274 SECTION 1 The Role of Accounting as an Information System 5 2.00% $16,551 5 3.50% 3.76% 5 3.58 $473,076 5 7.18% $16,551 5 2.44 $203,928 5 2.50 2.24 5 17.52% $16,551 5 92.34 _$_4_7_3_,0_7_6_ 5 70.37 176.36 _____ 92.34 5 3.95 days _3_6__5_ 5 12.27 $358,069 What matters most to the shareholders of these companies is not return on assets, but the return on equity (ROE). Both fall short of the industry average, but Walmart wins over Costco on this measure, with an ROE of 20.3% compared to Costco’s 17.5%. Walmart’s equity multiplier also is a bit higher than Costco’s (2.5 for Walmart compared to 2.4 for Costco), which causes the two companies’ ROEs to be even farther apart than their ROAs. A Costco shareholder looking at these numbers might wonder how best to increase Costco’s ROE. Should Costco attempt to increase operational efficiency on the asset turnover dimension? That might be tough, given its already high asset turnover. Or, should Costco attempt to increase profit margin? Given competitive pressures on retail pricing, can Costco generate a much higher profit margin with its current product mix and low-price strategy, or should it consider including more upscale, high-margin items in its inventory? Or, should Costco attempt to increase leverage and improve its equity multiplier, so that debt holders are financing a greater percentage of its assets? The essential point of our discussion here, and in Part C of Chapter 3, is that raw accounting numbers alone mean little to decision makers. The numbers gain value when viewed in relation to other numbers. Similarly, the financial ratios formed by those relationships provide even greater perspective when compared with similar ratios of other companies, or with averages for several companies in the same industry. Accounting information is useful in making decisions. Financial analysis that includes comparisons of financial ratios enhances the value of that information. Illustration 5–26B DuPont Framework and Activity Ratios—Costco Wholesale Corporation and Wal-Mart Stores, Inc. DuPont analysis: Costco Walmart Industry Average* Profit margin on sales 5 $2,061 _______ _ $102,870 ________ $473,076 3 3 3 Asset turnover 5 $102,870 ________ $28,712 ________ $203,928 5 2.32 2.51 5 5 5 Return on assets 5 $2,061 _______ $28,712 ________ $203,928 5 8.12% 9.33% 3 3 3 Equity Multiplier 5 $28,712 _______ $11,765 ________ $81,539 5 5 5 Return on equity 5 $2,061 _______ $11,765 _______ $81,539 5 20.30% 20.56% Other activity ratios: Receivables turnover 5 $102,870 ________$1,114 $6,723 Average collection period 5 365 70.37 5 5.19 days 4.60 days Inventory turnover 5 $91,948 _______ $7,495 ________ $44,331 5 8.08 5.53 Average days in inventory 5 _ 3__6_5_ 12.27 5 29.75 days _3_6_5_ 8.08 5 45.17 days 78.92 days * Industry average based on sample of eleven discount retail companies.
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