Investments, tenth edition

Margin 3 ATO 5 ROA

 Supermarket chain 

 2%  

5.0  

10% 

 Utility 

 20%  

0.5  

10% 

 Table 19.8 

 Differences between profit 

margin and asset turnover 

across industries 

  2010  

  2011  

  2012  

  2013  

Income statements

Sales revenue

$100,000

$120,000

$144,000

Cost of goods sold (including depreciation)

55,000

66,000

79,200

Depreciation

15,000

18,000

21,600

Selling and administrative expenses

15,000

18,000

21,600

Operating income

30,000

36,000

43,200

Interest expense

10,500

19,095

34,391

Taxable income

19,500

16,905

8,809

Income tax (40% rate)

7,800

6,762

3,524

Net income

$  11,700

$  10,143

$    5,285

Balance sheets (end of year)

Cash and marketable securities

$  50,000

$  60,000

$  72,000

$  86,400

Accounts receivable

25,000

30,000

36,000

43,200

Inventories

75,000

90,000

108,000

129,600

Net plant and equipment

150,000

180,000

216,000

259,200

 Total 

assets

$300,000

$360,000

$432,000

$518,400

Accounts payable

$  30,000

$  36,000

$  43,200

$  51,840

Short-term debt

45,000

87,300

141,957

214,432

Long-term debt (8% bonds maturing in 2025)

75,000

75,000

75,000

75,000

 Total 

liabilities

$150,000

$198,300

$260,157

$341,272

Shareholders’ equity (1 million shares outstanding)

$150,000

$161,700

$171,843

$177,128

Other data

Market price per common share at year-end

$    93.60

$    61.00

$    21.00

 Table 19.9 

 Growth Industries financial statements ($ thousand) 

bod61671_ch19_635-677.indd   649

bod61671_ch19_635-677.indd   649

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

650 

P A R T   V

 Security 

Analysis

 GI’s total asset turnover in 2013 was .303, which was below the industry average 

of .4. To understand better why GI underperformed, we can compute asset utilization ratios 

separately for fixed assets, inventories, and accounts receivable. 

 GI’s sales in 2013 were $144 million. Its only fixed assets were plant and equip-

ment, which were $216 million at the beginning of the year and $259.2 million at year’s 

end. Average fixed assets for the year were, therefore, $237.6 million [($216 million 

 1  $259.2 million)/2]. GI’s fixed-asset turnover for 2013 therefore was $144 million per 

year/$237.6 million  5  .606 per year. In other words, for every dollar of fixed assets, there 

were $.606 in sales. 

 Comparable figures for the fixed-asset turnover ratio for 2011 and 2012 and the 2013 

industry average are  

2011

2012

2013

2013 Industry Average

.606

.606

.606

.700

GI’s fixed asset turnover has been stable over time and below the industry average. 

 Notice that when a financial ratio includes one item from the income statement, which 

covers a period of time, and another from a balance sheet, which is a “snapshot” at a 

particular time, common practice is to take the average of the beginning and end-of-year 

balance sheet figures. Thus in computing the fixed-asset turnover ratio we divided sales 

(from the income statement) by average fixed assets (from the balance sheet). 

 Another widely followed turnover ratio is the    inventory  turnover  ratio,       which  is  the 

ratio of cost of goods sold per dollar of average inventory. (We use the cost of goods sold 

instead of sales revenue in the numerator to maintain consistency with inventory, which is 

valued at cost.) This ratio measures the speed with which inventory is turned over. 

 In 2011, GI’s cost of goods sold (excluding depreciation) was $40 million, and its 

average inventory was $82.5 million [($75 million  1  $90 million)/2]. Its inventory turn-

over was .485 per year ($40 million/$82.5 million). In 2012 and 2013, inventory turnover 

remained the same, which was below the industry average of .5 per year. In other words, 

GI was burdened with a higher level of inventories per dollar of sales than its competitors. 

This higher investment in working capital in turn resulted in a higher level of assets per 

dollar of sales or profits, and a lower ROA than its competitors. 

 Another aspect of efficiency surrounds management of accounts receivable, which is 

often measured by  days sales in receivables,  that is, the average level of accounts receiv-

able expressed as a multiple of daily sales. It is computed as average accounts receivable/

sales   3  365 and may be interpreted as the number of days’ worth of sales tied up in 

accounts receivable. You can also think of it as the average lag between the date of sale and 

the date payment is received, and is therefore also called the    average  collection  period.      

 For GI in 2013 the average collection period was 100.4 days:   

($36 million

1 $43.2 million)/2

$144 million

3 365 5 100.4 days 

The industry average was only 60 days. This statistic tells us that GI’s average receivables 

per dollar of sales exceeds that of its competitors. Again, this implies a higher required 

investment in working capital, and ultimately a lower ROA. 

 In summary, these ratios show us that GI’s poor total asset turnover relative to the indus-

try is in part caused by lower-than-average fixed-asset turnover and inventory turnover 

and higher-than-average days receivables. This suggests GI may be having problems with 

excess plant capacity along with poor inventory and receivables management practices.  

bod61671_ch19_635-677.indd   650

bod61671_ch19_635-677.indd   650

7/17/13   4:13 PM

7/17/13   4:13 PM

Final PDF to printer

---

  C H A P T E R  

1 9

 Financial 

Statement 

Analysis 

651