Du pont decomposition of ROE

LA Gear’s ROE has decreased over the last three years from 49.45% in 1988 to 15.22% in 1990. Profitability (NI/Sales) has also fallen dramatically from 9.8 % in 1988 to 3.47% in 1990. Asset turnover has increased from 1.69 to 2.48, because while sales have quadrupled, total assets have only increased by about 2.7 times.

Profitability

The gross profit margin has dropped from 42.29% in 1988 to 34.41% in 1990. LA Gear’s operating profit margin has decreased from 18.52% to 7.75%. This is due to a dramatic increase in operating expenses. The decreasing net profit margins (9.85% to 3.47%) is due to lower gross profit margins and expenses. Net profit margin, gross profit margin and operating profit margin are all below industry standards.

Asset turnover

La Gear’s total asset turnover has increased from 1.69 to 2.48 due to the fact that sales has increased at a faster rate than inventory levels have. Inventory turnover has also increased from 1.94 to 3.68 although it is still below industry standards. Slow inventory turnover may be due to out of date inventory. Average collection period decreased from 1988 to 1989 but then went up slightly in 1990

Leverage

LA Gear has not been able to improve its ROE even thought it improved its asset efficiency, its profitability and leverage have decreased. Assets to equity have decreased from 1988 but is still above the average. This increase in debt has led to an increase of inventory. Times interest earned has dropped from 10.10 to 3.77, which is way below industry standards.

Liquidity

LA Gear’s short-term liquidity (current ratio) has increased but is still below standards. This is due to an increase in current assets such as inventory and receivables.

Recommendations for Improvement

LA Gear might be able to increase inventory turnover by relaxing credit terms and accepting a higher collection period. Getting rid of old merchandise could also help bring the inventory turnover up to industry standards. Cutting operating expenses would increase their profit margins.

Bibliography

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