D366 Financial Statement Analysis - Set 4 - Part 3

Correct Answer: Operating expenses such as selling and administrative costs

If gross margin is unchanged but operating margin falls, the increase must come from operating expenses below the gross profit line, such as selling, general, and administrative costs, rather than from cost of goods sold.

Correct Answer: Efficient inventory management and strong sales

Higher inventory turnover with stable margins indicates the company sells inventory quickly without discounting, reflecting efficient inventory management and healthy demand for its products.

Correct Answer: 20%

ROE equals net income divided by average equity: $50,000 divided by $250,000 equals 0.20 or 20%. The company earns 20 cents of profit for each dollar of shareholders' equity.

Correct Answer: Generating more sales from the same asset base

Total asset turnover improves when a company generates more revenue from the same or a smaller asset base. Adding idle assets or cash without additional sales would lower the ratio.

Correct Answer: Industry peers and the company's own historical trend

Profit margins vary widely by industry, so they are most meaningful when compared to industry peers and the company's own past performance, revealing relative competitiveness and trends over time.

Correct Answer: Total asset turnover

ROA can be decomposed as net profit margin multiplied by total asset turnover. This shows that returns on assets stem from both how profitable each sale is and how efficiently assets generate sales.

Correct Answer: Using its assets more productively to generate additional sales

With strong margins but weak turnover, the company should focus on generating more sales from its existing assets, which would raise asset turnover and, through the DuPont relationship, improve ROA and ROE.

Correct Answer: One may achieve its ROE through high leverage rather than strong operations

Two firms can reach the same ROE differently: one through strong margins and efficiency, another through heavy debt. The leveraged firm carries greater financial risk, which DuPont analysis helps reveal.

Correct Answer: Earnings retention (plowback) ratio

The sustainable growth rate equals ROE multiplied by the retention (plowback) ratio, the portion of earnings reinvested rather than paid as dividends. It estimates how fast a firm can grow using internally generated equity.

Correct Answer: Operating income divided by revenue

Operating profit margin equals operating income (EBIT) divided by revenue. It measures the percentage of each sales dollar remaining after covering operating costs, reflecting core operating efficiency before interest and taxes.