Week 8 – CheckPoint – Interpreting Financial Ratios

Problem 6.2

Upon review of Luna Lighting’s financial ratios there are a few items that indicate their

inability to improve profitability. Their fixed asset turnover and total asset turnover

ratios are down. These are two approaches to assess management’s effectiveness in

generating sales from investment of assets. The fact that these ratios are lower that prior

year means that more investment is required in the generation of sales. The gross profit

margin, operating profit margin, and net profit margin, represent the firm’s ability to

translate sales dollars into profits. Although the gross profit margin stayed the same, the

operating profit margin declined almost a full point. The operating profit margin is a

measure of the overall operating efficiency incorporating all of the expenses associated

with normal business activities. The net profit margin was down most likely due to the

operating profit margin decline. The last indicators are the return on assets and return on

equity. Both of these ratios dropped considerably. These two ratios measure the overall

efficiency of the firm in managing it’s total investment in assets and in generating return

to shareholders. The return on assets indicates the amount of profit earned relative to the

level of investment in total assets was low. For Luna Lighting this number dropped a

point and a half from the previous year and two points from the year before. This states

that the company is not receiving a profit relative to the investment it is putting in, and

that their return to their shareholders in much lower also. After reviewing Luna

Lighting’s ratios they show the reason for their profitability problem the company is