Question

1.What four ratios would you use to evaluate a service business and why?

2.Reviewing Stryker Corporation's four years of ratios on page 65 of your text, what trends do you see and what are your suggestions for improvement?

3.How does Accounts Receivable Turnover relate to Number of Days Sales in Receivables?

4.What does context mean in ratio analysis and how did we use it to analyze the Stryker Corporation?

Chapter 2 Eluting Financial Performance 65 TABLE 22 Ratio Analysis of Stryker Corporation, 2009-2013, and Industry Averages, 2013 2009 2010 2011 2012 2013 Industry Average 16.8 122 15.1 18.5 17.0 162 13.0 11.7 16.5 17.4 15.6 710 70.0 18.1 7.1 Profitability ratios: Return on equity (%) Return on assets (%) Return on invested capital (%) Profit margin (%) Gross margin (%) Price-to-earnings ratio (X) Turnover-control ratios: Asset turnover (X) Fixed-asset turnover (X) Inventory turnover (X) Collection period (days) Days' sales in cash (days) Payables period (days) Leverage and liquidity ratios: Assets to equity (x) Debt to assets (%) Debt to equity (%) Times interest earned (X) Times burden covered (X) Debt to assets (market value, %) Debt to equity (market value, %) Current ratio (X) Acid test) 62.4 623 60.3 623 160.4 36.2 1502 180.7 218.4 50.2 75.3 105.9 1026 502 40.4 1.4 27.3 37.5 2.1 49.6 111.8 73,5 33.7 11.0 124 17.7 "Industry growwe firm in the medical technology industry Banner International, Beton Dick Nephew PICS Joke Medical, and Zimmer Holdings , PLC, Mark S cha Looking at Stryker's levers of performance can help explain the reasons behind its disappointing ROE. Asset turnover bears only a small part of the blame for the disappointing trend, having declined only slightly in 2013. Nor can we say that financial leverage is the villain, for although Stryker's assets-to-equity ratio is below industry peers, it is actually rising over the period. In fact, had Stryker's leverage not increased over the past five years, ROE in 2013 would have been only 9.4 percent (11.2% x 0.6 X 1.4 = 9.4%). This leaves Stryker'low and declining profit margin as the primary ex- planation for its disappointing ROE performance. Stryker's profit margin has fallen steadily from a 2010 peak of 17.4 percent to its most recent read- ing of only 11.2 percent, noticeably below the industry average of 15.6 per cent. Why the decline? Only a small part of the blame can be attributed to

Answer 1

(1)-The four ways to evaluate a service business are given below :

Liquidity ratios:

These measures the amount of liquidity (cash and easily converted assets) that you have to cover your debts, and provide a broad overview of your financial health. Examples:

Current Ratio: The current ratio measures your company's ability to generate cash to meet your short-term financial commitments. Also called the working capital ratio, it is calculated by dividing your current assets—such as cash, inventory, and receivables—by your current liabilities, such as the line of credit balance, payables and current portion of long-term debts.

Quick Ratio: The quick ratio measures your ability to access cash quickly to support immediate demands. Also known as the acid test, the quick ratio divides current assets (excluding inventory) by current liabilities (excluding the current portion of long-term debts). A ratio of 1.0 or greater is generally acceptable, but this can vary depending on your industry.

Efficiency ratios:

Often measured over a 3- to 5-year period, these give additional insight into areas of your business such as collections, cash flow, and operational results. Examples:

Inventory turnover ratio: It measures how long it takes for inventory to be sold and replaced during the year. It is calculated by dividing total purchases by average inventory in a given period. For most inventory-reliant companies, this can be a make-or-break factor for success. After all, the longer the inventory sits on your shelves, the more it costs.

Average collection Period: It calculates the average number of days customers take to pay for your products or services. It is calculated by dividing receivables by total sales and multiplying by 365. To improve how quickly you collect payments, you may want to establish clearer credit policies and set collection procedures. For example, to encourage your clients to pay on time, you can give them incentives or discounts. You should also compare your policies to those of your industry to ensure you remain competitive.

