Written ROE Exam 1 William Boswell 2

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Boswell 1 William Boswell Dr. Blazer BUAD 341 02/20/2022 Exam 1: Avery Corp ROE Decomposition OVERALL: Avery Corp’s ROE increased substantially over the past three years from 17% in 2019 to 21% in 2021 but, still was below the industry average of 24%. The cause of this increase comes from a decrease in Avery Corp’s profit margin and an increase in their asset turnover. These were offset by the increase in their financial leverage. Avery Corp’s net profit margin diminished from 8.07% to 6.89%, which is not a huge drop off over three years, they still were not near the industry average of 9.71%. Financial leverage rose from 1.51 in 2019 to 1.79 in 2021. This is above the industry average of 1.54 so, they are taking on more financial risk. Avery Corp’s asset turnover has increased from 1.47 in 2019 to 1.73 in 2021. Their asset turnover as of 2021 is better than the industry average of 1.67. PROFITABILITY: Regardless of Avery Corp’s sales holding steadily in an upwards direction, Avery Corp’s net profit margin decreased from 8.07% to 6.89%, which is below the industry average of 9.7%. Contributing to this decline are the increasing costs of good sold, SG&A, and the interest expense as a percentage of sales. Two offsetting factors were the decline of the tax expense and the depreciation expense as a percentage of sales. Avery Corp’s gross profit margin declined from 55.30% in 2019 to 54.70% in 2021 and remained below the industry average of 58%. SG&A as a percentage of sales rose from 13.04% in 2019 to 15.21% in 2021, which is no where near the industry average of 40%. Interest expense increased as a percentage of sales from 0.62% in 2019 to 0.99% in 2021, which is roughly above the industry average. This could be due to

Boswell 2 higher borrowing costs but, their financial leverage has risen over the past three years. A couple factors that offset these increasing expenses are the depreciation expense and the tax expense. Avery Corp’s depreciation expense decreased from 4.16% in 2019 to 3.92% in 2021, but still very much above the industry average of 2.10%. The tax expense for Avery Corp decreased as well from 4.35% in 2019 to 3.40% in 2021. This puts them below the industry average of 5.23%. This is due to Avery Corp’s decreased profitability and lower average tax rate, which dropped from 35% to 33%. ASSEST TURNOVER: Avery Corp’s decreasing profit margin has been contributed to by an increased asset turnover ratio. Avery Corp’s asset turnover increased from 1.47 in 2019 to 1.73 in 2021, which is now above the industry average of 1.67. Accounts receivable and inventories, which make up for roughly 30% of their total assets but, are not the primary source of improvement for their company. Increasing levels of cash have also contributed to the overall trend, while inventory turnover is an offsetting factor. Avery Corp has condensed its A/R collection period from 47 days to 37 days, which is well below the industry average of 55 days meaning Avery has had good control over its inventory for some time now. Avery Corp’s increased its inventory period from 63 days to 74 days, which is not near the industry average of 104 days. Avery Corp might be raising their prices which is offsetting the inventory turnover. Also, offsetting to Avery Corp’s improved turnover ratio is its increasing cash as a percentage of sales, day’s sales in cash has climbed from 6.30 days to 9.20, which is improvement towards the industry average of 24 days. However, this means that Avery Corp has liquidity issues. To what is contributing to the trend is Avery Corp’s increasing fixed asset turnover. Fixed asset turnover

Boswell 3 increased from 2.30 times in 2019 to 3.00 in 202. With an industry average of 4.76, this increased is expected to continue. FINANCIAL LEVERAGE: Avery Corp’s has decided to increase its financial leverage. Its asset to equity ratio increased from 1.51 in 2019 to 1.79 in 2021, which is well above the industry average of 1.54. On most occasions, an increase in financial leverage indicates more financial risk, which is causing Avery Corp to have some liquidity problems. Avery Corp’s operating cash flows positively $238 million over the past two years and has stayed profitable as well. Its financing cash flows were not that big of a help contributing over $334 million over the past two years. The $150 million decrease in common stock offsets to Avery Corp’s increase in financial leverage. Given that Avery Corp is profitable but has poor liquidity, they may have a hard time their equity in the future. Even though Avery Corp’s increased its financial leverage, its times interest ratio has dramatically declined from 21.11 to 15.35, which is just below the industry average of 16.46. While Avery Corp’s interest expense increased over the past three years, the primary source for the declining TIE ratio is Avery Corp’s decreasing profit margin. Avery Corp’s cash conversion cycle has declined from 153 days in 2019 to 139 days in 2021, which is a little over the industry average of 133 days. Avery Corp is working its way to lower their cash conversion cycle by lengthening their pay period but, have a long way to go. Avery Corp at this moment is not improving and has a weak financial position in terms of liquidity and equity. LIQUIDITY: Despite increasing having cash on hand, Avery Corp has a handful of liquidity problems. It has decreases on their current ratios, has reported negative financial cash flows for the past two

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Boswell 4 years, and has a bank loan to fund operations. While the only thing improved was days sales in cash from 6.30 to 9.20, it is still dramatically below its industry average of 24.09. Avery Corp’s current ratio is down 1.71 to 1.01 and their quick ratio has fallen from 1.15 to 0.61, which is well below their industry averages of 3.05 and 2.05. Although Avery Corp is profitable in their operating cash flows and can support their investing needs, they had negative financing cash flows of almost $334 million dollars due to the bank loan and long-term debt. Avery Corp’s operating cash flows are decreasing and becoming weaker due to them having to pay back their debt over the past three years. Avery Corp’s liquidity is not improving due to these factors and will continue to have a weak financial position until they pay off their bank loan and long-term debt. RECOMMEDATIONS: Avery Corp needs to find a way to pay off their bank loan and debt to have financing cash flows in the future. Even though they stayed profitable over the past three years, their operating cash flows are declining and is only a matter of time before they will not be able to meet their investing needs. Avery Corp should also consider trying to decrease their COGS and SG&A expenses as a percentage of sale to help the profit margin increase. Avery Corp needs to improve their TIE ratio and cash flow conversion cycle as well to start generating solvency to decrease their financial leverage.

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