Page 184 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 10: Analysis of Financial Statements

1991 to 1992, 566% from 1992 to 1993 and then 79% from 1993 to 1994. Although the profi t Notes
margin from 1994 to 1995 decreased 26%, that is more than acceptable when you look at

the substantial increases in the past few years. In the first year, Ford had a profi t margin
of -3.1%. That means for every dollar of sales, Ford lost $3.10. This is obviously not a good
position to be in. During 1991 and then carried over into 1992, it cost Ford more money to
make sales than it did when it recorded the income for those sales. They realized at this
time it was important for them to keep things such as selling and administrative expenses
lower, as well as the cost of sales, which included their production, manufacturing, and
warehousing costs. By following a plan more complex than I can describe here, Ford
steadily increased it’s sales while it lowered it’s expenses and it’s cost of sales. This directly

increased Ford’s profit margin at a substantial rate within the next three years.
Asset Turnover
Asset turnover involves Ford’s net sales divided by their average total assets. This ratio

demonstrates the efficiency of assets used in producing sales. A company like Ford Motor
Company has an enormous amount of assets. Computers to heavy equipment to buildings.
All of those assets, plus many more, are all taken into consideration when fi guring asset
turnover. For example, Ford would like to know that if it decides to purchase 20 new
computer-aided engineering stations for a cost of about $2,400,000, they would like to see a
higher asset turnover to give them the proof that the investment is being used at maximum
efficiency. Ford’s asset turnover steadily increased in incremental amounts between the

years of 1991-1995, but on average it was about .43 for the entire 5 year period. Using trend
analysis to understand this ratio would give you a pretty good idea that the asset turnover
of Ford Motor Company is stable. Trend analysis would give you an index number for
1992 of 100, while the index number for 1995 would be 112. These index numbers would
result in a slightly positive but relatively straight line across the page. As a prospective
investor this would probably cause you to investigate more deeply as to why Ford can’t
more efficiently use their assets to produce sales. As a current stockholder, this trend

over the past five years may give you some comfort because of the incremental increases

(at least it isn’t going down).
Return on Assets
Return on assets is a very good profitability ratio. It is comprehensive when compared

to profit margin and asset turnover. Return on assets overcomes the deficiency of profi t
margin by relating the assets necessary to produce income and it overcomes the defi ciency
of asset turnover by taking into account the amount of income produced. Mathematically,
return on assets is equal to net income divided by average total assets, or more simply put,

profit margin times asset turnover. Ford can improve it’s overall profitability by increasing

it’s profit margin, the asset turnover, or both. Looking at the numbers, it was actually

Ford’s increase in profit margin that really gave it the boost it needed to raise the return on
assets from the black to the red. A steady increase in return on assets from -1.3% in 1991 to
an acceptable 2.2% in 1994 is a good sign to investors. This steady climb of 169% resulted
in an overall increase in the earning power of Ford Motor Company. Ford’s increase in
profitability shows satisfactory earning power which results in investors continuing to

provide capital to it.
Debt to Equity
The debt to equity ratio shows the portion of the company financed by creditors in

comparison to that financed by the stockholders. It is total liabilities divided by stockholder’s

equity. Ford’s debt to equity ratio is relatively high. When measuring profitability, a high

debt to equity ratio means the company has high debt and must earn more profit to protect
the payment of interest to it’s creditors. This high debt to equity ratio would also interest
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