Financial Statement Analysis

Total asset turnover measures a company’s efficiency in generating revenue using its assets. It is given by dividing a company’s revenue by the total number of assets. The higher the figure the more efficient a company is in generating revenue from its assets.

Using the above formula we can get the total assets that both Clay and Roak had from 2008 through 2010. This is as follows:

 

Roak Company                                  Clay Company

2010       2009       2008                2010       2009          2008

132,258 135,714 132,000         123,529   113,333      91,667

 

The difference in total assets between the two companies in 2010 was only $ 8729 yet Roak Company was able to realize revenue of $3.1 for ever $1 of employed capital or total assets. During the same period Clay could only make $1.7 for every $1 of the total assets. This means that Roak is more efficient in the utilization of its assets to generate revenue.

Companies with a high total asset turnover tend to have lower profit margins and this can be seen in the case of Roak and Clay. This may be brought about because of higher depreciation costs as result of more utilization of the company’s assets to generate revenue. It could also be as a result of their pricing policies. A company can lower its selling prices in order to move more sales.

Return on Total Assets measures a company’s earnings before interest and taxes against its total net assets. The greater a company’s earnings as compared to its assets, the more effective the company is utilizing its assets. In our case, Roak has a higher Return on Assets Ratio than Clay and is therefore utilizing its assets more effectively.

This ratio can also be used to determine financial leverage which is defined as the degree to which a business is using borrowed money to realize more revenue. From the given information we can derive the two companies’ earnings before interest in 2010 assuming the firms have not yet paid taxes. The difference is then what is paid out as interest to debtors. This is as follows:

Roak Company                                Clay Company

Profit before tax 11,903                         6,176

Profit after tax     9,840                          5,880

Interest                  2,063                            396

 

From the above information we can derive Roak Company’s interest ratio to profit before tax as 17 % and that of Clay as 6.4%. This means that Roak uses its borrowed money to generate profits better than Clay.

Clay therefore risks running bankrupt if it continues with this trend.

 Reference:

Horne V. J, Wachowicz J (2004), Fundamentals of Financial Management, Pearson Books.