FREE ESSAY ON ROE DECOMPOSITION

ROE DECOMPOSITION

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turnover may be due to out of date inventory.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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