ROA Discussion 2발음듣기
ROA Discussion 2
This is given in some textbooks and maybe some professors would give this in a finance class: net income divided by assets.발음듣기
If you look on Wikipedia, they say it's net income plus interest minus tax savings from interest.발음듣기
They're still taking taxes into consideration, but they're saying you're not getting any tax deduction from your interest.발음듣기
It really just is kind of a simplifying assumption and really to give you the intuition in my mind of what ROA really is about, of how good is a company at operating its assets, at actually getting a return from them.발음듣기
And we talk about the fact that EBIT is just net income plus interest plus taxes, or another way to think about it, it's operating profit plus non-operating profit.발음듣기
So any other type of profit that the company might have gotten from some assets that it owns that actually aren't essential to actually managing the business.발음듣기
But then in the last part of the video, I talk about you have these definitions out here, but I don't like using them as much, and then I ran out of time, and I said I would cover in this video why I don't like using it as much.발음듣기
That's one company, and then this is the other company right here, and I'm drawing the left-hand side of their balance sheets.발음듣기
These are the assets. Now let's say that they're the same amount, so they have $10 million of assets.발음듣기
So if EBIT is 10% of this, that means that this guy is spitting out 10%, which would be $1 million of EBIT.발음듣기
And in a world where there's no non-operating profit, this you could view as operating profit.발음듣기
So if you add back interest and taxes, you essentially get back to operating profit unless there's a little bit of non-operating profit right here.발음듣기
For most functional purposes, unless you're talking about like a financial statement, most firms that aren't doing anything too fancy on their non-operating side of their balance sheet, EBIT and operating profit are pretty close to each other.발음듣기
And let's say that this company, Company B - we'll label these as Company A, this is Company B.발음듣기
So just when I look at the left-hand sides of the balance sheet - I haven't drawn the right-hand side yet - I would say that this guy is a better manager of these assets.발음듣기
He's better at extracting value, given the amount of capital that has been put into this company.발음듣기
So that's why I like the definition of EBIT divided by assets, or operating profit divided by assets.발음듣기
Let's say he has no debt and he has all equity, so the right-hand side of his balance sheet looks like this.발음듣기
So when you want to figure out this guy's pre-tax income, you take EBIT minus - actually, let me move the window down a little bit.발음듣기
So he has no interest. So his pre-tax earnings, or you can call it, which no one else ever does, is EBT, which you don't want to say because it sounds like EBIT, but Earnings Before Taxes.발음듣기
And then if you go even further, and you say, this guy for some reason, he had a bunch of tax credits this year or he had some losses last year that he was able to offset to use against his taxes, so this year, he also didn't have to pay any taxes.발음듣기
Fair enough. So this guy has a 10% EBIT return on his assets, but his earnings or his net income is also this $1 million.발음듣기
So his pre-tax - let's do the bottom part of his balance sheet - his EBIT, his Earnings Before Interest and Taxes, is $1.5 million, but then if you want to subtract out interest, you'd subtract out minus $0.5 million, $500,000, and so his pre-tax is going to be $1 million.발음듣기
And now this guy also - so essentially the equity holder before paying tax --this is equity here.발음듣기
Because he has $1 million pre-tax, he has to pay $300,000 in taxes, so he has a $700,000 net income.발음듣기
Now, let's look at what we would get in terms of an ROA if we did it using this definition that some textbooks will give you.발음듣기
By that definition over here, this guy made $700,000 of net income off of $10 million, so he is going to be making an ROA of what? $700,000 divided by 10 is 7%.발음듣기
So now if you just look superficially at these numbers as defined by this ratio right here, you'll say, oh, this guy, Company A, has a better return on asset.발음듣기
Company A was just better at, one, it didn't have any debt, and it was also better at maybe this year avoiding paying taxes.발음듣기
So when you talk about ROA, there are other ratios that start factoring in how good is a company at financing its assets and how good is a company at paying taxes efficiently, which is just another way of evading as many taxes as possible.발음듣기
But that's a separate ratio. Return on asset to me says, what does a company do with the left-hand side of the balance sheet?발음듣기
And when you do the net income version, you're factoring things in like interest and taxes, and then you're muddying up the picture.발음듣기
You're not telling me which company is better at actually giving a return just on its assets, not how it actually pays for its assets.발음듣기
This definition that Wikipedia gives - and it's good to be aware of all of them, because I don't want you to watch these videos and say, oh, no.발음듣기
What I'm telling you is that this definition is more of a real intuitive sense of what a company's doing with its assets, while these are kind of textbook definitions.발음듣기
This one attempts to add back interest. It adds back interest, so just the interest part between this company and this company won't differentiate between the two.발음듣기
In the next video, maybe I'll talk a little bit more in depth about the tax savings from interest, because it's an interesting concept right there.발음듣기
But I think I'm getting a little bit into the weeds now, because I want to kind of get back high level and give you an overarching view of how you can think about investments and price to earnings and whatever else.발음듣기
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