Chapter 11, Problem 4AP

1.

To determine

Calculate cash return on assets, cash flow to sales, and asset turnover ratio for Incorporation AE.

Explanation of Solution

Cash return on assets: Cash return on assets is the ratio that indicates the profit generated from the operating cash flows using the total assets of the company. It measures the operating cash flows earned per dollar of assets.

$\text{Cash Return on Assets}=\frac{\text{Operating cash flows }}{\text{Average Total Assets}}$

Given, Operating cash flow of Incorporation AE is $394,426 and total assets at beginning and at ending are $1,816,313 and $1,782,660 respectively.

Calculate Incorporation AE’s cash return on assets:

$\begin{array}{c}\text{Cash Return on Assets}=\frac{\text{Operating cash flows }}{\text{Average Total Assets}}\\ =\frac{\$394,426}{\left(\$1,816,313+\$1,782,660\right)÷2}\\ =\frac{\$394,426}{\$1,799,487}\\ =21.9\%\end{array}$

Therefore, cash return on assets of Incorporation AE is 21.9%.

Cash flow to sales: Cash flow to sales ratio is used to determine the amount of operating cash flows that is being generated per dollar of revenue or sales.

$\text{Cash flow to sales}=\frac{\text{Operating cash flows}}{\text{Net Sales }}$

Given, Operating cash flow is $394,426 and net sales revenue is $3,795,549.

Calculate Incorporation AE’s cash flow to sales:

$\begin{array}{c}\text{Cash flow to sales}=\frac{\text{Operating cash flows}}{\text{Net Sales }}\\ =\frac{\$394,426}{\$3,795,549}\\ =10.4\%\end{array}$

Therefore, profit margin of Incorporation AE is 10.4%.

Total Asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}$

Given, net sales are $3,795,549 and total assets at beginning and at ending are $1,816,313 and $1,782,660 respectively.

Compute Incorporation AE’s total assets turnover:

$\begin{array}{c}\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}\\ =\frac{\$3,795,549}{\left(\$1,816,313+\$1,782,660\right)÷2}\\ =\frac{\$3,795,549}{\$1,799,487}\\ =2.1\text{times}\end{array}$

Therefore, Incorporation AE’s total asset turnover is 2.1 times.

2.

To determine

Calculate the Incorporation B’s cash return on assets, cash flow to sales, and asset turnover ratio.

Explanation of Solution

Cash return on assets: Cash return on assets is the ratio that indicates the profit generated from the operating cash flows using the total assets of the company. It measures the operating cash flows earned per dollar of assets.

$\text{Cash Return on Assets}=\frac{\text{Operating cash flows }}{\text{Average Total Assets}}$

Given, operating cash flows of Incorporation B is $119,721 and total assets at beginning and at ending are $538,116 and $579,847 respectively.

Calculate Incorporation B’s cash return on assets:

$\begin{array}{c}\text{Return on Assets }\left(\text{ROA}\right)=\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}\\ =\frac{\$119,721}{\left(\$538,116+\$579,847\right)÷2}\\ =\frac{\$119,721}{\$558,982}\\ =21.4\%\end{array}$

Therefore, return on assets of Incorporation B is 21.4%.

Cash flow to sales: Cash flow to sales ratio is used to determine the amount of operating cash flows that is being generated per dollar of revenue or sales.

$\text{Cash flow to sales}=\frac{\text{Operating cash flows}}{\text{Net Sales }}$

Given, operating cash flows is $119,721 and net sales revenue is $913,380.

Calculate Incorporation B’s profit margin:

$\begin{array}{c}\text{Cash flow to sales}=\frac{\text{Operating cash flows}}{\text{Net Sales Revenue}}\\ =\frac{\$119,721}{\$913,380}\\ =13.1\%\end{array}$

Therefore, profit margin of Incorporation B is 13.1%.

Total Asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}$

Given, net sales are $913,380 and total assets are at beginning and at ending are $538,116 and $579,847 respectively.

Compute Incorporation B’s total assets turnover:

$\begin{array}{c}\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}\\ =\frac{\$913,380}{\left(\$538,116+\$579,847\right)÷2}\\ =\frac{\$913,380}{\$558,982}\\ =1.6\text{times}\end{array}$

Therefore, Incorporation B’s total asset turnover is 1.6 times.

3.

To determine

Identify the company which is doing better based on cash return on assets and also identify the company which is having higher cash flow to sales and total asset turnover.

Explanation of Solution

Find the company which is doing better based on return on assets and the company having higher cash flow to sales and asset turnover:

Particulars	Incorporation AE	Incorporation B
Cash return on assets	21.9%	21.4%
Cash flow to sales	10.4%	13.1%
Total assets turnover	2.1 times	1.6 times

Table (1)

As per Table (1), Incorporation AE is having the better cash return on asset ratio and higher total assets turnover ratio when compared with Incorporation B. The cash flow to sales ratio of Incorporation B is higher than the cash flow to sales ratio of Incorporation AE.