This paper is a finance paper featuring three questions. The first is about a household income statement and balance sheet. The second is about current and quick ratios, both calculations thereof and analysis. The third question is about a DuPont Analysis of both a company and its industry. The trends are analyzed.
Finance
Income Statement
Income
$36,000.00
COGS
Gross Income
$36,000.00
Expenses
Rent
$9,600.00
Car
$5,062.00
Food
$4,784.00
Clothing
$1,481.00
Communications
Other Expenses
$1,675.00
Operating Income
$12,438.00
Interest Exp
$1,800.00
Income before taxes
$10,638.00
Income tax
$10,800.00
Net Income
Balance Sheet
Assets
Cash
Car
$14,600.00
Supplies
Total Assets
$15,365.40
Liabilities
Car Loan
$14,600.00
Credit Card
$5,000.00
Total Liabilities
$19,600.00
Equity
-$4,234.60
a) Bauman Company's current and quick ratios for the past four years are as follows:
Item
2009
2010
2011
2012
Current Ratio
Quick Ratio
b) The firm's liquidity during the 2009-2010 period was generally good. Both the current ratio and the quick ratio during this period were relatively high, to the point where a creditor would be comfortable lending this company money in the short run. There was, however, a decline in both ratios over this period. The current ratio slipped slightly, and there was an equally slight slip in the quick ratio. Neither decline was strong, and both were partially reversed the next year. The decline was because the current liabilities grew at a faster rate than the current assets.
c) This information would neither support nor conflict with my evaluation. Inventory played a less significant role in my evaluation than the current liabilities did; one would reasonably look at both the numerator and denominator for an explanation. Indeed, inventory growth in 2010 was slow compared with the growth in other current assets as well. Bauman's inventory turnover is well below the industry average, but that is not relevant to the firm's liquidity except in context of industry-average liquidity, figures for which we do not have. However, a slight increase in inventory turnover in the 2009-2011 period would, all other factors being equal, reduce the current ratio, because it would reduce the current assets relative to the growth of other factors like current liabilities. This assumes that ordinarily current asset and liabilities classes would grow with sales. So bearing in mind all of the assumptions, the movement in the current ratio is in line with expectations given the change in inventory turnover. That said, the turnover ratio is not particularly consequential. In 2011, for example, the only thing that changed on the balance sheet was other current assets. Perhaps some growth in inventory might have been expected, but that assumption was never explicitly stated.
Part 3. a) The DuPont formula is ROE = profit margin * total asset turnover * equity multiplier (Investopedia, 2013).
So for 2012 at Johnson it is:
.049 * 2.34 * 1.85 = 0.212, or 21.2%
b) The ROE for Johnson and the industry for all three years is:
ROE
2010
2011
2012
Johnson
21.78%
22.12%
21.2%
Industry
18.5%
16.9%
14.4%
Johnson has a higher ROE than the industry in all three years. The first explanation is that Johnson has more leverage. Johnson also has superior margins. Johnson's total asset turnover is also higher. Thus, it is through a combination of the three factors that Johnson has a higher ROE. The biggest red flag that the DuPont analysis is supposed to reveal is whether a high ROE is the result of leverage rather than operating metrics. While the higher degree of leverage is certainly a factor in the higher ROE that Johnson enjoys, it is worth taking into consideration that it is not the only factor.
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