Question

The profit margin ratio is the only component of ROE that can be negative (except in the relatively rare case of negative shareholder equity). Describe how the interpretation of the Asset Turnover Ratio and the Financial Leverage Ratio change based on whether the Profit Margin Ratio is positive or negative.

Answer 1

Profit Margin Ratio analysis can be explained with DuPont analysis. The company's return on equity (ROE) help to identify whether it is high profit margin, efficient use of assets to generate more sales or use of more debt in its capital structure, but ROE can be negative due to change in level of profit margin means profit can become negative or loss.The company,s sale and average total asset are always positive and they are never negative. ROE can be positive when the company is earning the profit and if ROE is positive then it is considered to be good investment.

ROE = Net Income/Sales*Sales/Average Total Assets*Average Total Assets/ Average Shareholders' Equity