Companies in the same line of business usually have similar investments and capital structures, and an opportunity for similar rates of return. One of the key performance indicators that is used to assess the profitability of companies is the return on assets ratio. This ratio results from two key relationships- the profit margin and the total asset turnover- and in general terms can be written as follows:
Return on assets = Total asset turnover (or Sales/Total assets) x Prof it margin (or Income/Sales)
This says that profitability depends directly on how many sales dollars are generated for each dollar invested in assets (total asset turnover) and on how costs are controlled for each dollar of sales (profit margin). An increase in either ratio results in an increase in the return on assets. As property, plant, and equipment is often the largest single asset on the balance sheet, companies need to have strategies to manage their investment in such assets.
Instructions
Access the financial statements of two companies that are in the food distribution business: Empire Company Limited for the year ended May 5, 2012, and Loblaw Companies Limited for the year ended December 31, 2011. These are available at www.sedar.com or each company's website. Review the financial statements and answer the following questions.
(a) At each company's year end, determine the percentage of property, plant, and equipment to
total assets.
(b) Calculate each company's fixed asset turnover, total asset turnover, and profit margin (using net income) for the most recent year.
(c) Determine the return on assets for each company. Which company is more profitable?
(d) Which company appears to use its total assets more effectively in generating sales? Its fixed
assets?
(e) Are there any differences in accounting policies that might explain the differences in the fixed asset turnover ratios?
(f) Examine the leasing note for each company. How might the amount of assets that are leased
impact the above asset turnover ratios?
(g) Which company has better control over its expenses for each dollar of sales? How do you
explain the asset turnover ratios and the profit ratio comparisons?