Lecture 3:

Analysis of Financial Performance

and Financial Position
Lau Chee Kwong

Lau CK Financial Analysis 1

Learning Outcomes
By the end of this lecture you should be able to:

 Evaluate the effect of financial performance on

financial position
 Deconstruct the ROE and comment upon the findings

Lau CK Financial Analysis 2

Linking Financial Performance with Position

IASB Conceptual Framework: Elements of Financial Statements

• Income – increases in economic benefits during the

accounting period in the form of increases in assets or
decreases of liabilities that result in increases in equity, other
than those relating to contributions from the equity holders

• Expenses - decreases in economic benefits during the

accounting period in the form of decreases in assets or
increases of liabilities that result in decreases in equity, other
than those relating to distributions to the equity holders

Lau CK Advanced Financial Reporting 3

Linking Financial Performance with Position

Clean surplus relation:

Net assets at end =

Net assets at beginning + Income – Dividends paid

Net assets at end =

Net assets at beginning + [Profit for the year + Other
comprehensive income] – Dividends paid

Lau CK Advanced Financial Reporting 4

Linking Financial Performance with Position

Return on Equity
 profit earned on every equity capital dollar.
 Return to equity capital
 ROE is given by
Net earnings
Shareholders’ equity
Tesco plc:

2013 2012 2011 2010 2009 2008

15.8% 16.1% 15.9% 16.6% 17.9%

Lau CK Financial Analysis 5

Linking Financial Performance with Position

Return on Assets (Investment)

 profit earned on every investment (total assets) dollar.
 Return to total capital (assets)
 ROA is given by
Net earnings
Total assets

Tesco plc:
2013 2012 2011 2010 2009 2008
5.5% 5.7% 5.1% 4.7% 7.1%

Lau CK Financial Analysis 6

Linking Financial Performance with Position

Total Asset Turnover

 Sales created on every investment (total assets) dollar.
 TA Turnover is given by Net sales
Total assets

Tesco plc:

2013 2012 2011 2010 2009 2008

1.27X 1.28X 1.24X 1.18X 1.57X

Lau CK Financial Analysis 7

Return on Equity - the Du Pont System
The summary ratios used are the following:
(1) (2) (3)
Net profit margin Total asset turnover Financial leverage

Net income Net sales Total assets

Net sales X Total assets X Stockholder equity

Return on equity

Net income
= Stockholder equity

Lau CK Financial Analysis 8

Return on Equity - the Du Pont System
• Net profit margin = profitability

• Total asset turnover = management efficiency

• Financial leverage = capital efficiency

Lau CK Financial Analysis 9

Return on Equity - the Du Pont System

• Helps analyst see how the firm’s decisions and activities

over the course of an accounting period interact to
produce overall return to shareholders

• By reviewing this series of relationships, the analyst can

identify strengths and weaknesses as well as trace
potential causes of problems in the overall financial
condition and performance of the firm.

• Evaluation can then focus on specific areas contributing

to changes.

Lau CK Financial Analysis 10

Return on Equity - the Du Pont System
Tesco plc:

2013 2012 2011 2010 2009 2008

NPM 0.044 0.044 0.041 0.040 0.045

TA T/O 1.27 1.28 1.24 1.18 1.57
FL 2.85 2.84 3.13 3.53 2.53

ROE 0.72%* 15.8% 16.1% 15.9% 16.6% 17.9%

* Rounded in order to be consistent with ROE calculation in previous slide

Lau CK Financial Analysis 11

Return on Equity - the Du Pont System
Tesco: 2008-2013

• Net profit margin = profitability

• Total asset turnover = management efficiency

• Financial leverage = capital efficiency

Return on Equity

Lau CK Financial Analysis 12