Question

7-6 Profit margins and turnover ratios vary from one industry to another. What differences would you expect to find between a grocery chain, such as Safeway, and a steel company? Think particularly aboutthe turnover ratios and the profit margin, and consider the effect on the DuPont equation.

Answer 1

Grocery chains and supermarkets sell ' mass market' products, whereas a steel company does not sell a ' mass market' product. Grocery chain sales are Business to Consumer ( B to C ), while steel company sales are normally Business to Business ( B to B ). Therefore, while grocery chain would be characterized by high asset turnover and lower profit margin, a steel business would have lower asset turnover, but higher profit margin.

Profit Margin = Net Income / Sales

Turnover = Sales / Total Assets.

DuPont Equation :

Return on Assets ( ROA ) = Profit Margin x Turnover

For a grocery chain, turnover would be higher because of the much lower asset base. The main asset would be the inventory of groceries.

For a steel company, capital expenditures on putting up a plant would be very high. Therefore asset base would be very large. In the initial years, and therefore sales relative to assets would be lower as compared to a grocery chain.

Inventory turnover: for supermarkets, would be higher due to the following reasons:a. Higher volume of sales; b. Spoilage of perishable items and b.just-in-time ordering. Steel, does not have shelf life, and therefore can be stored for lengths of time without deterioration. Hence, overall asset turnover for a grocery chain would be expected to be higher.

Profit margin for a grocery chain would be lower as it caters to the masses plus it is a merchandising business. A steel company's profit margin is likely to be higher as it is a manufacturing business plus the product is more premium.