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The Financial Performance Measurement

Calculation

The values of operating leverage, return on investment, economic value added (EVA) and return on equity will be calculated. The calculations are presented below.

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2013
(Millions)
2014
(Millions)
Sales 146,917 144,077
Variable expenses 125,195 123,516
Fixed expenses 16,244 17,121
Total expenses 141,439 140,637
Operating income 5,478 3,440
Net income 7,175 3,186
Tax -135 1,156
Net operating income after tax 5,613 2,030
Shareholder’s equity 26,145 24,832
Debt 114,688 119,171
Capital/investment 140,833 144,003
Weighted average cost of capital (WACC) 19.54%
Ratios
Operating leverage
(Total contribution / Total contribution – fixed asset)
3.97 5.98
Return on investment
(Net income / total investment)
5.09% 2.21%
EVA
(Net operating income after tax – (WACC * total capital))
-21,905.77 -26,108.19
Return on equity
(Net income / Shareholders’ equity)
27.44% 12.83%

Operating leverage

The ratio gives information on how growth in revenue is converted to increase in operating income. The operating leverage for the company dropped from 3.97 in 2013 to 5.98 in 2014. The growth in the value of the ratio means that the operating income of the company is quite volatile. A low value of the ratio is preferred because it implies that the earnings of the company are less volatile. Further, the low ratio enables a company to earn a profit even at low values of the sales. One advantage of this ratio is that it facilitates the calculation of the break-even point. On the other hand, it highly depends on the value of sales.

Return on investment

The ratio compares the value of the investment benefit to the investment cost. The value of return on investment dropped from 5.09% to 2.21%. This implies that the amount of benefit generated from a unit of total investment dropped. A high value of the ratio is preferred because it shows that a high amount of gain is generated from a unit of investment. One advantage of this ratio is that it facilitates the comparison of the efficiency of various investments. The disadvantage of this ratio is that it is too simple and cannot be used alone. There is a need to use more ratios to analyze the profitability of a company or a project (Walther, 2012).

EVA

The ratio puts together the net operating profit after tax, weighted average cost of capital and book value of capital employed in one value. It estimates the amount by which the earnings surpass or fall short of the minimum required rate of return by capital providers. The EVA for the company was negative during the two years. Besides, the value dropped from ($21,905.77m) in 2013 to ($26,108.19m) in 2014. The negative values imply that the company is not creating value for the shareholders and it is advisable to close the business. In such a scenario, the company needs to put in place turn around measures that that can help in increasing profitability. One advantage of this tool is that it gives the true economic profit of a company. This can help to know the true financial standing. On the other hand, this approach is not adequate, it needs to be used with other techniques (Agrawal, 2010).

Return on equity

Through the DuPont analysis, the return on equity can be broken down into three components. These are net profit margin, financial leverage and asset turnover. The return on equity for the company dropped from 27.44% in 2013 to 12.8% in 2014. This implies that the ability of the company to generate funds for the shareholders dropped. One advantage of approach is that it gives information on profitability, efficiency and leverage of the entity. A disadvantage is that it highly depends on the denominator (Stuart, 2009).

References

Agrawal, N. K. (2010). Principle of management accounting. India: Asian Books Private Limited.

Stuart, A. (2009). Transfer pricing: a world of pain. Web.

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Walther, l. (2012). Chapter twenty-one – budgeting: planning for success. Web.

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