Financial Reporting II
Review of Ratio Analysis
Ratio analysis is a useful tool for analyzing financial statements. Calculating ratios will aid in understanding the company’s strategy and in understanding its strengths and weaknesses relative to other companies and over time. They can sometimes be useful in identifying earnings management and in understanding the effect of accounting choices on the firm’s reported profitability and growth. Finally, the ratios help in obtaining a better understanding of a firm’s current profitability, growth, and risk which can improve forecasts of future profitability and growth and estimates of the cost of capital.
In reviewing the basic financial ratios, we will examine the ratios of Best Buy
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Thus, the fall in ROA is not due to the reduction in income before financing costs per dollar of sales.
Asset Turnover
The asset turnover ratio (ATO) measures a firm's ability to generate revenues from a particular level of investment. ATO is calculated as follows:
Revenues
Average Total Assets
Best Buy
2002
2001
ATO
19597
6107.5
= 3.21
15327
3917.5
= 3.92
It appears that Best Buy’s fall in ROA was driven by a fall in ATO, not a fall in PM. The firm had difficulty generating sales from the assets in 2002 relative to 2001. For every dollar of average assets, Best Buy generated only $3.21 in sales in 2002 while Best Buy generated $3.92 in sales in 2001.
In order to gain even more insight into the source of the change in the ROA ratio, we can disaggregate the PM ratio and the ATO ratio to determine the source of the changes in those ratios.
Disaggregating the Profit Margin Ratio
To better understand why the profit margin ratio changed, the analyst can examine each income and expense item on the income statement as a percentage of revenue. This will provide insight into which components of the income statement changed over the period.
Best Buy
2002 2001
Cost of goods sold/sales 77.43% 80.04%
Selling, general and administrative expense/sales 17.82% 16.02%
Best Buy’s rise in profit margin in 2002 is due to
The change in the contribution margin for all the products is responsible for the change in profitability.
Financial ratio analysis is a valuable tool that allows one to assess the success, potential failure or future prospects of the company (Bazley 2012). The ratios are helpful in spotting useful trends that can indicate the warning signs of
Asset turnover (T/O) demonstrates how effective the asset base is in generating top line revenue. High T/O values have implications in terms of plant structure, level of backward integration, and aggressiveness of pricing policy. CUMULATIVE PROFITS Formula Cumulative Profits is the total Description of all year 's Net Profit. :
Profit margin ratio is the ratio between net income and net sale. This ratio discloses the earning capacity of the business. Higher profit margin ratio ensures high return to the owner or shareholders. It also helps in the growth of the business. Profit margin ratio of Peyton Approved is 53.44%, which is excellent and shows that company is has a good prospects in terms of
* Return on assets (ROA) – ROA shows how successful a company is in generating profits on the amount of assets they own. Since assets consist of debt and equity, ROA is a measure of how well a company converts investment dollars into profit. The higher the percentage, the more profit a company is generating per dollar of investment. Similar to ROS, this ratio needs to be looked at compared to the industry as different industries have different requirements that can affect ROA. For example, companies in the airline and mining industries need expensive assets to operate so will have lower ROA’s compared to companies in the pharmaceutical or advertising industries.
First of all, return on asset (ROA) is a ratio used to measure how efficient a company generates profit using its assets, which is the invested capital. We noticed that HH’s ROA was increasing from 2006 to 2010. However, HH’s ROA for 2011 dropped dramatically from 18.41%(year
Ratio analysis is a very useful tool when it comes to understanding the performance of the company. It highlights the strengths and the weaknesses of the company and pinpoints to the mangers and their subordinates as to which area of the company requires their attention be it prompt or gradual. The return on shareholder’s fund gives an estimate of the amount of profit available to be shared amongst the ordinary shareholders; where as the return on capital employed measures an organization 's profitability and the productivity with which its capital is utilized. Return on total assets is a profitability ratio that measures the net income created by total assets amid a period.
The rate of return on assets for Dollar General for 2010 was 6.8% thus for each dollar the company used it earned $0.068. For 2009 ROA was 3.8%, so ROA increased between 2009 and 2010 fiscal years. Profit Margin for ROA is 4.8% for 2010 and for 2009 is 2.9%. We can see an increase
The paper illustrates that financial ratio analysis is an important tool for firm’s to evaluate their financial health in order to identify areas of weakness so as to institute corrective measures.
So while the company increased its net income, it has done so with diminishing profit margins.
10. Fixed asset turnover = Total Revenues in Statement of Operations / Net Property and
Ratio analysis: Perform trend and ratio analysis on current and fixed assets, current and long term liabilities, owner’s equity, sales revenues, EBIT, net income, and earnings per share. Project these trends
With this company the inventory management ratios further indicate that there may be an issue with inventory and inventory controls. The inventory turnover ratio is lower than the industry average and the days’ sales in inventory are high. A company wants to turn inventory quickly to reduce storage costs, and
The Total Asset Turnover or ROA (Return on Asset) lets us know how effectively assets generate revenue. Accounts Receivable Turnover tells us how effectively a company is collecting money from sales. As we can see, both companies are doing pretty comparable and so far, this does not explain the sudden cliff on Profit Margin.
Asset utilization ratios measure how quickly a company is able to turn over their receivables, inventory, and other assets. The faster the company is able to turn over their assets, the more efficiently the company is running because they