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

Gross receivables as of 2007 are $131. or one or more large accounts are in arrears.248 / $146. 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.071. consistent with Intuit’s financial statements) Gross receivables as of 2008 are $127. computed as ($15. It could be that the industry suffered an economic downturn in 2007 and 2008 and customers are having difficulty paying. be low for this portion of its business. $3. Intuit’s allowance seems high – over 10% in both 2007 and 2008.000 = 21.939) in 2007 b. and the collection period is likely to be longer for this segment of Intuit’s business.636 = $142.636 / $142. Its overall average collection period for accounts receivable is an average of these lines of business.939 + 2 . This could be because there is greater uncertainty about the collectability of receivables in general.866 / ($3. Its average collection period for receivables will.866 $146. Service revenues are likely on account.4%. we would compare Intuit’s ratios to the allowances of Intuit’s competitors.248 = $146. d.000 / 365) = 16.866) in 2008 10.691 + $15. computed as ($15.071. therefore.19 The receivables turnover rate is $142.9%.230 + $15. a. To assess this. c. Estimated uncollectible accounts as a percentage of gross accounts receivable are: 10. Average collection period (days sales in accounts receivable) is: $142.939.866.P6-40 ($ in thousands.98 days Intuit’s sales to consumers are primarily via on-line purchases using credit cards for payment.

from $14.881 + $11.636. Intuit has increased its allowance account by a cumulative amount of $38. Either way. 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. As mentioned above. It has written off a cumulative total of $37. e. therefore. The increase charged to expense has slightly exceeded its write-offs.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”). Over the three-year period covered by the table.269 + $14. the effect is to shift profit from the current period into one or more future periods.$37. . It might also be the case that Intuit is conservative and is intentionally depressing its current profit.657).743 + $9. if the allowance account is inflated. increased by $669 ($38.565).027 + $12. An inflated allowance can be used to absorb future receivable write-offs with no impact on future profit.234 . or can be reversed in a future year to provide an immediate reduction in expense and consequent increase in profit. The allowance account has.222).967 to $15. this increase might be due to customers’ weakening credit quality.234 ($14.565 ($13.

511 million × 35%). Dow has saved taxes of $528. DOW’s reduction of inventory quantities resulted in the matching of lower-cost inventories against higher current selling prices.9 million ($1.058 ). 2 The average inventory days outstanding for 2007 is 54. Thus.65 million ($419 million × 35%) in taxes. This increased its income by $321 million in 2007. The average inventory days outstanding does not appear excessive. a. 2007. Since the overall cost of its inventories has been increasing. thus. As of 2007. it requires a certain level of raw materials and continually maintains inventories in production and awaiting delivery.16 ($6.885 / [$46.511 million .511 million. During 2007. DOW is a manufacturer.$1.092 million).400 $6. b. This tax saving increased operating cash flow by that same amount. saving the company $146. The inventory turnover rate for 2007 is 7. This reduction in inventory quantities is called LIFO liquidation. and $110 million in 2005. c. pretax income has been reduced by $1. the LIFO reserve increased by $419 million ($1.17 (computed as $46. cumulatively. cumulatively.511 million because Dow uses LIFO.400/ 365 days]).P6-41 ($ millions) Dow uses LIFO inventory costing for 34% of inventories at December 31. . $97 million in 2006. 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.885+ $6. the LIFO inventory reserve is $1. Assuming a tax rate of 35%.

121. Abbott Labs 57.669) / 2] = 3.03 years a.021 . For example. the estimate of 13. we would expect assets to be 50% depreciated. (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”).079. on average.597. Percent used up = Accumulated depreciation/ Depreciable asset cost = $8.P6-42 Average useful life = Depreciable asset cost / Depreciation expense = ($15. 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).897 / [($2. the company must expense most. This indicates that Rohm and Haas is more capital intensive than the median publicly traded company.801 . Rohm and Haas’ balance sheet does not reflect all of its operating assets.072.328) = 57. PPE turnover for 2007 is: $8.597.$494.0 years rests between these two reported values.$1.652 / ($15.21. b.$494. but not high enough to cause concern that it will need markedly higher capital expenditures in the near future to replace aging assets.801 .8% is slightly higher than this level.121.328) / $1. 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.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. Thus. of its R&D expenditures. if not all. This turnover is lower than the 5.871 + $2.$1. . P6-43 $ millions a. Assuming that assets are replaced evenly as they are used up.03 median for all publicly traded companies. under generally accepted accounting principles. Substantial R&D costs not reflected on the balance sheet would yield understated PPE assets and thus.021 .

c. assuming straight-line Depreciable asset cost / Depreciation expense ($8. Since asset impairment charges are nonrecurring. the discounted value of the future expected cash flows. These assets are not yet in service and are consequently not yet depreciable.8% “used up. Moreover.44 years *Note: We eliminate land from the computation because land is never depreciated. 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. which is typically. 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). An asset impairment charge (such as Rohm and Haas’ $24 million charge in 2007) reduces net income. the sum of the undiscounted future cash flows is less than the net book value.$352* .$271*) / $412 = 19.” on average.908 / ($8. . Rohm & Haas’ depreciable assets appear to be substantially “used up” based on this analysis.$352* . the plant assets are written down to their fair value. we would be justified in treating them as transitory (operating) items for analysis purposes. 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).76% *Note: We eliminate land from the computation because land is never depreciated. Such a situation would negatively impact future cash flows. but has no effect on current period cash flows because an impairment charge is a noncash expense. can be estimated as b. If plant assets are replaced at a constant rate.779 . d. That is. the company’s plant assets were approximately 73. that is. If impaired. 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).$146*.$271*) = 73. As of 2007.Rohm and Haas’ average asset depreciation. we would expect those assets to be about 50% “used up. the impairment charge is not deductible for tax purposes until the asset is disposed of.$146*.” which is computed as follows: Accumulated depreciation / Depreciable asset cost $5.779 . These assets are not yet in service and are consequently not depreciated. life. until the loss is realized.

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