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ACC 230 Week 8 CheckPoint 2: Interpreting Financial Ratios

Interpreting key financial ratios for decision-making.

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    ACC 230 Week 8 CheckPoint 2: Interpreting Financial Ratios ACC 230 Week 8 CheckPoint 2: Interpreting Financial Ratios · Resource: Ch. 6 of Understanding Financial Statements · Due Date: Day 4 [Individual forum] · Complete Problem 6.2 on p. 230 (Ch. 6). Submit your answer in 200 to 300 words. From the data it is evident that Luna lighting has a modest increase in sales. This is shown by the inventory turn over, which has increased from 8.1 to 8.3 times and is equal to the industrial norm. The business has failed to achieve the levels of profitability that other businesses in the same industry have managed and there are several reasons to back this statement. Luna's gross margins of 43% throughout the three years are better than that of the industry but it seems that Luna is incurring a considera ble amount of operating expenses as well as high interest costs, which might belong to debt taken for the medium to short term. This fact is backed up by the operating profit margin, which has fallen from 8 to 6.3% in two years. Such drastic falls between the two ratios can only occur when there are increasing operating expenses. A fall in the net profit margin also suggests that there are higher interest costs being serviced by the business. The same factor is also backed up by fixed charge coverage, which has fallen from 5.5 to 4%. Another reason for poor profitability is that the fixed assets of the business are not being properly used to generate sales and the debt taken up is also not being utilized to good effect. The low fixed asset turnover is evidence of poor asset utilization and the low return on equity is evidence of poor debt utilization, since return on equity is the product of profitability, asset turnover and use of debt/equity mix. Since the asset turnover and profit margins are already low, there must be a poor debt/equity mix so that a low return on equity figure is obtained. From this we conclude that higher

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