Page 185 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting

Notes stockholders because it shows what part of the business is financed through borrowing or

in other words, is debt financed. Of the five years we analyzed, the lowest debt to equity

ratio was during 1991 (6.65) and the highest was in 1993 (11.71). In comparison to return

on assets, a higher creditor financed year such as 1991 did not have an positive effect on

profitability. It seemed that through increased borrowing in 1993, a higher debt to equity
ratio was produced, but overall profitability also went up. Debt to equity is only one part

in a full profitability analysis. The only real information that the debt to equity ratio can
produce is it can show how much expansion is possible through the borrowing of long-
term funds; basically it show’s a company’s long-term solvency. A higher debt to equity
ratio essentially means that the company will be able to borrow less money. The company
must rely more on stockholder investment. Ford was able to lower it’s borrowing of funds
from 1993 through 1994 and into 1995, while still effectively increasing it’s profi t margin
and return on assets. This means Ford was able to use stockholder’s investments to increase
it’s profitability rather than borrow the funds to do it.

Return on Equity
Return on equity is the ratio of net income divided by the average stockholder’s equity. This
ratio is of great interest to stockholders because it shows how much they have earned on
their investment in the business. In the years of 1991 and 1992, stockholders lost money on
their investment in Ford Motor Company. No one likes to lose money, even if it is a couple
of cents on the dollar. A major stockholder could incur quite a loss because of this. In the
next three years, return on equity was on the positive side, the peak being in 1994 when
stockholders earned about 28% on every dollar invested. Quite a good return considering
some investors are happy with a steady 8% return. Considering the previous years, the
return on equity for Ford seems to be positive. Common knowledge dictates that most
companies experience a downturn every now and then. Ford’s investors are able to remain
invested in the company because it’s overall 5 year return on equity is high enough to give
investors the high returns they seek. A return on equity consistently above 16% with a few
negative years mixed in is certainly lucrative enough to maintain a strong profi tability
measurement and project a positive image to the investors of Ford Motor Company.

Conclusion
Although Ford Motor Company is one of the largest companies in the world, we can
still attribute accounting trends to some of the key events in Ford’s history. In 1990, Ford
acquired Jaguar Cars, Ltd. Jaguar was a company suffering terrible loses due to poor
quality, and lack of sales. Jaguar has been in the black since Ford purchased them until
1994. It is important to note that Ford’s net income trend from 1991 to 1995 illustrates this.
In 1992, the Ford Taurus became the number one selling car in the United States, which
helped increase 1992 net earnings, and in 1994 the Ford Falcon was the top selling car in
Australia, helping maintain the trend of increasing net income. It is important to note that
Ford’s net income has increased from 1991 to 1994, and then decreased in 1995. There are
several possible causes for this change in the trend. In 1995, Ford acquired 20% equity in a
major Chinese truck manufacturer, and launched several new vehicles; including the Ford
Contour, Ford Mondeo, Mercury Mystique, Ford F-150, and Ford Taurus. These additional
investments and expenses help explain the decrease in net income in 1995. Overall, the
company has done well, and with reorganization in 1996 to decrease spending and increase

efficiency, Ford is striving for future periods of growth.
Questions
1. What do you see as the main cause behind the result of trend analysis at Ford?

2. “Ford was able to use stockholder’s investments to increase it’s profi tability rather
than borrow the funds to do it”. Justify the statement on the basis of the case.

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