Question

In: Finance

S&J Plumbing, Inc.'s 2010 income statement shows a net profit before tax of $468, whereas the...

S&J Plumbing, Inc.'s 2010 income statement shows a net profit before tax of $468, whereas the balance sheet that the company's equity for the fiscal year-end 2010 is $1,746.

  • Calculate the company's return on equity and explain whether the managers are providing a good return on the capital provided by the company’s shareholders.
  • Diagram and explain the operating cycle of a service company.

Solutions

Expert Solution

Calculation of Return on Equity of S&J Plumbing Inc in 2010:

Return on Equity= Net Income /Shareholder's Equity

Net Income is also referred as the Profit Before Tax or PAT

As per the information given in the question:

Net Income(2010)=$468 (as already mentioned above net income is also referred as the Profit before Tax)

Shareholder's Equity(2010) = $1,746

Substituting these values into the formula for Return on Equity we get:

Return on Equity= $468/$1746 ie. 0.2680 or 26.80%

Return on Equity is always expressed in %.

Whether this ROE is considered as a good return on capital provided to the company's shareholders:

Return on Equity (ROE) measures how many dollars of profit a company generates by using each dollar of a shareholder's equity .

ROE is primarily considered as a measure of efficiency.

A rising ROE indicates that a company is increasing it's ability to generate more profit by using less capital.It also indicates how well an organization's management is distributing(utilizing) the shareholder's capital.Exactly the opposite is indicated by a falling ROE.

Typically, a ROE value of equal to or more than 20(%) is considered to be good.

As given above the ROE for 2010 for S&J Plumbing Inc is: 26.80%.

This means that S&J Plumbing Inc is generating a profit of $ 0.268 per $1 of the shareholder's capital.

The value of ROE of S&J Plumbing INC is 26.80% which is higher than 20% and therefore it can be considered as a good return on the capital.

Diagram and Explanation of a  Operating Cycle of a Service Company:

Let us first understand what is a service company.

A service company is a company that gives service to consumers or other companies.

Let us now understand what an operating cycle of a service company is.

The Operating Cycle of a Servicing Company  refers to the average time period required by the company to obtain supplies and services, sell those services to the customers and collect cash from the customers in exchange for the services provided.

Let us understand the operating cycle of a company with an example:

Let us assume Company XYZ is a Financial Advisory Company which advises its clients on their investments.

Company XYZ uses the initial cash to pay it's employees acquire clients ,etc.It then sales its various investment options and other investment products of other companies to these customers, once the client is satisfied with these services they pay Company XYZ which again uses this cash to repeat the cycle.

Diagram:


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