Question

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 about the turnover ratios, the profit margin, and the DuPont equation?

Answer 1

Analysis of financial ratios assists Short term creditors to know the ability of company to pay their short term obligation. Calculation of Current ratio, receivable turnover and accounts payable are some of the ratios that helps short term creditors to analyze company’s credit history.
Financial ratios analysis helps long term creditors to know company’s ability to meet interest expenses and long term obligations on time. Times interest earned ratio, debt to total assets turnover ratio, debt to shareholders equity ratio are some of the ratios that are helpful for long term creditors.

Profit margin is the ratio between revenue and income. Business with higher profit margin have lower cost of sales and hence high profit while business with lower profit margin have higher cost of sales. Thus business with low margin needs to have high volume to sales to make up for the low margin. Turnover ratios show how many times a year company is replacing their inventories or collecting their debtors. Higher turnover indicates that company is producing and selling their products quickly and lower turnover ratio indicates that company is producing and selling their products late.

Grocery chains like Safeway are business having lower profit margin, high turnover ratio and hence higher volume of business transaction where as Steel company is a business having higher profit margin, low turnover ratio and hence lower volume of business transactions.