Chapter 13, Problem 5EYK

a.

To determine

Compute the financial ratios of Incorporation GM for years 2013 and 2014.

Answer to Problem 5EYK

Ratios of Incorporation GM for years 2013 and 2014:

Particulars	Amount $ (in millions)	Amount $ (in millions)
	2013	2014
1. Gross profit percentage
Net sales (A)	17,774.1	17,909.6
Cost of sales (B)	11,350.2	11,539.8
Gross profit (C) $\left(\text{A}\right)-\left(\text{B}\right)$	6,423.9	6,3693.8
Net sales (D)	17,774.1	17,909.6
Gross profit percentage $\left(\text{C}\right)÷\left(\text{D}\right)$	36.14%	35.56%
2. Return on sales
Net income (A)	1,855.2	1824.4
Net sales (B)	17,774.1	17,909.6
Return on sales $\left(\text{A}\right)÷\left(\text{B}\right)$	10.61%	10.19%
3.  Assets turnover
Beginning Total Assets (A)	21,096.8	22,658.0
Ending Total Assets (B)	22,658.0	23,145.7
Average Total Assets (C) $\left[\left(A+B\right)÷2\right]$	21,877.4	22,901.8
Net sales (D)	17,774.1	17,909.6
Asset turnover ratio $\left(\text{D}\right)÷\left(\text{C}\right)$	0.81 times	0.78times
4. Return on Assets:
Beginning Total Assets (A)	21,096.8	22,658.0
Ending Total Assets (B)	22,658.0	23,145.7
Average Total Assets (C) $\left[\left(A+B\right)÷2\right]$	21,877.4	22,901.8
Net Income (D)	1,855.2	1824.4
Return on Assets $\left(\text{D}\right)÷\left(\text{C}\right)$	8.48%	7.97%
5. Return on Common Stockholders’ Equity:
Net Income	1,855.2	1,824.4
Less: Preferred Dividends	0	0
Net Income Available for Common Stockholders (A)	1,855.2	1,824.4
Beginning  Stockholders’ Equity (B)	6,421.7	6,672.2
Ending Common Stockholders’ Equity (C)	6,672.2	6,534.8
Average Common Stockholders’ Equity (D) $\left[\left(\text{B+C}\right)\text{ ÷ 2}\right]$	6,546.9	6,603.5
Return on Common Stockholders’ Equity $\left(\text{A}\right)÷\left(\text{D}\right)$	28.79%	27.63%
6. Current Ratio:
Total Current Assets (A)	4,298.9	4,393.5
Total Current Liabilities (B)	5,293.9	5,423.5
Current Ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	0.81	0.81
7. Quick Ratio:
Cash	741.4	867.3
Accounts receivable	1,446.4	1,483.6
Total Quick Assets (A)	2,187.8	2,350.9
Total Current Liabilities (B)	5,293.9	5,423.5
Quick Ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	0.41	0.43
8. Operating-cash-flows-to-current-liabilities:
Beginning Current liabilities (A)	3,843.2	5,293.9
Ending Current Liabilities (B)	5,293.9	5,423.5
Average Current Liabilities (C) $\left[\left(\text{A+B}\right)÷2\right]$	4,568.5	5,358.7
Cash flows from operating activities (D)	2,926.0	2,541.0
Operating-cash-flows-to-current-liabilities $\left(\text{D}\right)÷\left(\text{C}\right)$	0.64	0.47
9. Accounts receivable Turnover Ratio:
Net sales (A)	17,774.1	17,909.6
Beginning receivables (B)	1,323.6	1,446.4
Ending receivables (C)	1,446.4	1,483.6
Average Receivables (D) $\left[\left(\text{B+C}\right)\text{ ÷ 2}\right]$	1,385	1,465
Accounts receivables Turnover Ratio $\left(\text{A}\right)÷\left(\text{D}\right)$	12.83 times	12.22 times
10. Average collection period
Number of days in a year (A)	365	365
Accounts receivables Turnover Ratio  (B)	12.83 times	12.22 times
Average collection period $\left(\text{A}\right)÷\left(\text{B}\right)$	28 days	30 days
11. Inventory Turnover Ratio:
Cost of Goods Sold (A)	11,350.2	11,539.8
Beginning Inventory (B)	1,478.8	1,545.5
Ending Inventory (C)	1,545.5	1,559.4
Average Inventory (D) $\left[\left(\text{B}+\text{C}\right)\text{ ÷2}\right]$	1,512.2	1,552.5
Inventory Turnover Ratio $\left(\text{A}\right)÷\left(\text{D}\right)$	7.5times	7.4times
12. Days’ sales in inventory
Number of days in a year (A)	365	365
Inventory Turnover Ratio (B)	7.5 times	7.4 times
Days’ sales in inventory $\left(\text{A}\right)÷\left(\text{B}\right)$	49 days	49 days
13. Debt-to-Equity:
Total Liabilities (A)	14,562.0	15,156.2
Total Stockholders’ Equity (B)	6,672.2	6,534.8
Debt-to-Equity $\left(\text{A}\right)÷\left(\text{B}\right)$	2.18	2.31
14. Times-Interest-Earned:
Income before interest and income tax expense (A)	2,534.9	2,655.0
Interest Expense (B)	316.9	302.4
Times-Interest-Earned $\left(\text{A}\right)÷\left(\text{B}\right)$	7.99	8.78
15. Operating cash flow to capital expenditures:
Cash flows from operating activities (A)	2,926.0	2,541.0
Purchases of land, buildings and equipment	613.9	663.5
Proceeds from disposal of land, buildings and equipment	(24.2)	(6.6)
Net capital expenditures (B)	589.7	656.9
Operating cash flow to capital expenditures $\left(\text{A}\right)÷\left(\text{B}\right)$	4.96	3.86
16. Earnings per share
Net Income	1,855.2	1,824.4
Less: Preferred Dividends	0	0
Net Income Available for Common Stockholders (A)	1,855.2	1,824.4
Common stock	754.6	754.6
Less: Treasury stock	113.8	142.3
Weighted average common shares outstanding (B)	868.4shares	896.9shares
Earnings per share $\left(\text{A}\right)÷\left(\text{B}\right)$	$2.13 per share	$2.03 per share
17. Price earnings ratio:
Market price per share (A)	$48.98	$53.81
Earnings per share (B)	$2.13	$2.03
Price earnings ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	22.99 times	26.51 times
18. Dividends yield:
Dividends (A)	$867.6	$983.3
Number of common shares outstanding (B)	754.6 shares	754.6 shares
Dividends per share (C) $\left(\text{A}\right)÷\left(\text{B}\right)$	$1.14 per share	$1.30 per share
Market price per share (D)	$48.98	$53.81
Dividends yield $\left(\text{C}\right)÷\left(\text{D}\right)$	2.32%	2.41%
19. Dividends payout ratio:
Dividends per share (A)	$1.14	$1.30
Earnings per share (B)	$2.13	$2.03
Dividends payout ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	53.52%	64.03%

