Chapter 9, Problem 9.4EYCT

(a)

To determine

Financial Ratios: Financial ratios are the metrics used to evaluate the overall financial performance of a company during a specific period of time.

To explain: the difference in the return on assets and the assets turnover of Company B from an online retailer.

Explanation of Solution

In the present case, Company B once the largest retailer of electronics lost its position to the online retailers of electronics. Thus, its profitability faced a drastic fall over the years, and the very survival was at stake. Since the growth of online retailers for electronics, whose return on assets, and assets turn over gaineddominance overtime, in comparison to Company B due to the following reasons:

• The customers can easily compare the expensive and non-expensive electronics online.
• The customers find it easy to order online as they do not have to spend extra hours in collecting their purchases from the stores.
• As, the online retailers do notlevy sales tax to the customers, their sales and profits surge on being less expensive for the customers than Company B.
• The online retailers are in an advantageous position as they do not incur much operating costs for running their stores. Thus, it further boosts up their net income thereby, increasing their profit margin.
• The online retailers have less total assets that increase their asset turnover and return on assets.

(b)

To determine

To Compute: the profit margin, asset turnover and return on assets of Company B for 2017 and 2012.

Explanation of Solution

Compute the profit margin, asset turnover and return on assets of Company B for 2017 and 2012.

Title: Compute the ratios
Formula	2017	2012
$\begin{array}{l}\text{Profit }\\ \text{margin}\end{array}]=\frac{\text{Net income}}{\text{Net sales}}\times 100$	$\begin{array}{l}=\frac{\text{\$1,277}}{\text{\$50,272}}\times 100\\ =2.5\%\end{array}$	$\begin{array}{l}=\frac{\text{\$1,140}}{\text{\$30,848}}\times 100\\ =3.7\%\end{array}$
$\begin{array}{l}\text{Asset }\\ \text{turnover}\end{array}]=\frac{\text{Net sales}}{\text{Average total assets}}\times 100$	$\begin{array}{l}=\frac{\text{\$50,272}}{\text{\$18,075}\text{.5}}\times 100\\ =2.78\text{ times}\end{array}$	$\begin{array}{l}=\frac{\text{\$30,848}}{\text{\$11,079}}\times 100\\ =2.78\%\end{array}$
$\begin{array}{l}\text{Return }\\ \text{on assets}\end{array}]=\frac{\text{Net income}}{\text{Average total assets}}\times 100$	$\begin{array}{l}=\frac{\text{\$1,277}}{\text{\$18,075}\text{.5}}\times 100\\ =7.1\%\end{array}$	$\begin{array}{l}=\frac{\text{\$1,140}}{\text{\$11,079}}\times 100\\ =10.3\%\end{array}$

Table (1)

Working notes:

Compute the average total assets for Company B for the year 2017.

Beginning total assets =$17,849

Ending total assets =$18,302

$\begin{array}{c}\text{Average total assets = }\frac{\left[\begin{array}{l}\text{Beginning total }\\ \text{assets}\left(2016\right)\end{array}\right]+\left[\begin{array}{l}\text{Ending total}\\ \text{ assets}\left(2017\right)\end{array}\right]}{2}\\ =\frac{\$17,849+\$18,302}{2}\\ =\$18,075.5\end{array}$ (1)

Compute the average total assets for Company B for the year 2012.

Beginning total assets =$11,864

Ending total assets =$10,294

$\begin{array}{c}\text{Average total assets = }\frac{\left[\begin{array}{l}\text{Beginning total }\\ \text{assets}\left(2011\right)\end{array}\right]+\left[\begin{array}{l}\text{Ending total}\\ \text{ assets}\left(2012\right)\end{array}\right]}{2}\\ =\frac{\$11,864+\$10,294}{2}\\ =\$11,079\end{array}$ (2)

Return on assets is used to measure the overall earning ability of the company. Thus, it shows the relationship between the net income and the average total assets.

Profit Margin: It measures the amount of net income earned from each dollar of sales revenue generated by a company. Thus, it shows the relationship between the net income and net sales.

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

Conclusion

The profit margin, asset turnover and return on assets of Company B for 2017 and 2012 are as follows:

2017:

Profit margin =2.5%

Asset turnover =2.78 times

Return on Assets =7.1%

2012:

Profit margin =3.7%

Asset turnover =2.78 times

Return on Assets =10.3%

(c)

To determine

To present: The profit margin, asset turnover, and the return assets in the equation format.

Explanation of Solution

Present the profit margin, asset turnover, and the return assets in the equation format.

$\text{Profit}\text{margin}\times \text{Asset}\text{turnover}=\text{Return}\text{on}\text{assets}$

For the year 2012:

$\begin{array}{c}\text{Profit margin}\times \text{Asset turnover = Retun on assets}\\ 3.7\%\times 2.78\text{ times = 10}\text{.3\%}\end{array}$

For the year 2017:

$\begin{array}{c}\text{Profit margin}\times \text{Asset turnover = Retun on assets}\\ 2.5\%\times 2.78\text{ times = 7}\text{.1\%}\end{array}$

(d)

To determine

To discuss: the implications of the profit margin, asset turnover, and the return assets ratios.

Explanation of Solution

The implications of the ratiosprofit margin, asset turnover, and the return assets calculated in part b and part c are as follows:

• The profit margin of Company B has been reduced from 3.7% to 2.5% from the year 2012 as compared to 2017.
• The return on assets also reduced in the same period from 10.3% to 7.1%. It resulted from the reduced percentage of profit margin from 2012 to 2017.
• However, the asset turnover remains unchanged at 2.78 for both the years. It implies that the company generated same amount of sales revenue out of the invested assets.
• It can be concluded that Company B is going through a hard time as the degree of competition with the online retailers is very high.
• Unlike online retailers, the company cannot reduce its selling price to compete with the online retailers as it would reduce its profit margin.
• Moreover, the company cannot survive with low profit margin in the long run as it has to meet its operating costs.