FINANCIAL RATIOS QUESTION

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THEROCK

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If a company's ROA is 20% and the profit margin is 5%, the company's total asset turnover is :
1)1
2)4
c)5
d)20

B is correct.

Please explan...thanks !!!
 
ROA = NI/Average total assets
NI Margin = NI/Sales
Assets turnover = Sales/Average Total assets = ROA*NI Margin

Assets turnover = 20% * {1/5%} = 20/5= 4.

I hope it is clear.



Edited 1 time(s). Last edit at Thursday, September 14, 2006 at 04:27PM by CFAMontreal.
 
Good explanation that demonstrates good knowledge of the ratios. However, if you can't make the connection, you can go about it GMAT style:

Here is what you know:

1) ROA= NI/Assets= 0.20

2) Margin= NI/Sales= 0.05

3) TAT= Sales/Assets= ?

Here's what you can do:

1) plug any number for assets (100 is a good one)

2) If Assets are 100, than NI must be 20 (to have ROA of 20%)

3) Given that NI is 20, you know that Sales must be 400 (to have your margin at 5%)

4) Just plug your numbers in TAT: 400/100= 4



Hope this helps
 
This is a very basic question and you will definitly need to be able to do this with ROE and other ratios. The best way is to write out the ratio you need and then right out the ratios your given and see how you can use those ratios to arrive at your answer.

This is very important
 
but isn't roa= (net income + interest expense)/ total assets

or am i missing sth..pls clarify
 
That's an area of confusion because the use ROA=NI/Total Assets but then they use ROC=(EBIT+Interest)/Total Capital saying that total capital is equal to total assets
 
it depends on what is the purpose of ratio you want to calculate. ROA=NI/TA is very generic, but ROiC is a ratio on capital, contributed by equityholders and creditors of the firm. Why ROiC = TA, we assume that all invested capital goes into acquiring new assets (long-term assets) and working capital needs (current assets in BS)...I don't thnk you may calculate this ratio in such a way for WalMart or Microsoft: many more adjustments are needed...Just look at the meanings of these ratios, nominators and denominators in them and try tro understand.

Good luck!
 
ROIC disregards the capital structure and therefore you need to add back the interest component. Also, invested capital doesnt mean total asset; instead it should be defined as total asset - excess cash - non-interest bearing liabilities.

Hope it helps.
 
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