Table (1)

Explanation of Solution

1. 1. Gross profit percentage: The percentage of gross profit generated by every dollar of net sales is referred to as gross profit percentage. This ratio measures the profitability of a company by quantifying the amount of income earned from sales revenue generated after cost of goods sold are paid. The higher the ratio, the more ability to cover operating expenses. It is computed by the formula:
   
   

   $\text{Gross profit percentage}=\frac{\text{Gross profit on sales}}{\text{Net sales}}$

2. 2. Return on sales: It is one of the profitability ratios. Return on sales ratio is used to measure the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Net margin}=\frac{\text{Net income}}{\text{Net sales}}$

1. 3. Asset turnover: 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.

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

1. 4. Return on assets: Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets. Return on investment is calculated as follows:

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

1. 5. Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on equity is as follows:

   $\text{Return on equity}=\frac{\text{Net income}-\text{Preferred dividend}}{\text{Average stockholders' equity}}\times 100$

2. 6. Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. Current ratio is calculated by using the formula:

$\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

1. 7. Quick ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

$\text{Quick ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

1. 8. Operating-cash-flow-to-current-liabilities ratio: The operating-cash-flow-to-current-liabilities ratio measures the firm’s ability to pay the current liabilities from the cash flows from operating activities. It can be calculated by using the given formula:

$\begin{array}{l}\text{Operating-cash-flows-}\\ \text{current-liabilities Ratio}\end{array}]=\frac{\text{Cash flows from operating activities}}{\text{Average Current liabilities}}$

1. 9. Accounts Receivable turnover ratio: Account Receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. This ratio is determined by dividing credit sales and average accounts receivables.

