Capital Expenditure (CAPEX)
Working Capital
Return on Equity:
Financial Gearing (or Leverage)
Asset Turnover (Efficiency)
Profit Margin
Capital Employed:
Explanation: It represents the total amount of capital used for the acquisition of profits. It's
a measure reflecting the long-term funds used by a company to generate profits through its
operations.
Links and Explanations
Capital Employed = Debt (long-term liability) + Equity: The sum of money borrowed
(debt) and money raised from the owners or shareholders (equity) represents the total
capital employed in the business.
Capital Employed = Total Asset - Total Current Liability: When you subtract the short-
term debts/obligations from the total assets, you get the net capital employed in long-
term investments and operations.
Capital Employed = Fixed assets + Working Capital: This formula highlights the fixed
investments plus the net current assets required to run everyday operations.
Equity:
Explanation: It represents the ownership value belonging to the shareholders of a company.
It signifies the residual interest in the assets of the company after deducting liabilities.
Links and Explanations
Equity = Net Asset = Asset - Liabilities
Equity = Common Shareholder’s Equity (CSE) + Preferred Stock: Equity is split between
common shareholders and preferred shareholders. Common Shareholder’s Equity is
what belongs to the common shareholders, and Preferred Stock is what belongs to
preferred shareholders.
Beginning CSE + Net Income to Common (Profit) + Stock-Based Compensation +
Common Shares Issued - Common Dividends - Common Shares Repurchased = Ending
CSE: This formula shows the changes in common shareholders' equity over a period
Liabilities:
Explanation: It represent the financial obligations or debts that a company owes to external
parties. These can be short-term (current) liabilities that need to be settled within a year, or
long-term liabilities that are due beyond one year.
Links and Explanations
Liabilities = Asset - Equity: It means that after accounting for the owners' stake, the
remainder of the assets' value is owed to creditors.
Liabilities = Current Liabilities + Non-Current Liabilities: Liabilities are split into current
and non-current to distinguish between short-term and long-term obligations, which
helps in assessing the company's liquidity and financial health.
Current Liabilities = Operating Current Liabilities (Part of Working Capital) + Non-
Operating Current Liabilities: Current liabilities are separated into those arising from
operations and those from non-operating activities, providing a clearer picture of the
company's immediate financial obligations.
Assets
Sales Revenue
OPEX
Debt
EBITDA
Financial Gearing (or Leverage)
Asset Turnover (Efficiency)
Profit Margin
Operating Cash Flow
Profit
ROE = Profit Margin * Asset Turnover * Financial Gearing
Profitability: Sales Revenue, OPEX,EBITDA, Profit
Operating Efficiency: Working Capital,
Efficiency of utilizing external financing & Solvency:
Asset Turnover = Revenue / Asset
Denominator Drivers:
A) Financing sources to support Asset Acquisition
a) Equity: Internal source of financing => Components: Common/Preferred Stock +
Retained Earnings; Explanation: Equity funding is like using your own savings to start a
business. Since it often comes from retained earnings or shares sold to investors, it
represents the company's own resources and long-term financial commitment.
b) Liability: External source of financing; Components: Debt + Operating Liabilities (Non-
Interest Bearing); It provides necessary capital but requires regular interest payments
and eventual repayment of the principal amount.
i. Important Note: There's a consideration regarding whether operating liabilities
should be included as part of external financing sources. These non-interest
bearing liabilities, such as accounts payable and accrued expenses, arise from
business operations and may not be explicitly intended as financing sources. =>
Therefore, to avoid confusion and get a clear picture of the total financing used for
asset acquisition, it is logical to consider Capital Employed
c) Capital Employed: Debt + Equity => By focusing on Capital Employed as the measure,
we gain a comprehensive view of the total financing available to the business,
encapsulating all significant internal and external sources.
B) Ways of Asset Acquisition
1. CAPEX:
CAPEX involves the investment in non-current assets, such as Property, Plant, and Equipment
(PPE).
CAPEX and Working Capital both play pivotal roles in asset acquisition and have a direct impact
on asset turnover and future economic benefits.
The efficiency and effectiveness with which these investments translate into future revenue
determine whether they will lead to an increase or decrease in asset turnover:
CAPEX: A higher future economic benefit per unit of additional PPE translates to increased asset
turnover, while a lower benefit translates to a decreased turnover.
Working Capital: Similarly, efficient changes in working capital that yield higher future revenue
increase asset turnover, while inefficient changes lead to a decrease.
2. Increase of Non-Current Assets (PPE); higher future economic benefit (future revenue) created
by the per unit increase of PPE increase asset turnover; Lower future economic benefit created
by the per unit increase of PPE decrease asset turnover
3. Working Capital: Derived from changes in Net Operating (current) Asset, higher future
economic benefit (future revenue) created by the per unit increase of WC increase asset
turnover; Lower future economic benefit created by the per unit increase of WC decrease asset
turnover
