Ratios Tell A Story 2007 Harvard Case Solution & Analysis


Understanding the industry norms and benchmark ratio can help in many ways when comparing two different companies’ financial performance using their financial ratios. However, since different companies adopt different policies and management philosophies to run the business operations, hence, their spending and strategies vary according to the industry in which they operate. Such as some industries need to heavily invest in property and plant, while other need heavy investment in inventory. Similarly, some industries require investment in account receivables,while, others invest in research and development work.

Furthermore, capital structure and the way the assets are financed also differ industry to industry, such as in some industries long term fixed assets are financed from debt capital, meanwhile, in other industries the long term fixed assets are financed through equity capital. Further, the dividend payment is linked to the management philosophy which also vary industry to industry, therefore, in order to understand an industry, it is vital to understand these variations and the management philosophy and policies governing the operation, hence, a better way to understand these variants is to analyze the industry ratios relating to each industry.

Industries and Ratios Analysis

However, the case presented with 13 different industries with their balance sheet and commonly used financial ratios, hence, using the provided ratios of 13 different companies their respective industries have been identified.

Return on Sales:

Return on sales ratios calculates the returns that a company has generated for every $1 of sales revenue during a particular period; however, it is common to understand that the companies that do not incur high cost to generate sales revenue will have a higher return on sales because they do not incur the high cost of goods sold or the cost of providing the services. Therefore, analyzing the ratios of 13 companies it can be identified that the company #2 enjoys the highest return on sales among 13 companies, which makes it a service oriented company, also the fact that this company has zero inventories also indicate that this company is in the service industry, furthermore, the fact that this company does not have to incur the high cost of sales and hence generates the highest return on sales confirms that this company operates in the software industry. Because software companies do not have to incur high expenses on generating sales because their software is developed at initial stage and later with a copy of the developed software is sold to different companies which do not requirethe high expense to complete the sales, meanwhile, companies in the software industry do not keep inventories.

Asset turnover:

Asset turnover ratio calculated that efficiency in the utilization of assets that a company uses in order to generate sales revenues. Since, asset turnover ratio uses two variables, of which one is sales revenue and other is the assets of the company, therefore, it can be established that the higher the sales revenues, higher will be the asset turnover ratio, or otherwise it is equally true that the lower the assets of a company, higher will be the asset turnover ratio. Therefore, the fact that staffing service industry do not heavily invest in fixed asset because their main source is human capital, which never gets capitalized, therefore, the company at #4 has the highest turnover of 3.20 times which confirms that this company is in staffing service industry.

Meanwhile, the company at #5 can be classified in the automobile industry because it has a high level of plants, equipment and machinery that it uses to manufacture the automobile units, therefore, this company has lower asset turnover. Further, the company at #13 can be classified in the utility industry because it has lowest asset turnover due to the high level of investment in development of infrastructure and installation of plant and equipment.

Return on Assets:

Return on assets also uses the total assets as a denominator, meanwhile, instead of sales revenues, it uses the net income that a company has generated suing the assets deployed in the business. Therefore, due to the fact the companies in staffing service industry do not have a high level of fixed assets, it be established that the companies in the staffing service industry will have the highest return on assets. Hence, company #4can be categorized as a company in staffing service industry. Further, the second highest return on asset ratio is of the company#2which has been categorized in the software industry, this is because the main resource of companies in software industries, are the software engineers and developers instead of other property plant and equipment.

Financial Leverage:

Financial leverage ratio calculates theinvestment in assets using the debt finance at times of equity financing. However, an evaluation of the 13 industries shows that banking industry heavily rely on debt financing in comparison to the equity financing because their main source if business is taking deposits from the customer and utilizing them in creating assets such as loan to commercial companies and other business individuals....................

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