating assets, operating liabilities the difference between these two is net operating assets , financial assets Target does not report any financial assets in the form of investments in marketable securities , and financial liabilities interest-bearing debt.

The difference between financial assets and financial liabilities is net financial obligations. Also, a firm with financial assets greater than financial liabilities would effectively have negative financial liabilities financial assets and negative interest expense interest income.

Similarly, the income statement calculates net operating profit after tax NOPAT and then subtracts after-tax interest to arrive at net income, which is the same as in the GAAP format. We are now ready to apply the advanced DuPont model formulation to Target and Costco.

From Exhibit 2 , we reproduce the income statement and balance sheet items shown in Exhibit 3 all Target and Costco financial statement numbers are in millions and balance sheet numbers are averages of values for the beginning and end of the year :. Both firms have virtually identical operating performance RNOA.

We now understand how operating performance and nonoperating performance combine to create return on equity. To gain a better understanding of operating performance, we can disaggregate it into profit margin and asset turnover components.

This is accomplished in the following manner note the algebraic identity because revenue REV cancels out :. Target achieves its operating performance with higher profit margins but lower operating asset turnover. How do we know this is strategy and not happenstance? Firms that choose a cost leadership strategy will typically sell at lower prices but with higher volume, while firms that choose a differentiation strategy will sell smaller quantities but at higher prices. However, providing actionable advice to clients or achieving specific performance goals for your firm requires even more detail.

This leads to a closer examination of expense and turnover ratios for specific assets. The large differences between cost of goods sold CGS to sales and selling, general and administrative expense to sales suggest that Target and Costco classify their costs into each major expense category differently.

A review of the footnotes to the financial statements did not allow us to make the classifications comparable. Unfortunately, this problem also precludes unambiguous inferences about number of days inventory and number of days payables because both metrics include CGS. This is one of those examples where more detailed information from management is necessary to recast the income statement and balance sheet numbers on a comparable basis.

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