Return On EquityLooking For Wealth
| INCOME STATEMENT | ||
| Sales | $160,000 | 100.0% |
| Variable Costs | $90,000 | 56.3% |
| Period Costs | $40,000 | 25.0% |
| EBIT | $30,000 | 18.8% |
| Interest | $4,000 | 2.5% |
| Tax | $9,100 | 5.7% |
| Profit | $16,900 | 10.6% |
| LIABILITIES & OWNER'S EQUITY | ||
| Accounts Payable | $9,380 | 7.0% |
| Current Debt | $12,060 | 9.0% |
| Long Term Debt | $58,960 | 44.0% |
| Total Liabilities | $80,400 | 60.0% |
| Common Stock | $21,038 | 15.7% |
| Retained Earnings | $32,562 | 24.3% |
| Total Equity | $53,600 | 40.0% |
| Total Liab. & O. E. | $134,000 | 100.0% |
| RATIOS | ||
| ROS | 10.6% | |
| Asset Turnover | 119.4% | |
| Leverage | ||
| Assets/Equity | 2.5 | |
| (OR Assets/Debt | 1.7 | |
| times Debt/Equity) | 1.5 | |
| ROE | 31.5% | |
Traditionally, wealth is found at the EBIT line on the income statement. Looking at the income statement we can see that the wealth is split between lenders (interest) , government (taxes) , and owners (profits).
However, managers capture wealth before the EBIT line in form or salaries, buried in period costs. In recent times this has become a major issue in strategy, expressed in two parts, executive compensation and management turnover. Although that discussion is far broader than we can discuss here, we can note that if the company is publicly held, management will seek moderate levels of leverage, neither too low (risk of take-over) nor too high (risk of bankruptcy) . In privately held companies, management will prefer ROA to ROE and reduce leverage to more modest levels.