Question

Asset management ratios are used to measure how effectively a firm manages its assets, by relating the amount a firm has invested in a particular type of asset (or group of assets) to the amount of revenues the asset is generating. Examples of asset management ratios include the average collection period (also called the days sales outstanding ratio), the inventory turnover ratio, the fixed asset turnover ratio, and the total asset turnover ratio. Consider the following case: Polk Software Inc. has a quick ratio of 2.00x, $24,750 in cash, $13,750 in accounts receivable, some inventory, total current assets of $55,000, and total current liabilities of $19,250. The company reported annual sales of $200,000 in the most recent annual report. Over the past year, how often did Polk Software Inc. sell and replace its inventory? 12.12x 13.33x 8.01x 2.86x The inventory turnover ratio across companies in the software industry is 10.302x. Based on this information, which of the following statements is true for Polk Software Inc.? O Polk Software Inc. is holding more inventory per dollar of sales compared with the industry average. O Polk Software Inc. is holding less inventory per dollar of sales compared with the industry average. You are analyzing two companies that manufacture electronic toys-Like Games Inc. and Our Play Inc. Like Games was launched eight years ago, whereas Our Play is a relatively new company that has been in operation for only the past two years. However, both companies have an equal market share with sales of $200,000 each. You've collected company data to compare Like Games and Our Play. Last year, the average sales for all industry competitors was $510,000. As an analyst, you want to make comments on the expected performance of these two companies in the coming year. You've collected data from the companies' financial statements. This information is listed as follows: (Note: Assume there are 365 days in a year.)

Answer 1

Answer a.

Current assets = Cash + Accounts receivable + Inventory
$55,000 = $24,750 + $13,750 + Inventory
Inventory = $16,500

Inventory turnover = Sales / Inventory
Inventory turnover = $200,000 / $16,500
Inventory turnover = 12.12 x

Answer b.

Polk Software Inc. is holding less inventory per dollar of sales compared to the industry average.

Answer c.

Like Games:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $5,400 / $200,000
Days of sales outstanding = 9.86 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $200,000 / $110,000
Fixed assets turnover = 1.82 times

Total assets turnover = Sales / Total assets
Total assets turnover = $200,000 / $190,000
Total assets turnover = 1.05 times

Our Play:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $7,800 / $200,000
Days of sales outstanding = 14.24 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $200,000 / $160,000
Fixed assets turnover = 1.25 times

Total assets turnover = Sales / Total assets
Total assets turnover = $200,000 / $250,000
Total assets turnover = 0.80 times

Industry Average:

Days of sales outstanding = 365 * Accounts receivable / Sales
Days of sales outstanding = 365 * $7,700 / $510,000
Days of sales outstanding = 5.51 days

Fixed assets turnover = Sales / Net fixed assets
Fixed assets turnover = $510,000 / $433,500
Fixed assets turnover = 1.18 times

Total assets turnover = Sales / Total assets
Total assets turnover = $510,000 / $469,200
Total assets turnover = 1.09 times

Our Play has 14.24 days of sales tied up in receivables, which is much higher than the industry average. It takes Our Play more time to collect cash from its customers than it takes Like Games.

Like Games’s fixed assets turnover ratio is higher than that of Our Play. This is because Like Games was formed eight years ago, so the acquisition cost of its fixed assets is recorded at historic values when the company bought its assets and has been depreciated since then, Assuming that fixed assets price (not book values) rose over the past six years due to inflation, Our Play paid a higher amount for its fixed assets.

The average total assets turnover in the electronic toys industry is 1.09x, which means that $1.09 of sales is being generated with every dollar of investment in assets. A higher total assets turnover ratio indicates greater efficiency. Both companies’ total assets turnover ratios are lower than the industry average.