Read in Fields Ch. 7 Using Return on Assets to Measure Profit Centers

Use the DuPont ratio analysis methodology to perform a financial analysis of case of Paley Products located in Appendix C of the Fields text.

Ratio	Industry	/---------------Paley Products----------------/
		2016	2015	2014
Return on Equity	23.40%	7.00%	12.02%	20.08%
Return on Sales (NPM)	4.50%	1.85%	3.27%	5.10%
Gross Profit % Sales	23.00%	20.00%	20.00%	20.00%
Expense % Sales	16.10%	17.14%	14.96%	12.31%
Asset Turnover	2.60	1.95	2.57	3.15
Days' Sales Outstand. a	32.00	49.59	36.77	33.72
Inventory Turnover	7.00	2.77	4.32	6.93
Fixed Assets Turnover	13.00	12.39	10.71	11.60
Equity Multiplier	2.00	1.94	1.43	1.25
ST Debt/ Assets	0.20	0.46	0.29	0.17
LT Debt/ Assets	0.30	0.03	0.04	0.05
Total Debt/ Assets	0.50	0.48	0.33	0.23
Current Ratio	2.70	1.84	2.60	4.16
Quick Ratio	1.00	0.61	0.97	2.08
a Used 365 days
b Used liabilities, rather than debt

Use the DuPont ratio analysis methodology to perform a financial analysis of case of Paley Products located in Appendix C of the Fields text.

Start with the ratios from p. 298, plus a few others, organized in the DuPont structure:

Remembering the DuPont equation, ROE = ROS x AT x EM, we can see that, if ROE (also known as Net profit margin (NPM)) is less than the industry, and/or is deteriorating over time, at least one of the components, ROS, AT or EM must also be lower than the industry and/or deteriorating over time. We usually focus on ROS and AT more than EM because they are the 'drivers'. EM is more a result, as the reason EM increases are often that ROS and/or AT are too low, and an increasing EM 'fills the hole' as borrowings are increased to cover the lack of profitability or inefficient use of assets. This is a dangerous sign because it is unsustainable since at some point lenders will not advance additional funds.

1. Which of the ROE components (ROS and/or AT) seem(s) to be the principal cause(s) of Paley's worse-than-industry ROE? If more than one is less than the industry, is one of them much worse?

Once we have established which of the 'drivers', ROS and/or AT, is(are) the main cause(s) of the low ROE, we can follow it down to the subsidiary ratios, which are indented in the spreadsheet above. For most ratios, higher is better. The exceptions are Equity Multiplier, the Debt-to-Equity ratios, and Days' Sales Outstanding.

2. Following down to the next level, which ratio(s) do you trace the unsatisfactory performance of ROS and/or AT to?

Then when we have identified the underperforming subsidiary ratio(s), we can consider what operating actions would either increase the numerator or decrease the denominator, for the ratios where higher values are better, Just the opposite for the exceptions mentioned above.

3. For the ratios causing the unsatisfactory performance of ROS and/or AT, what operational changes could improve the value of that ratio? In other words, what could Paley do to increase the value of the numerator of the ratio or decrease the denominator, for most ratios, or just the opposite for the exception ratios mentioned above (EM, Debt to equity, and Days' sales outstanding)?