Does it make sense to adjust net income by multiplying by the proportion of equity to total assets when calculating ratios? Not for the exams, but for practical purposes?
Makes sense for what? Some leverage-adjusted notion of net income for some reason?
To me not. Do you know the rationale for this adjustment?
A friend of mind suggested it to me as a way to adjust for leverage and get a ‘truer’ sense of NI. It didn’t seem right to me, but I wanted to get your opinions. Thanks!
Never heard of that. You want to look at debt-equity mix and interest coverage ratios among other things to understand how levered a company is. Total assets really aren’t that relevant.
That seems odd. If you did that, you might be trying to get at “what proportion of Net Income can be attributed to equity provision vs debt provision.” However, it wouldn’t make any sense to do that with Net Income, because NI comes after interest payments have been deducted, so debt holders should get no portion of NI. If you add back the (after tax) interest paid, you might get a kind of quick and dirty cash flow to assets estimation and apportion it to different capital providers. Then, if you compare that to ROE, you get a sense of how leverage has magnified equity returns. But it seems that there are other more direct and appropriate ways to analyze this sort stuff (just look at ROA, or do a FCF calculation), and it doesn’t require all that much more work.