Question

Asset management ratios are used to measure how effectively a firm manages its assets, by relating the amount a firm has invested in a particular type of asset (or group of assets) to the amount of revenues the asset is generating. Examples of asset management ratios include the average collection period (also called the days sales outstanding ratio), the inventory turnover ratio, the fixed asset turnover ratio, and the total asset turnover ratio.

Consider the following case:

Walker Telecommunications has a quick ratio of 2.00x, $35,550 in cash, $19,750 in accounts receivable, some inventory, total current assets of $79,000, and total current liabilities of $27,650. The company reported annual sales of $200,000 in the most recent annual report.

Over the past year, how often did Walker Telecommunications sell and replace its inventory?

9.28x

8.44x

8.01x

2.86x

The inventory turnover ratio across companies in the telecommunications industry is 9.284x. Based on this information, which of the following statements is true for Walker Telecommunications?

Walker Telecommunications is holding less inventory per dollar of sales compared with the industry average.

Walker Telecommunications is holding more inventory per dollar of sales compared with the industry average.

You are analyzing two companies that manufacture electronic toys—Like Games Inc. and Our Play Inc. Like Games was launched eight years ago, whereas Our Play is a relatively new company that has been in operation for only the past two years. However, both companies have an equal market share with sales of $200,000 each. You’ve collected company data to compare Like Games and Our Play. Last year, the average sales for all industry competitors was $510,000. As an analyst, you want to make comments on the expected performance of these two companies in the coming year. You’ve collected data from the companies’ financial statements. This information is listed as follows: (Note: Assume there are 365 days in a year.)

Data Collected (in dollars)

Like Games | Our Play | Industry Average | |

Accounts receivable | 5,400 | 7,800 | 7,700 |

Net fixed assets | 110,000 | 160,000 | 433,500 |

Total assets | 190,000 | 250,000 | 469,200 |

Using this information, complete the following statements to include in your analysis.

1. | Our Play has__days of sales tied up in receivables, which is much (higher/lower) than the industry average. It takes Our Play (more/less) time to collect cash from its customers than it takes Like Games. |

2. | Like Games’s fixed assets turnover ratio is (higher/lower) than that of Our Play. This is because Like Games was formed eight years ago, so the acquisition cost of its fixed assets is recorded at historic values when the company bought its assets and has been depreciated since then. Assuming that fixed assets prices (not book values) rose over the past six years due to inflation, Our Play paid a (higher/lower) amount for its fixed assets. |

3. | The average total assets turnover in the electronic toys industry is__, which means that__of sales is being generated with every dollar of investment in assets. A (higher/lower) total assets turnover ratio indicates greater efficiency. Both companies’ total assets turnover ratios are (higher/lower) than the industry average. |

Answer #1

Part 1

Inventory Turnover ratio =

As Inventory figures are not explicitly given, we first need to find it using the other given information. We know that here

Total current assets = Cash + Accounts receivable + Inventories

Substituting the given figures, we get: Inventories = 79,000- 35,500- 19,750

= $23700

Thus Inventory Turnover ratio = $200,000 / $23700

= 8.44x

So over the past year, Walker Telecommunications sold and replaced its inventory 8.44 times

Part 2

Now comparing it with the given industry average of 9.284x we find that Walker Telecommunications is rotating inventory at a slower pace than the industry average which implies that it is holding more inventory (on average) at any given time compared to its competitors. Thus statement 2 is correct i.e. Walker Telecommunications is holding more inventory per dollar of sales compared with the industry average.

Part 3

Days Sales Outstanding =

DSO for Our Play= 7800 / ($200,000/365)

=7800 / 547.95

= 14.24

DSO (Industry Average) = 7700 / ($510,000 / 365)

= 5.1

Clearly DSO for Our Play is much larger, so the correct statement is:

Our Play has 14.24 days of sales tied up in receivables, which is much higher than the industry average. It takes Our Play more time to collect cash from its customers than it takes Like Games.

Part 3.2

Fixed Assets Turnover Ratio=

For Like Games, it becomes

= 200,000/110,000

= 1.82x

For Our Play, the ratio will be

= 200,000/160,000

= 1.25x

So the correct statement will be:

Like Games’s fixed assets turnover ratio is higher than that of Our Play. This is because Like Games was formed eight years ago, so the acquisition cost of its fixed assets is recorded at historic values when the company bought its assets and has been depreciated since then. Assuming that fixed assets prices (not book values) rose over the past six years due to inflation, Our Play paid a higher amount for its fixed assets.

Part 3.3

Total Assets Turnover Ratio =

For industry it becomes

= 510,000 / 469,200

= 1.09x

For Like games, it will be

= 200,000 / 190,000

= 1.05x

For Our Play, it will be

= 200,000 / 250,000

= 0.8x

So the correct statement will be:

The average total assets turnover in the electronic toys industry is 1.09x, which means that $1.09 of sales is being generated with every dollar of investment in assets. A higher total assets turnover ratio indicates greater efficiency. Both companies’ total assets turnover ratios are lower than the industry average.

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