[titine]

Currently doing ratio questions and I’m stuck at these explanations.

Transactions may increase or decrease a particular ratio, or have no effect. The first column below lists a transaction. The second column lists a ratio along with its value just before the indicated transaction. In the third column, indicate the immediate effect of the transaction on the ratio by double-clicking on the related cell and select increase, decrease, or no effect from the popup list provided. For each transaction, assume that the dollar amount of the transaction is not significant in relation to the absolute amounts in the numerator and denominator of the relevant ratio before the transaction.

Transaction: Write off inventory

Ratio and Value Before Transaction: Return on equity, .20 (20%)

Effect: Decrease

Transaction: Sell goods costing $60 for $100

Ratio and Value Before Transaction: Profit margin, .09 (9%)

Effect: Increase

Rationale:

Write off inventory: both net income and average total OE decrease but net income is reduced by a greater percentage. The ratio decreases.

Sell goods costing $60 for $100: income and sales both increase but income increases by a higher percentage than sales. The ratio increases.

I can’t figure out how we can know it’s *greater percentage*? Pls help, thank you!

[titine]

Anyone?

[GosiaS]

OK, let me try. It has been a while since I've done it.

Proft margin is normally calculated as (net income/revenue)x100. We have 9% given for the original profit margin ratio, so we can assume that the previous calculation looked something like (900/10,000)x100 (assuming that net income was 900 and revenue was 10,000).

Now lets say that our data changes, and there is a $100 sales price increase (holding all the other variables constant).

So, our profit margin calculation will change to (1000/10,100)x100=9.9%. Since our numerator was originally lower than denominator, the $100 will represent the higher percentage of the original $900 than of the $10,000 in denominator.

FAR 10/04/11 83
REG 11/29/11 82
AUD 01/17/12 92
BEC 02/28/12 87

[Anonymous]

“Write off inventory: both net income and average total OE decrease but net income is reduced by a greater percentage. The ratio decreases.”

Net Income 20,000/Owner's Equity 100,000 = .2 (.2 is given but I made up the NI and OE numbers)

I made up the following numbers…Write of inventory of 10,000 then Net Income 10,000/Owner's Equity 90,000 = .11

To figure out change in percentage, it's New-Old/Old so for Net Income = 10,000-20,000/20,000 = 50% and for Owner's Equity it's 90,000-100,000/100,000 = 10%. So Net Income decreased by a greater percentage than Owner's Equity.

Does that help at all? I know it's kind of hard to follow. Whenever I'm faced with a ratio problem, I always make up my own numbers to help figure out what direction everything goes.

As I stated above, the formula for calculating % change is new-old/old (sorry if you already knew that… some people do, some people don't.)

[titine]

Thanks Gosia S and apbandj. I got the part about write off inventory but for selling goods, I thought net income only increases $40? Sorry if this sounds dumb…

[Anonymous]

Not a dumb question at all… hope this helps. Again, I'm using made up numbers.

What was given in problem: $9 Income/$100 Sales = 9% (you can use any combination of #'s as long as the result is 9%)

Then you have to add in transaction they gave you above which is… Transaction: Sell goods costing $60 for $100

Now you have…

Numerator: Income $9 + $40 = $49

Denominator: Sales $100 + $100 = $200

$49/$200 = 24.5% so your ratio increased from 9% to 24.5%

Now for percentage change, do new-old/old like I mentioned last night.

Income: 49-9/9 = 40/9 = 444%

Sales: 200-100/100 = 100%

So Income increased by a higher percentage than Sales. Make sense?

[titine]

Got it, thank you so much!

[Author]

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