Profitability ratios

These ratios are used not only to evaluate the financial viability of your business but are essential in comparing your business to others in your industry. You can also look for trends in your company by comparing the ratios over a certain number of years.

Net profit margin: These measures how much a company earns (usually after taxes) relative to its sales. A company with a higher profit margin than its competitor is usually more efficient, flexible and able to take on new opportunities

Operating profit margin or Coverage ratio: It measures earnings before interest and taxes. The results can be quite different from the net profit margin due to the impact of interest and tax expenses. By analyzing this margin, you can better assess your ability to expand your business through additional debt or other investments.

Return on assets (ROA): It tells how well management is utilizing the company's various resources (assets). It is calculated by dividing net profit (before taxes) by total assets. The number will vary widely across different industries. Capital-intensive industries such as railways will yield a low return on assets since they need expensive infrastructure to do business. Service-based operations such as consulting firms will have a high ROA, as they require minimal hard assets to operate.

Return on Equity (ROE): It measures how well the business is doing in relation to the investment made by its shareholders. It tells the shareholders how much the company is earning for each of their invested dollars. It is calculated by dividing a company’s earnings after taxes (EAT) by the total shareholders’ equity, and multiplying the result by 100%.

Leverage ratios:

These ratios provide an indication of the long-term solvency of a company and to what extent you are using long-term debt to support your business.

Debt-to-equity and debt-to-asset ratios are used to see how your assets are financed, whether it comes from creditors or your own investments, for example. In general, a bank will consider a lower ratio to be a good indicator of your ability to repay your debts or take on additional debt to support new opportunities

(2)- Analysis of Stryker Corporation's four years of ratios and suggestions for improvement

Return on equity has gone down from 16.8 in 2009 to 11.8 in 2013 maybe because the entity is unable to generate the profit too as shown that profit margin is also falling from 16.5 in 2009 to 11.2 in 2013. The entity might be facing problems in growing the business.

The asset turnover ratio had fallen from 0.7 in 2012 to 0.6 in 2013 it doesn't add a great reason to be in low equity.

(3)-Accounts Receivable Turnover relate to Number of Days Sales in Receivables in the following way :

Firstly, The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid. The receivables turnover ratio is also called the accounts receivable turnover ratio.

The formula for :

Accounts Receivable Turnover=Net Credit Sales​/Average Accounts Receivable

1. Add the value of accounts receivable at the beginning of the desired period to the value at the end of the period and divide the sum by two. The result is the denominator in the formula.
2. Divide the value of net credit sales for the period by the average accounts receivable during the same period.
3. Net credit sales are the revenue generated from sales that were done on credit minus any returns from customers.

Example Receivables Turnover Ratio

Let's say Company A had the following financial results for the year:

• Net credit sales of $800,000
• $64,000 in accounts receivables on January 1st or the beginning of the year
• $72,000 in accounts receivables on December 31st or at the end of the year

We can calculate the receivables turnover ratio in the following way:

Let's say Company A had the following financial results for the year:

• Net credit sales of $900,000
• $65,000 in accounts receivables on January 1st or the beginning of the year
• $73,000 in accounts receivables on December 31st or at the end of the year

Solution:

Average account receivable =($65000+$73000 )/2 =$ 69000

Accounts receivable turnover ratio = $900000/$69000=13

We can interpret the ratio to mean that Company A collected its receivables 13 times on average that year. In other words, the company converted its receivables to cash 13 times that year. A company could compare several years to ascertain whether 13 is an improvement or an indication of a slower collection process.

A company could also determine the average duration of accounts receivable or the number of days it takes to collect them during the year. In our example above, we would divide the ratio of 13 by 365 days to arrive at the average duration. The average accounts receivable turnover in days would be 365 / 13 or 28.07 days.

For Company A, customers on average take 28 days to pay their receivables.

(4)-What Is Ratio Analysis?

Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by comparing information contained in its financial statements. Ratio analysis is a cornerstone of fundamental analysis.

In the given entity's info, we will make the analysis of each ratio and identify the measures to make the entity financially strong.