ACC 230 Week 8 CheckPoint 2: Interpreting Financial Ratios
Interpreting key financial ratios for decision-making.
Evelyn Morris
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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
considerable 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
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
considerable 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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Document Details
University
Hult International Business School
Subject
Accounting