How Operations Impacts Financial Performance

Abstract

This note explains the building blocks of common financial performance metrics and show how operations affect those metrics. Return on assets (ROA) and return on equity (ROE) are two key measures of the financial performance of a firm. ROA captures the operational aspects of the firm while ROE captures the financing decisions of the firm.

Excerpt

UVA-OM-1779

Oct. 24, 2022

How Operations Impacts Financial Performance

This note will explain the building blocks of common financial performance metrics and show how operations affect those metrics. Return on assets (ROA) and return on equity (ROE) are two key measures of the financial performance of a firm. ROA captures the operational aspects of the firm while ROE captures the financing decisions of the firm.

ROA is defined as net income divided by total assets, and ROE is defined as net income divided by shareholders' equity. From an operational perspective, ROA and ROE are measures of productivity, as they capture output created per unit of input. In general, the higher these numbers, the better the firm's performance.

ROA and ROE are related, and in the 1920s, the DuPont Corporation invented a model that decomposed ROA and ROE into their component parts in order to provide a more detailed analysis of performance. ROA can be shown to be equal to profit margin multiplied by asset turnover:

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Keywords: financial performance metrics, operations, return on assets, return on equity, DuPont chart, sales