Businessman Investor

Touching base with the rational business psyche of stock market investors

Sunday, December 7, 2014

The Burden of Taxation and the Final Form of Corporate Profitability


After Tax as The Final Form of Corporate Profitability.
Return on Assets (ROA) is the final form of corporate profitability
which factors in all components: mark-up, working capital
turnover, capital spending, cost of borrowing, and tax burden.
As of this stage, we have arrived at After Interest Business Profitability (or as expressed mathematically, EBT/Operating Assets). This profitability metric, in conjunction with Non-core Business Profitability, would now be more appropriate to be subjected to the Burden of Taxation. To review:

EBT / Operating Assets = After Interest Business Profitability

Other Income / Non-core Business Investments = Non-core Business Profitability

Non-core Business Profitability captures profitability that is outside the company's core business operations. It has something to do with investment income earned (e.g. interest income, capital gains, dividends, etc.) from real estate, stock, bonds, or other money market investment instruments. We combine both After Interest Business Profitability and Non-core Business Profitability as follows:

(EBT/Operating Assets) x (Operating Assets/Total Assets)
plus
(Other Income/Non-core Business Investments) x (Non-core Business Investments/Total Assets)
equals
(EBT + Other Income)/Total Assets

where:

EBT + Other Income = Income Before Taxes
thus:

Income Before Taxes/Total Assets = Before Tax Corporate Profitability (notice I omitted the use of the word "Business" since this profitability measure also factors in profitability coming from non-core business operations).

This pre-tax profitability measure would now be appropriate to be subjected to taxation, or the Tax Burden:

Net Income/Income Before TaxesTax Burden

Tax Burden is a ratio of post-tax income (i.e. Net Income) against pre-tax income (Income Before Taxes). Thus, if tax rate is at 30%, then that would imply a tax burden of 70%. Applying the Tax Burden towards Before Tax Corporate Profitability, we observe the following:

(Income Before Taxes/Total Assets)
multiplied by
(Net Income/Income Before Taxes)

equals

Net Income/Total Assets

... which as we would all be familiar with, our standard Return on Assets (ROA).

As we can observe throughout the process of dissecting corporate profitability, ROA is the final form of corporate profitability which factors in all components at different levels: mark-up, working capital turnover, capital spending (i.e. depreciation & amortization), cost of borrowing (i.e. interest), and taxes.

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The information presented here is for educational purposes only. Under no circumstances should it be construed as a recommendation to buy, sell, or hold any stocks. If you choose to use this information, you do so at your own risk.

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