Question

(Ratio Analysis) The 2014 annual report of Tootsie Roll Industries contains the following information.

(in millions)	December 31, 2014	December 31, 2013
Total assets	\(910.4	\)888.4
Total liabilities	219.3	208.1
Net sales	539.9	539.6
Net income	63.2	60.8

Instructions

Compute the following ratios for Tootsie Roll for 2014.

1. Asset turnover.
2. Return on assets.
3. Profit margin on sales.
4. How can the asset turnover be used to compute the return on assets?

Short answer

Answer

a. Asset turnover ratio = 0.6003 times

b. Return on assets = 7.03%

c. The profit margin on sales =11.706%

d. Return on assets =7.03%

Step-by-step solution

Meaning of Ratio Analysis 

Ratio analysis is a basic approach to assessing a company's health by examining the relationships between key financial indicators. Ratio analysis, according to many analysts, is the most important aspect of the analytical process.

(a) Calculating asset turnover ratio

$\begin{array}{rcl}\text{Asset}\text{turnover}\text{ratio}& =& \frac{\text{Net}\text{sales}}{\frac{\text{Total}\text{asset}\text{of}2013\text{and}2014}{2}}\\ & =& \frac{\$539.9}{\frac{\$910.4+\$888.4}{2}}\\ & =& \frac{\$539.9}{899.4}\\ & =& 0.6003\text{times}\end{array}$

(b) Calculating return on asset

$\begin{array}{rcl}\text{Return}\text{on}\text{asset}& =& \frac{\text{Net}\text{income}}{\frac{\text{Total}\text{asset}\text{of}2013\text{and}2014}{2}}\\ & =& \frac{\$63.2}{\frac{\$910.4+\$888.4}{2}}\\ & =& \frac{\$63.2}{\$899.4}\\ & =& 7.03\%\end{array}$

(c) Calculating profit margin on sales 

$\begin{array}{rcl}\text{Profit}\text{margin}\text{on}\text{sales}& =& \frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\\ & =& \frac{\$63.2}{\$539.9}\\ & =& 11.706\%\end{array}$

(d) Explaining the asset turnover that is used to compute the return on assets 

The asset turnover times the profit margin on sales provides the rate of return on assets computed for Tootsie Roll as follows:

$\begin{array}{rcl}\text{Return}\text{on}\text{Asset}& =& \text{Profit}\text{magin}\text{on}\text{sales}\times \text{Asset}\text{turnover}\\ 7.03\%& =& 11.706\%\times 0.6003\end{array}$

Note: The answer 7.03% is the same as the rate of return on assets computed in (b) above.