Question

A company had net income of $86,000 in Year 1 and $118,000 in Year 2. Its net sales were $640,000 in Year 1 and $611,000 in Year 2. Its average total assets in Year 1 were $1,670,000 and $1,712,000 in Year 2. Calculate the profit margin, total asset turnover and return on total assets for both years. Comment on the results.

Answer 1

1) Asset Turnover = Net sales / Average total asset

Year-1: 640,000 / 1,670,000 = 0.38 times

Year-2: 611,000 / 1,712,000 = 0.36 times

The higher asset turnover ratio indicates that the company is using the resources efficiently

2) Return on total assets = Net income / Average total assets

Year-1: 86,000 / 1,670,000 = 0.05 or 5.15%

Year-2: 118,000 / 1,712,000 = 0.07 or 6.89%

ROA's above 5% are usually are considered to be efficient

3) Profit margin = ROA / Asset Turnover

Year-1: 0.05 / 0.38 *100 = 13.16%

Year-2: 0.07 / 0.36 * 100 = 19.44%

The profit margin of 10% is considered to be average while the profit margin of nearly 20% is considered to be good