BUS-4072_FouchTashia_Week3Assignment

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Week 3 Assignment: Key Ratios and Performance Measures Tashia Fouch Capella University BUS-4072: Analysis for Financial Management Professor Robert Watson January 2024

P.74 – Problem 8 Table 3.1 in Chapter 3 presents financial statements over the period 2014 through 2017 for R&E Supplies, Inc.

a. Use these statements to calculate as many of the ratios in Table 2.2 as you can. 2014 2015 2016 2017 Profitability Ratios Net Profit Ratio [(Net Profit/Net Sales)*100] 3.29% [(369/11,190)*100] 2.89% [398/13,764)*100] 2.37% [(383/16,104)*100] 1.41% [(291/20,613)*100] Gross Profit Ratio [(Gross Profit/Net sales)*100] 15.99% [(1,790/11,190)*100] 15% [(2,065/13,764)*100] 15% [(2,416/16,104)*100] 14% [(2,886/20,613)*100] Return on Equity [Net Income/Shareholder's Equity] 0.30 [369/ (150+1043)] 0.28 [398/(150+1,242)] 0.24 [383/(150+1,434)] 0.16 [291/(150+1,580)] Liquidity and Leverage Ratios Current Asset Ratio (Current Assets/Current Liabilities) 2.80 (3,147/1,122) 2.40 (3,728/1,550) 1.84 (4,685/2,536) 1.65 (5,583/3,380) Debt to Asset Ratio (short term liabilities + long term liabiities / Total Assets) 0.63 [(1,122+960)/3,275] 0.63 [(1,550+910)/3,852] 0.68 [(2,536+860)/4,980] 0.70 [(3,380+760)/5,870)] Debt to Equity Ratio 1.74 [(1,122+960)/(150+1,043)] 1.76 [(1,550+910)/(150+1,242)] 2.14 [(2,536+860)/150+1,434)] 2.39 [(3,380+760)/(150+1,580)] Turnover Ratios Asset Turnover Ratio (Net Sales/Average Total Assets) 3.41 [11,190/3,275] 1.93 [13,764/(3,275+3,852)/2] 3.64 [16,104/(3,852+4,980)/2] 3.79 [20,613/(4,980+5,870)/2] Fixed Asset Turnover Ratio (Net Sales/Average Net Fixed Assets) 87.42 [11,190/128] 109.2 [13,764/(128+124)/2] 76.86 [16,104/(124+295)/2] 70.83 [20,613/(295+287)/2] Inventory Turnover Ratio (COGS/Average Inventory) 8.4 [9,400/1,119] 9.37 [11,699/(1,119+1,376)2] 8.27 [13,688/(1,376+1,932)/2] 8.44 [20,613/1,932+2,267)/2] b. What insights do thes e ratios provide about R&E’s financial performance? What problems, if any, does the company appear to have? R&E ’ s profitability ratios increased over the period from 2012 to 2016. The profitability ratios are more than the industry average, so the company is performing well financially. R&E ’ s profit margin increased from 8.2 in 2012 to 11.0 in 2016, which is a bit lower than the industry average of 11.5. The gross margin ratio increased from 53.2 to 55.6 over the period and is higher than the industry average of 53.8. The price-to-earnings ratio increased from 13.8 to 17.9 over the period, but is lower than the industry average of 29.9. R&E ’ s asset turnover ratios are performing good when compared to industry averages. The inventory turnover ratio is very low when compared to the industry average of 14.0, which means that R&E ’ s ability to sell its inventory is less than it should be. R&E ’ s collection period is in the 90s throughout the period. Compared to the industry average of 60, this indicates that R&E is unable to timely collect its debts as per industry standard. Days sales in cash is less when compared to the industry average, which means that R&E is able to sell products in cash quicker than industry average. Payable period days are lower than the industry average, which means R&E pays its suppliers very quickly. Debt-to-assets and debt-to-equity ratios are more when compared to industry average, indicating that R&E is using more debt, which increases its cost of debt. Times interest earned is also lower than industry average, which means R&E ’ s ability to pay interest is less. The current ratio is also lower than industry average, indicating that R&E is able to pay its current liabilities, but not on the level of industry standard.

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From these ratios, R&E ’ s problems are: low profit margin, higher collection period (which suggests inability to collect its debts, which may lead to bad debts), and losses to the company. The payable period is lower than industry average, which decreases the company ’ s cash flows. The ratio of debt to assets and equity is also higher than average, which increases the cost of debt and lowers R&E ’ s ability to pay the interest, which is evident by the times interest earned ratio being lower than industry average. Additional Problem Observe the sales-to-net property, plant, and equipment ratios for the same year for American Airlines (1.258), Oracle Corporation (10.338), Alcan, Inc. an aluminum manufacturer (1.907), and Yahoo, Inc. (5.834). Respond to the following: What does the ratio tell you about each of these companies? How can you explain the wide differences you observe in the ratio? The total asset turnover ratio is an efficiency measure that compares a company ’s net sales with its average total assets in order to assess the company ’s ability to generate sales from its assets. The total asset turnover ratio calculates net sales as a percentage of assets to show how many sales are generated from each dollar of the company ’s assets. For example, a ratio of 1.258 means that each dollar of net assets generates $1.258 of sales for American Airlines. Similarly, a ratio of 10.338 means that each dollar of net assets generates $ 10.338 of sales for Oracle; a ratio of 1.907 means that each dollar of net assets generates $1.907 for Alcan; and a ratio of 5.834 means each dollar of net assets generates $5.834 of sales for Yahoo, Inc. The asset turnover ratio is calculated by dividing net sales by average total assets. Net sales shown on the company's income statement are used to calculate this ratio, so it is very important to eliminate all returns/refunds to accurately measure the ability of the company's assets to generate sales. Average total assets are calculated by adding the beginning and ending total asset balances and dividing by two. It ’s a simple average based on a two-year balance sheet. A more in-depth, weighted average calculation is generally preferred. A higher ratio is always more favorable. Higher asset turnover ratios imply that Oracle is using its assets far more efficiently than Yahoo, Alcan and American Airlines. Lower ratios mean that the company isn't using its assets efficiently and most likely has management or production problems, i.e. idle time, down time, strikes, lockouts, operations scheduling, crew availability, etc. It could also mean that a particular company, American Airlines for example, doesn ’ t offer incentives (i.e. cabin, check-in, travel discounts, free miles, etc,) that are sufficiently competitive with other companies. This would result in lower sales. Like most ratios, the asset turnover ratio is based on industry standards. Therefore, it ’ s necessary to compare each company ’ s asset turnover ratio with those of its industry peers. This gives the most accurate view of the implications of ratios because it takes into consideration that the company ’ s industry peers may also be facing similar constraints to efficient use of their assets.

BUS-4072_FouchTashia_Week3Assignment

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