Chapter 20, Problem 40E

To determine

Compute the following ratios for Incorporation, Y B for 2012 and 2013.

1. a. Gross margin percent
2. b. Return assets
3. c. Return on equity

Explanation of Solution

Analysis of the financial ratio utilizes the ratios of financial statements to evaluate the performance of the firm. Two common performance measures include liquidity and profitability. The four key profitability ratios are gross margin percent, return on assets, return on equity, and earnings per share.

Profitability ratios are a class of financial metrics that are used over time to evaluate the ability of a business to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders' equity, using data from a specific time point.

1. a. Gross margin percent

The Gross Margin Ratio is a profitability ratio, which is also known as the gross profit margin ratio. It shows how much profit a firm makes after paying off its cost of goods sold.

1. a. Calculate Gross margin percent ratio for Incorporation, Y B.

For 2013,

Gross margin for 2013 is $3,583.

Sales in 2013 are $13,084.

The formula to calculate gross margin ratio is:

$\text{Gross margin \% ratio}=\frac{\text{Gross margin}}{\text{Sales}}\times 100$

Calculate gross margin % ratio:

$\begin{array}{c}\text{Gross margin \% ratio}=\frac{\$3,583}{13,084}\times 100\\ =27.4\%\end{array}$

Hence, the gross margin ratio for 2013 is 27.4%.

For 2012,

Gross margin for 2012 is $3,780

Sales in 2012 are $13,632.

The formula to calculate gross margin ratio is:

$\text{Gross margin \% ratio}=\frac{\text{Gross margin}}{\text{Sales}}\times 100$

Calculate gross margin % ratio:

$\begin{array}{c}\text{Gross margin \% ratio}=\frac{\$3,780}{13,632}\times 100\\ =27.7\%\end{array}$

Hence, the gross margin ratio for 2013 is 27.7%.

1. b. Return on assets

Return on assets is a profitability ratio that gives a company how much profit a business can generate from its assets. It initiatives how efficiently a company manages to generate profits from its economic resources or assets in its balance sheet

For 2013

Net income in 2013 is $1,091.

Total assets in 2013 are $8,695.

Total assets in 2012 are $9,013.

Calculate average total assets:

$\begin{array}{c}\text{Average total assets}=\frac{\$8,695+\$9,013}{2}\\ =\$8,854\end{array}$

The formula to calculate the return in assets ratio is:

$\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}$

Calculate return in assets ratio for 2013:

$\begin{array}{c}\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}\\ =\frac{\$1,091}{\$8,854}\\ =12.3\%\end{array}$

Hence, the return in assets for 2013 is 12.3%.

For 2012

Net income in 2012 is $1,597.

Total assets in 2012 are $9,013.

Total assets in 2011 are $8,834.

Calculate average total assets:

$\begin{array}{c}\text{Average total assets}=\frac{\$9,013+\$8,834}{2}\\ =\$8,923.5\end{array}$

The formula to calculate the return in assets ratio is:

$\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}$

Calculate return in assets ratio for 2012:

$\begin{array}{c}\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}\\ =\frac{\$1,597}{\$8,923.5}\\ =17.9\%\end{array}$

Hence, the return in assets for 2012 is 17.9%.

1. c. Return on equity

The return on equity ratio essentially measures the rate of return received by the owners of a company's common stock on their shareholdings. It means how efficient a company is in producing returns on the investment that its shareholders have received.

The formula to calculate the return on equity ratio is:

$\text{Return on equity Ratio}=\frac{\text{Net income}}{\text{Stockholder's equity}}$

Net income in 2013 is $1,091.

Shareholder’s equity in 2013 is $2,229.

Shareholder’s equity in 2012 is $2,253.

Calculate average shareholder’s equity:

$\begin{array}{c}\text{Average shareholder's equity}=\frac{\$2,229+\$2,253}{2}\\ =2,241\end{array}$

Calculate return on equity ratio for 2013:

$\begin{array}{c}\text{Return on equity Ratio}=\frac{\text{Net income}}{\text{Stockholder's equity}}\\ =\frac{\$1,091}{\$2,241}\\ =48.7\%\end{array}$

Hence, the return on equity ratio for 2013 is 48.7%.

The formula to calculate the return on equity ratio is:

$\text{Return on equity Ratio}=\frac{\text{Net income}}{\text{Stockholder's equity}}$

Net income in 2012 is $1,597.

Shareholder’s equity in 2012 is $2,253.

Shareholder’s equity in 2011 is $1,916.

Calculate average shareholder’s equity:

$\begin{array}{c}\text{Average shareholder's equity}=\frac{\$2,253+\$1,916}{2}\\ =2,084.5\end{array}$

Calculate return on equity ratio for 2012:

$\begin{array}{c}\text{Return on equity Ratio}=\frac{\text{Net income}}{\text{Stockholder's equity}}\\ =\frac{\$1,597}{\$2,084.5}\\ =76.6\%\end{array}$

Hence, the return on equity ratio for 2012 is 76.6%.

It is concluded that, from 2012 until 2013, the gross margin ratio is fairly constant. The large decline in revenue in 2013 far exceeded the decline in assets, thus drastically reducing return on assets. Stockholders ' equity was fairly stable, resulting in a substantial decrease in return on equity.