Question

xercise 12-6B Evaluate profitability ratios (LO12-4)

The Year 2 income statement of Company A reports sales of $22,310,000, cost of goods sold of $13,000,000, and net income of $2,300,000. Balance sheet information is provided in the following table.

COMPANY A Balance Sheets December 31, Year 2 and Year 1
	Year 2				Year 1
Assets
Current assets:
Cash	$	1,000,000			$	1,010,000
Accounts receivable		1,975,000				1,325,000
Inventory		2,525,000				1,875,000
Long-term assets		5,200,000				4,490,000
Total assets	$	10,700,000			$	8,700,000
Liabilities and Stockholders' Equity
Current liabilities	$	2,250,000			$	1,940,000
Long-term liabilities		2,670,000				2,680,000
Common stock		2,275,000				2,125,000
Retained earnings		3,505,000				1,955,000
Total liabilities and stockholders' equity	$	10,700,000			$	8,700,000

Industry averages for the following profitability ratios are as follows:

Gross profit ratio	45	%
Return on assets	25	%
Profit margin	15	%
Asset turnover	16.5	times
Return on equity	35	%

Required:
1. Calculate the five profitability ratios listed above for Company A. (Round your answers to 1 decimal place.)

2. Do you think the company is more profitable or less profitable than the industry average?

• More profitable

• Less profitable

Answer 1

Ans. 1
Ans. A	Gross profit margin = Gross profit / Net sales * 100
	$9,310,000 / $22,310,000 * 100
	41.7%
	*Calculations for Gross profit:
		Year 2
	Net sales	$22,310,000
	Less: Cost of goods sold	-$13,000,000
	Gross profit	$9,310,000
Ans. B	Return on assets =   Net income / Average assets * 100
	$2,300,000 / $9,700,000 * 100
	23.7%
	*Average assets = (Beginning assets + Ending assets) / 2
	($8,700,000 + 10,700,000) / 2
	$9,700,000
Ans. C	Profit margin = Net income / Net sales * 100
	$2,300,000 / $22,310,000 * 100
	10.3%
Ans. D	Assets turnover = Sales / Average assets
	$22,310,000 / $9,700,000
	2.3	times
Ans. E	Return on equity =   Net income / Average stockholder's equity * 100
	$2,300,000 / $4,930,000 * 100
	46.7%
	*Calculation of total stockholder's equity:
		Year 2	Year 1
	Common stock	$2,275,000	$2,125,000
	Retained earnings	$3,505,000	$1,955,000
	Total Equity	$5,780,000	$4,080,000
	* Average Stockholder's equity =   (Beginning equity + Ending equity) / 2
	($4,080,000 + $5,780,000) / 2
	$4,930,000
Ans. 2	Less profitable
	Explanations: Gross profit ratio, profit margin and return on assets of the company
	are less than industry average so the company is considered to be less profitable.