Chapter 6

M 6-15 a. Accounts Receivable Turnover for the current year Procter & Gamble.................... $83,503 / [($6,761+$6,629) / 2] = 12.47 Colgate-Palmolive................... $13,790 / [($1,681+$1,523) / 2] = 8.61 b. P&G turns its accounts receivable much faster than Colgate-Palmolive. Differences can arise due to variations in the product mix of competitors, the types of customers they sell to, their willingness to offer discounts for early payment, and their relative bargaining strength vis-à-vis the companies or individuals owing them money. Both of these companies sell a significant amount of their product to Wal-Mart. P&G is a sizable company, and may have greater bargaining power with WalMart than does the smaller Colgate-Palmolive. M 6-18 a. Inventory Turnover rates for 2008 ANF......................................... TJX.......................................... $1,238 / [ ($333 + $427) / 2 ] = 3.26 $14,082 / [($2,737+$2,582) /2] = 5.29

b. TJX’s inventory turnover rate is higher than ANF’s. TJX concentrates on the value-priced end of the clothing spectrum. Thus, it realizes a lower profit margin that must be offset with higher turnover to yield an acceptable return on net operating assets (see discussion of profitability and turnover in Module 4). c. Inventory turnover improves as the volume of goods sold increases relative to the dollar value of goods available for sale. Retailers must balance the cost savings from inventory reductions against the marketing implications of lower inventory levels. Companies can lower inventory levels by reducing the depth and breadth of product lines carried (such as not carrying every style, size and color), eliminating slow-moving product lines, working with suppliers to arrange for delivery when needed, and marking down goods for sale at the end of product seasons.

thus minimizing finished goods inventories. but. Manufacturers.. c. The longer term of these receivables reduces turnover rates. Recall that the turnover ratio includes credit sales.. or that require substantial investment in long-term assets yield much lower receivable.. on the other hand. builds a relatively smaller number of high cost machines that likely take a much longer period of time to manufacture. or that normally stock inventories for production and sale. and PPE turnover rates respectively.... Microsoft’s PPE turnover is much higher than Carnival’s.. Those industries that sell on credit.. on the other hand. Industry Retailing.. The relative asset turnover rates reported generally conform to our expectations across industries. Generally. inventory. Oracle is a software development and service company and does not carry inventories of products for sale. compared with Caterpillar. Caterpillar and Harley-Davidson. check. These lower turnover rates must be accompanied by higher profit margins and/or higher financial leverage to yield a satisfactory return on net operating assets. requires relatively few PPE assets to support its operations. on the other hand... The likely reason for this is that retail sales are usually via cash. is capital-intensive.. Microsoft. or credit cards (which are like cash for the retailers). usually sell to retailers on credit and the accounts are not collected for a much longer period of time.. CAT and HOG both have finance subsidiaries that provide loan and lease financing. CAT. a. we are forced to use total sales when we calculate the turnover ratio. rather than using credit cards... Microsoft’s R&D costs are expensed under GAAP rather than capitalized as PPE. the cruise ship line. most likely reflects the fact that demand is high for Harley-Davidson’s products and the motorcycles are sold before production begins.P6-38 Best Buy (a retailer) reports a much higher receivables turnover rate than do the manufacturers. because most firms do not report credit sales. we expect the following: d... Thus. Manufacturing. Harley-Davidson’s relatively higher inventory turnover rate.. Receivables Turnover ↑ ↓ Inventory Turnover ↑ ↓ PPE Turnover ↑ ↓ . b. Carnival.

computed as ($15. a.9%. Intuit’s allowance seems high – over 10% in both 2007 and 2008.000 / 365) = 16.939) in 2007 b. Service revenues are likely on account. we would compare Intuit’s ratios to the allowances of Intuit’s competitors.P6-40 ($ in thousands. computed as ($15. It could be that the industry suffered an economic downturn in 2007 and 2008 and customers are having difficulty paying.4%. To assess this.939. $3.230 + $15.866 $146. c.636 / $142. d. The 2008 allowance for uncollectible accounts increased slightly as a percentage of gross accounts receivable – the allowance increased despite a decrease in gross accounts receivable.691 + $15.071.866 / ($3. Average collection period (days sales in accounts receivable) is: $142. Its average collection period for receivables will.248 / $146.248 = $146.98 days Intuit’s sales to consumers are primarily via on-line purchases using credit cards for payment. Its overall average collection period for accounts receivable is an average of these lines of business. This could be because there is greater uncertainty about the collectability of receivables in general.000 = 21. therefore.19 The receivables turnover rate is $142. consistent with Intuit’s financial statements) Gross receivables as of 2008 are $127.636 = $142. be low for this portion of its business. Estimated uncollectible accounts as a percentage of gross accounts receivable are: 10. Gross receivables as of 2007 are $131.866) in 2008 10. and the collection period is likely to be longer for this segment of Intuit’s business. or one or more large accounts are in arrears.866.071.939 + 2 .

