Review of Accounting Studies, 6, 371–385, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
Using Asset Turnover and Proﬁt Margin
to Forecast Changes in Proﬁtability
PATRICIA M. FAIRFIELD AND TERI LOMBARDI YOHN*
Abstract. Financial statement analysis textbooks advocate disaggregating proﬁtability into asset turnover and
proﬁt margin in performing ﬁnancial analysis. In spite of the prominence of this technique, there is no evidence
demonstrating its usefulness in a forecasting context. We provide evidence that disaggregating return on assets
into asset turnover and proﬁt margin does not provide incremental information for forecasting the change in return
on assets one year ahead, but that disaggregating the change in return on assets into the change in asset turnover
and the change in proﬁt margin is useful in forecasting the change in return on assets one year ahead.
Keywords: ﬁnancial statement analysis, disaggregation, return on assets
One objective of ﬁnancial statement analysis is to determine ﬁrm value. Research suggests
that a ﬁrm’s value is a function of the expected future growth and proﬁtability of the ﬁrm
(e.g., Ohlson, 1995). In analyzing ﬁnancial statements, analysts often use current growth
and proﬁtability as a starting point for predicting future growth and proﬁtability. Textbooks
on ﬁnancial statement analysis present a variety of simple techniques for analyzing current
proﬁtability that may lead to improved forecasts of future proﬁtability. Most commonly, the
textbooks present ratio analysis in which return on assets is systematically disaggregated into
more speciﬁc ratios to provide insights into the ﬁrm’s proﬁtability. The most fundamental
disaggregation, featured prominently in many books (Bernstein and Wild, 1998; Revsine,
Collins and Johnson, 1999; Stickney and Brown, 1999), is the decomposition of return
on assets into asset turnover and proﬁt margin.
Textbooks suggest that calculating the
relative contributions of asset turnover (or “asset utilization”) and proﬁt margin (“operating
performance”) to current proﬁtability is useful in providing insights into the ﬁrm’s strategy.
Furthermore, many textbooks also suggest calculating changes in the ratios to track changes
in the company’s asset utilization and operating performance over time.
Since one purpose of ﬁnancial statement analysis is to predict future performance, it
would be useful to know whether this fundamental disaggregation improves proﬁtability
forecasts. Although this simple decomposition is presented as a fundamental building block
of ﬁnancial analysis, there is no evidence in the accounting literature to demonstrate its
usefulness for forecasting proﬁtability.
Prior research provides evidence on the usefulness
of a variety of descriptors in prediciting future proﬁtability; (e.g., Ou, 1990; Abarbanell and
Corresponding Author: Teri Lombardi Yohn, 307 Old North, McDonough School of Business, Georgetown
University, Washington D.C. 20057. E-mail: email@example.com