$\text{Accounts Receivables turnover}=\frac{\text{}\text{Net credit sales}}{\text{Average accounts receivables}}$

1. 10. Average collection period: This ratio is used to determine the number of days a particular company takes to collect accounts receivables. It is calculated by using the formula:

$\text{Average collection period}=\frac{\text{365}}{\text{Receivables turnover}}$

1. 11. Inventory Turnover Ratio: This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated by using the formula:

$\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

1. 12. Days’ sales in inventory: This ratio is determined as the number of days a particular company takes to make sales of the inventory available with them. It is calculated by using the formula:

$\text{Days sales in inventory}\}=\frac{\text{365}}{\text{Inventory turnover}}$

1. 13. Debt–to-equity ratio: The debt-to-equity ratio indicates that the company’s debt as a proportion of its stockholders’ equity. The debt-to-equity ratio is calculated using the formula:
   
   

   $\text{Debt-to-equity ratio}=\frac{\text{Total liabilities}}{\text{Total stockholders' equity}}$

2. 14. Time interest earned: Number of times interest is earned quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

$\text{Times interest earned}=\frac{\text{Earnings before interest and taxes expense}}{\text{Interest expense}}$

1. 15. Operating-cash-flow-to-capital-expenditures Ratio: The operating-cash-flow-to- capital-expenditures ratio measures the firm’s ability to provide sufficient cash and expand the property, plant, and equipment of the firm from the cash flows from operating activities.

$\text{Operating-cash-flows-current-liabilities Ratio}=\frac{\text{Cash flows from operating activities}}{\text{Annual Net Capital Expenditures}}$

1. 16. Earnings per share: Earnings per share represent the amount of income earned per share of outstanding common stock in a period. This ratio is used for analyzing the profitability of company’s stockholders. The following formula can be used to calculate earnings per share:

$\text{Earnings per share}\text{= }\frac{\text{Net income}\left(\text{loss}\right)\text{ – Preferred dividends}}{\text{Average number of common shares outstanding}}$

1. 17. Price/Earnings Ratio: It depicts the relation of market price of a share to earnings per share of that company. The price/earnings ratio presents the market value of the amount invested to earn $1 by a company. It is major tool to be used by investors before the decisions related to investments in a company.

$\text{Price/Earnings Ratio}\text{=}\frac{\text{Market Price per Share }}{\text{Earnings per Share}}$

1. 18. Dividend yield: Dividend yield ratio indicates how much percentage of share prices a company pays out in the form of dividends price. The formula to calculate the dividend yield percentage is as follows:

$\text{Dividend yield}=\frac{\text{Dividends per share}}{\text{Market price per share}}\times 100$

1. 19. Dividends payout ratio: The financial metric which measures the dividends declared per common share in relation to the earnings per share of a company is referred to as dividend payout ratio.

$\text{Dividend Payout }=\frac{\text{Annual dividend per share}}{\text{Earnings}\text{per}\text{share}}$

b.

To determine

Comment on the changes in ratios from 2013 to 2014.

Explanation of Solution

Analysis of ratios:

The computed ratios are compared in the following ways:

1. 1. The gross profit percentage of Incorporation GM has decreased to 35.56% in 2014 from 36.14% in 2013.
2. 2. The return on sales of Incorporation GM has decreased to 10.19% in 2014 from 10.61% in 2013.
3. 3. The asset turnover of Incorporation GM has slightly decreased to 0.78 in 2014 from 0.81 in 2013.
4. 4. The return on assets of Incorporation GM has decreased to 7.97% in 2014 from 8.48% in 2013.
5. 5. The return on common stockholders’ equity of Incorporation GM has decreased to 27.63% in 2014 from 28.79% in 2013.
6. 6. The current ratio of Incorporation GM has no changes during the year 2014 and 2013 with 0.81.
7. 7. The quick ratio of Incorporation GM has slightly increased to 0.43 in 2014 from 0.41 in 2013.
8. 8. The Operating-cash-flow-to-current liabilities ratio has decreased to 0.47in 2014 from 0.64 in 2013.
9. 9. The accounts receivable turnover ratio has decreased to 12.22 times in 2014 from 12.83 times in 2013.
10. 10. The average collection period has increased to 30days in 2014 from 28 days in 2013.
11. 11. The inventory turnover ratio has decreased to 7.4 times in 2014 from 7.5 times in 2013.
12. 12. The days’ sales in inventory have no changes during the year 2014 and 2013 with 49days.
13. 13. The debt equity ratio has increased to 2.31in 2014 to 2.18 in 2013.
14. 14. The times interest earned has increased to 8.78 times in 2014 from 7.99 times in 2013.
15. 15. The Operating-cash-flow-to-capital-expenditures Ratio has decreased to 3.86 in 2014 from 4.96 in 2013.
16. 16. The earnings per share have decreased to $2.03 per share in 2014 from $2.13 per share in 2013.
17. 17. The price earnings ratio has increased to 26.51 in 2014 from 22.99 per share in 2013.
18. 18. The dividend yield of Incorporation GM has slightly increased to 2.41% in 2014 from 2.32% in 2013.
19. 19. The dividend pay-out ratio of Incorporation GM has increased to 64.03% in 2014 from 53.52% in 2013.