Rollins Products Company has had poor operating results for the past two years.

Question

Rollins Products Company has had poor operating results for the past two years. As the accountant for Rollins Products Company, you have the following information available to you:
2011 2010

Current assets $45,000 $35,000
Total assets 145,000 110,000
Current liabilities 20,000 10,000
Long-term liabilities 20,000 --
Owner’s equity 105,000 100,000
Net sales 262,000 200,000
Net income 16,000 11,000

Total assets and owner’s equity at beginning of 2010 were $90,000 and $80,000, respectively. The owner made no investments 2010 or 2011.
1. Compute the following measures of liquidity for 2010 and 2011: (a) working capital and (b) current ratio. Comment on the differences between the years.
2. Computer the following measures of profitability for 2009 and 2010: (a) profit margin, (b) asset turnover, (c) return on assets,(d)debt to equity ratio, and (e) return on equity. Comment on the change in performance from 2010 to 2011

Explanation / Answer

1. a. Working capital = Current Assets – Current Liabilities

For 2010: 35,000 – 10,000 = 25,000

For 2011: 45,000 – 20,000 = 25,000

b. Current ratio = current assets/current liabilities

For 2010: 35,000/10,000 = 3.5

For 2011: 45,000/20,000 = 2.25

Working capital and current ratio are both liquidity ratios. The working capital stayed the same while the current ratio decreased, which means their short-term debt paying ability has decreased.   

2. a. Profit margin = Net Income/Net Sales

For 2010: 11,000/200,000 = 0.055 or 5.5%

For 2011: 16,000/262,000 = 0.0611 or 6.11%

b. Asset turnover = Net Sales/Average Total Assets

For 2010: 200,000/100,000 = 2 times

For 2011 262,000/127,500 = 2.05 times

c. Return on assets = Net Income/Average Total Assets

For 2010: 11,000/100,000 = 0.11 or 11%

For 2011: 16,000/127,500 = 0.1255 or 12.55%

d. Debt-to-equity ratio = Total Liabilities/Total Equity

For 2010: 10,000/100,000 = 0.1

For 2011: 40,000/105,000 = 0.38

e. Return on Equity = Net Income/Average Owners Equity

For 2010: 11,000/90,000 = 0.1222 or 12.22%

For 2011 16,000/102,500 = 0.1561 or 15.61%

Profit Margin, return on assets and return on equity are all measures of profitability. They have all increased, so that would mean that 2011 was more profitable than 2010. Asset turnover is a measure of efficiency of the use of assets to produce sales. This has risen slightly, which means they used their asset a little more efficiently in 2011. The debt-to-equity ratio is a measure of solvency. It increased, which means they have a higher percentage of debt in their capital structure in 2011.

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