Question 2 Interpreting ratios The following table provides a historical summary

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Question 2 Interpreting ratios The following table provides a historical summary of key financial ratios for Somv Corporation. Ratio Return on Equity Return on Assets Cost of Sales to Sales Research and Development Expenses to | 6.3% Sales EBITDA to Sales* Debt to Total Assets Ratio 2014 10.8% 3.0% 75.6% 2015 |-3.1% -0.8% | 78.5% 6.9% 2016 |-1.4% |-0.3% | 74.8% 6.6% 10.2% 12.3% 5.6% 72.4% | 75.3% 76.9% *EBITDA is earnings before interest, tax, and depreciation a. With reference to the appropriate ratios, analyse the trend in Somy's profitability providing plausible reasons for any changes. Explain what an inventory turnover ratio is measuring and how inventory turnover impacts on Somy's profitability. b.

Explanation / Answer

a.The profitability ratios, as well as, the efficiency ratios show that the performance of the company has been dropped in 2016 in comparison to 2015. However, the ratios show that the company started to recover in the year 2017. In each of the three years, the profit margin is much less than the gross profit margin. This means the company performed well in managing its cost of goods sold, but the operating management, responsible for controlling the operating expenses, have performed much below the expected level thereby reducing the gross profit margin steeply resulting in negative net profit margins in the year 2016 and 2017. Although the company recovered its gross profit margin in 2017, the performance of the management in controlling the operating expenses in 2017 is worst resulting in the lowest profit margin even after making the highest gross profit margin in all the three years.

The gradually decreasing performance in maintaining a consistent profitability is also reflected from the gradually decreasing return on assets, which has become negative in the year 2016 and 2017 in spite of being positive in the year 2015

The debt ratio shows that the debt portion in the capital structure of the company has been rising steadily thereby increasing the financial risk of the company.

bExplain what an inventory turnover ratio is measuring and how inventory impacts som's profitability

This ratio is important because total turnover depends on two main components of performance. The first component is stock purchasing. If larger amounts of inventory are purchased during the year, the company will have to sell greater amounts of inventory to improve its turnover. If the company can’t sell these greater amounts of inventory, it will incur storage costs and other holding costs.

The second component is sales – sales have to match inventory purchases otherwise the inventory will not turn effectively. That is why the purchasing and sales departments must be in tune with each other.

In case of Somy's profitability it is seen that in 2017 the opearting expenses have gone up that is the cost of goods sold is not been maintained properly.Also the ROA is also poor which is refelected in the downtrend in ROA which means the assets are not properly mainitained by the sales of the company.So the inventory turnover would also be poor bearing in mind that the cost of goods sold and the inventory portion of the fixed assets are more due to obsolete stocks at the end year.

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