Profitability: comparing corporate performance Kao Corporation is a Japanese toiletries and household products group. The range of its products is similar to that of US-based Procter & Gamble but the group is smaller (2001/02 sales of US$6.3 bn vs P&G’s US$40 bn) and less international (domestic sales 75% vs 53% for P&G). Although Kao’s profits have grown rapidly in the five years to 2002, its profitability in 2001/02 still lagged behind P&G’s. P&G’s group ROE in 2001/02 was 33.8%. By contrast, Kao’s was only 12.9% that year. Kao’s financial statements for 2001/02 are presented in condensed form in Exhibit 19.17.

Summary income and balance sheet numbers taken from P&G’s 2001/02 accounts are given below. (P&G discloses no information about minority interests. Group and parent company equity are assumed to be the same.)
Procter & Gamble Financial year to: 30 June 2002 US$ bn Net sales 40.24 Cost of sales −20.99 Selling, general and administrative expenses −12.57 Interest expense, net −0.50 Other non-operating income, net 0.20 Income taxes −2.03 Net earnings 4.35 Average net operating assets 23.27 Average shareholders’ equity 12.86 Required

(a) Calculate Procter & Gamble’s and Kao’s return on net operating assets (RONOA) for each company’s 2001/02 financial year. P&G’s marginal tax rate is 35%, Kao’s is 42% that year.

(b) Break down RONOA into its profit margin and assets turnover components. What are the reasons for P&G’s higher profit margin?

(c) The president of Kao Corporation is puzzled. P&G’s RONOA in 2001/02 is only around 3.7 percentage points greater than Kao’s but its ROE that year is over 20 percentage points greater (33.8% vs 12.9%). Explain the reason for P&G’s superior performance at the ROE level.AppenedixLO1

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Exhibit 19.17 Kao Corporation: condensed financial statements, 2002 Condensed income statement for year to 31 March 2002 Net sales Cost of sales Gross profit Selling, general and administrative expenses Operating Income Interest income, net of interest expense Other non-operating expense, net Income before taxes and minority interests Income tax expense Income before minority Interests Minority interests in earnings of consolidated subsidiaries Net Income Condensed balance sheets at end-March 2001 and 2002 million 839,026 -361,433 477,593 -365,865 111,728 31 -3,818 107,941 -45,778 62,163 -1,888 60,275 million 2002 2001 Current assets Cash and short-term investments 159,130 173,250 Notes and accounts receivable, net of allowance for doubtful accounts 102,244 105,319 Inventories 67,220 69,903 Other current assets 24,168 17,739 Total current assets 352,762 366,211 Property, plant and equipment, at net book value 295,563 297,958 Intangible assets 53,158 57,370 Investments and other assets 70,662 62,221 Total assets 772,145 783,760 Current liabilities Short-term debt and current portion of long-term debt 19,290 26,272 Notes and accounts payable 91,603 98,627 Accrued expenses and other current liabilities 103,759 105,695 Total current liabilities 214,652 230,594 Long-term liabilities Long-term debt 36,676 43,142 Other long-term liabilities 38,354 26,314 75,030 69,456 Minority Interests 22,732 20,722 Shareholders' equity 459,731 462,988 Total liabilities and shareholders' equity 772,145 783,760