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FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Profitability ratios

Your boss has asked you to calculate the profitability ratios of Triptych Food Corp. and make comments on its second-year performance as compared with its first-year performance.

The following shows Triptych Food Corp.’s income statement for the last two years. The company had assets of $7,050 million in the first year and $11,278 million in the second year. Common equity was equal to $3,750 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year.

Triptych Food Corp. Income Statement For the Year Ending on December 31 (Millions of dollars)

	Year 2	Year 1
Net Sales	3,810	3,000
Operating costs except depreciation and amortization	1,365	1,268
Depreciation and amortization	191	120
Total Operating Costs	1,556	1,388
Operating Income (or EBIT)	2,254	1,612
Less: Interest	304	169
Earnings before taxes (EBT)	1,950	1,443
Less: Taxes (40%)	780	577
Net Income	1,170	866

Calculate the profitability ratios of Triptych Food Corp. in the following table. Convert all calculations to a percentage rounded to two decimal places.

Ratio	Value
	Year 2	Year 1
Operating margin		53.73%
Profit margin	30.71%
Return on total assets		12.28%
Return on common equity		23.09%
Basic earning power	19.99%

Decision makers and analysts look deeply into profitability ratios to identify trends in a company’s profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.

1. A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both.

2. If a company’s operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.

3. An increase in the return on assets ratio implies an increase in the assets a firm owns.

4. If a company issues new common shares but its net income does not increase, return on common equity will increase.

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