The impact of the tax advantage on corporate profitability: The decomposition approach

Abstract

Copyright © 2018 International Business Information Management Association (IBIMA). The financial performance of an enterprise is affected by many microeconomic as well as macroeconomic factors. A tax advantage, also called a tax shield, affects four interconnected components of financial performance: profit, cash flow, profitability and the value of business. Traditionally, the value of tax shield is associated with the issue of capital structure and the value of business. In this paper, we examined the impact of the tax shield (tax advantage) on corporate profitability. As a suitable method, an extended DuPont analysis has been chosen to distinguish five ratios affecting ROE: tax-effect ratio, financial cost ratio, operating profit margin, asset turnover and equity multiplier. The aim of the paper is to analyse the impact of the total tax shield on ROE by deviation analysis. Multi-period deviation analysis has been used because tax benefits have a long-term effect on the profitability of an enterprise. At the same time, two period deviation analysis was used to assess the development trend of the impact of the tax shield. The analysis results show that the tax effect represented by the tax effect ratio has a relatively low overall impact on the profitability of the analysed enterprise. On the other hand, deviation analysis should be interpreted with regard to the business and macroeconomic environment. In this regard, four major factors in the Slovak Republic were found: the change in the rules on depreciation of fixed assets, the change in the rules of loss carry forward, changes in the corporate tax rate and the decrease in interest rates.