565). Either way. this increase might be due to customers’ weakening credit quality.234 ($14. An inflated allowance can be used to absorb future receivable write-offs with no impact on future profit.027 + $12.P6-40—continued Intuit’s allowance for uncollectible accounts is increased by the provision (“additions charged to expense”) and is decreased by writeoffs of accounts receivable (“deductions”). As mentioned above. . therefore. increased by $669 ($38.967 to $15.881 + $11. It has written off a cumulative total of $37. The increase charged to expense has slightly exceeded its write-offs.$37. or can be reversed in a future year to provide an immediate reduction in expense and consequent increase in profit. Over the three-year period covered by the table.565 ($13. The allowance account has. from $14.636.743 + $9. It might also be the case that Intuit is conservative and is intentionally depressing its current profit. if the allowance account is inflated.234 . This does not appear to be the case for Intuit since the additions to the allowance account have nearly mirrored write-offs of accounts receivable. Intuit has increased its allowance account by a cumulative amount of $38.222). the effect is to shift profit from the current period into one or more future periods.269 + $14.657). e.

saving the company $146. a. c. Dow has saved taxes of $528.885 / [$46. Thus.511 million × 35%). pretax income has been reduced by $1.9 million ($1. it requires a certain level of raw materials and continually maintains inventories in production and awaiting delivery. We could usefully compare both of these ratios to those of other manufacturers in the same industry as DOW to make a more informed comparison.16 ($6.400/ 365 days]).885+ $6.511 million. The average inventory days outstanding does not appear excessive. DOW is a manufacturer.$1. During 2007.400 $6. the LIFO inventory reserve is $1.058 ). This reduction in inventory quantities is called LIFO liquidation. This tax saving increased operating cash flow by that same amount.17 (computed as $46. This increased its income by $321 million in 2007. DOW’s reduction of inventory quantities resulted in the matching of lower-cost inventories against higher current selling prices. . The inventory turnover rate for 2007 is 7.511 million because Dow uses LIFO. cumulatively. and $110 million in 2005. 2007. Since the overall cost of its inventories has been increasing.092 million).P6-41 ($ millions) Dow uses LIFO inventory costing for 34% of inventories at December 31.65 million ($419 million × 35%) in taxes. 2 The average inventory days outstanding for 2007 is 54. cumulatively. thus. the LIFO reserve increased by $419 million ($1. Assuming a tax rate of 35%. b. As of 2007. $97 million in 2006.511 million .

(Note: We eliminate land and construction in progress from the computation because land is never depreciated and construction in progress represents assets that are not in service yet and are consequently not yet “depreciable”). P6-43 $ millions a.328) = 57.21. This turnover is lower than the 5. .669) / 2] = 3.072. under generally accepted accounting principles. Thus.597. Rohm and Haas’ balance sheet does not reflect all of its operating assets.328) / $1.871 + $2. This indicates that Rohm and Haas is more capital intensive than the median publicly traded company. b. on average.897 / [($2. The footnote indicates that buildings have estimated useful lives ranging from 10-50 years (27-year average) and Equipment from 3-20 years (11-year average). if not all. For example. the estimate of 13. Assuming that assets are replaced evenly as they are used up.8% (Note: We eliminate land and construction in progress from the computation because land is never depreciated and construction in progress represents assets that are not in service yet and are consequently not “depreciable”).855 = 13. Percent used up = Accumulated depreciation/ Depreciable asset cost = $8.$494. we would expect assets to be 50% depreciated.597.03 median for all publicly traded companies.P6-42 Average useful life = Depreciable asset cost / Depreciation expense = ($15. of its R&D expenditures.021 .$494.8% is slightly higher than this level.801 . Substantial R&D costs not reflected on the balance sheet would yield understated PPE assets and thus.652 / ($15.0 years rests between these two reported values.$1.079. but not high enough to cause concern that it will need markedly higher capital expenditures in the near future to replace aging assets. PPE turnover for 2007 is: $8. an overstated PPE turnover rate – the sales resulting from the R&D investments are included in the numerator of PPE turnover but the R&D related assets are excluded from the denominator.121.121.03 years a.801 .$1.021 . the company must expense most. Abbott Labs 57.

That is. A substantially higher percentage “used up” indicates that the assets are closer to the end of their useful lives and will require replacement (and usually higher maintenance costs near the end of their useful lives). We eliminate construction in progress and capitalized interest because these represent assets that the company is building (and the interest paid on the construction loans). that is. but has no effect on current period cash flows because an impairment charge is a noncash expense. Such a situation would negatively impact future cash flows. can be estimated as b. d. the impairment charge is not deductible for tax purposes until the asset is disposed of.44 years *Note: We eliminate land from the computation because land is never depreciated.” on average. we would be justified in treating them as transitory (operating) items for analysis purposes. assuming straight-line Depreciable asset cost / Depreciation expense ($8. Plant assets are deemed to be impaired if the undiscounted expected future cash flows from those assets are not sufficient to recover their net book value. the company’s plant assets were approximately 73. An asset impairment charge (such as Rohm and Haas’ $24 million charge in 2007) reduces net income.908 / ($8.779 . We eliminate construction in progress and capitalized interest because these represent assets that the company is building (and the interest paid on the construction loans). Moreover. These assets are not yet in service and are consequently not depreciated. If impaired. the discounted value of the future expected cash flows.$352* . If plant assets are replaced at a constant rate.76% *Note: We eliminate land from the computation because land is never depreciated. . we would expect those assets to be about 50% “used up. life.8% “used up. which is typically. the sum of the undiscounted future cash flows is less than the net book value.” which is computed as follows: Accumulated depreciation / Depreciable asset cost $5. the plant assets are written down to their fair value.Rohm and Haas’ average asset depreciation. These assets are not yet in service and are consequently not yet depreciable. As of 2007. until the loss is realized.$146*.$271*) / $412 = 19. Since asset impairment charges are nonrecurring.$352* . c.$146*.$271*) = 73. Rohm & Haas’ depreciable assets appear to be substantially “used up” based on this analysis.779 .

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