Consider a small business that started in 2010. The business started with $50 in
ID: 2810539 • Letter: C
Question
Consider a small business that started in 2010. The business started with $50 in cash provided as an equity investment by its owner. This is a very simple business. Think lemonade stand or food truck. ie, currently it has no debt, no long term capital depreciation or inventory. They buy and sell everything on a cash basis, so no A/P or A/R. And all net sales (sales net of costs) becomes cash.
Over the last several years, this has been their sales and cost structure (this is also included as a spreadsheet).
Year
2010
2011
2012
2013
2014
2015
2016
2017
Income Statement
Sales
$ 100.00
$ 120.00
$ 144.00
$ 172.80
$ 207.36
$ 248.83
$ 298.60
$ 358.32
Cogs
$ 60.00
$ 72.00
$ 86.40
$ 103.68
$ 124.42
$ 149.30
$ 179.16
$ 214.99
GSA
$ 6.00
$ 7.20
$ 8.64
$ 10.37
$ 12.44
$ 14.93
$ 17.92
$ 21.50
What has the growth rate of Sales been from 2010 to 2017. How do you interpret this?
What has the growth rate of COGS, and the ratio of COGS to Sales been? How do you interpret this?
What has the GSA growth rate and ratio of GSA to Cogs to Sales been?
What is the gross income and net income over this period? How do you interpret that?
Given the business started with a $50 cash investment. What is the Balance sheet for this company. Ie, for 2010-2017, what is the cash, assets and liabilities?
What is the ROE for every year?
ROE is decomposed into profitability, turn and leverage. What are each of these three metrics over 2010-2017. How do you interpret these measures, and what do you think they mean for the business.
Suppose the owner wants to start taking money out of the business in the form of a dividend. This is common on small businesses. The business will reward owners by paying them directly. Suppose over time, the payments are as follows. A dividend is paid out as cash directly. It does not impact gross income. But it does come out of Net income. Given this change, what happens to ROE, Profitability, Turn and Leverage over time
Dividend
$ 25.00
$ 30.00
$ 35.00
$ 40.00
$ 50.00
$ 50.00
$ 70.00
$ 90.00
How do you interpret the change in these 4 measures (from 8). Are these adviseable and why?
Now imagine a similar but different business. Assumptions are the same as in the paragraph at top of page. However, in order to sustain this growth rate, the company must buy $400 in equipment every year to sustain growth. It finances this investment in equipment by getting a bank loan. So it owes 400 in year one, 800 in year 2, etc. For now, assume no interest. Dividend is zero. Depreciation is zero.
In this scenario, what is the ROE, Profitability, Turn and leverage of the company. How do you interpret this?
Same scenario as 10. However, owner decides to extract $30 in dividend every year. What is the ROE, Profitability, Turn and Leverage. How do you interpret this?
Year
2010
2011
2012
2013
2014
2015
2016
2017
Income Statement
Sales
$ 100.00
$ 120.00
$ 144.00
$ 172.80
$ 207.36
$ 248.83
$ 298.60
$ 358.32
Cogs
$ 60.00
$ 72.00
$ 86.40
$ 103.68
$ 124.42
$ 149.30
$ 179.16
$ 214.99
GSA
$ 6.00
$ 7.20
$ 8.64
$ 10.37
$ 12.44
$ 14.93
$ 17.92
$ 21.50
Explanation / Answer
Year 2010 2011 2012 2013 2014 2015 2016 2017 Income Statement Sales $100.00 $120.00 $144.00 $172.80 $207.36 $248.83 $298.60 $358.32 Cogs $60.00 $72.00 $86.40 $103.68 $124.42 $149.30 $179.16 $214.99 GSA $6.00 $7.20 $8.64 $10.37 $12.44 $14.93 $17.92 $21.50 Profit $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Answer Interpretations Growth rate of sales 20% 20% 20% 20% 20% 20% 20% Constant YoY Increase @ 20% COGS to Sales % 60% 60% 60% 60% 60% 60% 60% 60% Constant YoY COGS to Sales ratio @ 60% Growth rate of COGS 12% 12% 12% 12% 12% 12% 12% Constant YoY Increase @ 12% Growth rate of GSA 17% 17% 17% 17% 17% 17% 17% Constant YoY Increase @ 17% GSA to COGS % 10% 10% 10% 10% 10% 10% 10% 10% Constant YoY GSA to COGS @ 10% GSA to Sales % 6% 6% 6% 6% 6% 6% 6% 6% Constant YoY GSA to Sales @ 6% Balance sheet 2010 2011 2012 2013 2014 2015 2016 2017 Assets Cash Orgininal Cash $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Due to sales - COGS- GSA $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Total assets $84.00 $90.80 $98.96 $108.75 $120.50 $134.60 $151.52 $171.83 Equity $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Reserves includes profit $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Total liabilities $84.00 $90.80 $98.96 $108.75 $120.50 $134.60 $151.52 $171.83 Difference $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 ROE - Du Pont Net income / Sales 0.34 0.34 0.34 0.34 0.34 0.34 0.34 0.34 Constant Net income to sales Revenue / Total assets 1.19 1.32 1.46 1.59 1.72 1.85 1.97 2.09 Incremental revenue to total assets Total assets / Shareholder equity 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Constant total assets to shareholder value ROE 40% 45% 49% 54% 59% 63% 67% 71% Increasing ROE Dividend Year 2010 2011 2012 2013 2014 2015 2016 2017 Income Statement Sales $100.00 $120.00 $144.00 $172.80 $207.36 $248.83 $298.60 $358.32 Cogs $60.00 $72.00 $86.40 $103.68 $124.42 $149.30 $179.16 $214.99 GSA $6.00 $7.20 $8.64 $10.37 $12.44 $14.93 $17.92 $21.50 Profit $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Dividend $25.00 $30.00 $35.00 $40.00 $50.00 $50.00 $70.00 $90.00 Transfer to equity $9.00 $10.80 $13.96 $18.75 $20.50 $34.60 $31.52 $31.83 Change in Balance Sheet - Dividend 2010 2011 2012 2013 2014 2015 2016 2017 Assets Cash Orgininal Cash $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Due to sales - COGS- GSA- Dividend $9.00 $10.80 $13.96 $18.75 $20.50 $34.60 $31.52 $31.83 Total assets $59.00 $60.80 $63.96 $68.75 $70.50 $84.60 $81.52 $81.83 Equity $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Reserves includes profit $9.00 $10.80 $13.96 $18.75 $20.50 $34.60 $31.52 $31.83 Total liabilities $59.00 $60.80 $63.96 $68.75 $70.50 $84.60 $81.52 $81.83 Difference $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 ROE - Du Pont Net income / Sales 0.34 0.34 0.34 0.34 0.34 0.34 0.34 0.34 Constant Net income to sales Revenue / Total assets 1.69 1.97 2.25 2.51 2.94 2.94 3.66 4.38 Incremental revenue to total assets Total assets / Shareholder equity 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Constant total assets to shareholder value ROE 58% 67% 77% 85% 100% 100% 125% 149% Increasing ROE when compared to models were dividends were not paid Equipment purchase Year 2010 2011 2012 2013 2014 2015 2016 2017 Income Statement Sales $100.00 $120.00 $144.00 $172.80 $207.36 $248.83 $298.60 $358.32 Cogs $60.00 $72.00 $86.40 $103.68 $124.42 $149.30 $179.16 $214.99 GSA $6.00 $7.20 $8.64 $10.37 $12.44 $14.93 $17.92 $21.50 Profit $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Dividend $30.00 $30.00 $30.00 $30.00 $30.00 $30.00 $30.00 $30.00 Transfer to equity $4.00 $10.80 $18.96 $28.75 $40.50 $54.60 $71.52 $91.83 Change in Balance Sheet - Dividend 2010 2011 2012 2013 2014 2015 2016 2017 Assets Cash Orgininal Cash $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Due to sales - COGS- GSA $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Equipment $400.00 $800.00 $1,200.00 $1,600.00 $2,000.00 $2,400.00 $2,800.00 $3,200.00 Total assets $484.00 $890.80 $1,298.96 $1,708.75 $2,120.50 $2,534.60 $2,951.52 $3,371.83 Equity $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Reserves includes profit $34.00 $40.80 $48.96 $58.75 $70.50 $84.60 $101.52 $121.83 Loans $400.00 $800.00 $1,200.00 $1,600.00 $2,000.00 $2,400.00 $2,800.00 $3,200.00 Total liabilities $484.00 $890.80 $1,298.96 $1,708.75 $2,120.50 $2,534.60 $2,951.52 $3,371.83 Difference $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 ROE - Du Pont Net income / Sales 0.34 0.34 0.34 0.34 0.34 0.34 0.34 0.34 Constant Net income to sales Revenue / Total assets 0.21 0.13 0.11 0.10 0.10 0.10 0.10 0.11 Revenue to total assets Total assets / Shareholder equity 5.76 9.81 13.13 15.71 17.60 18.83 19.48 19.62 Increasing total assets to shareholder value ROE 40% 45% 49% 54% 59% 63% 67% 71% Increasing ROE when compared due to debt inclusion With Dividend Assets Cash Orgininal Cash $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Due to sales - COGS- GSA $4.00 $10.80 $18.96 $28.75 $40.50 $54.60 $71.52 $91.83 Equipment $400.00 $800.00 $1,200.00 $1,600.00 $2,000.00 $2,400.00 $2,800.00 $3,200.00 Total assets $454.00 $860.80 $1,268.96 $1,678.75 $2,090.50 $2,504.60 $2,921.52 $3,341.83 Equity $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 $50.00 Reserves includes profit $4.00 $10.80 $18.96 $28.75 $40.50 $54.60 $71.52 $91.83 Loans $400.00 $800.00 $1,200.00 $1,600.00 $2,000.00 $2,400.00 $2,800.00 $3,200.00 Total liabilities $454.00 $860.80 $1,268.96 $1,678.75 $2,090.50 $2,504.60 $2,921.52 $3,341.83 Difference $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 ROE - Du Pont Net income / Sales 0.34 0.34 0.34 0.34 0.34 0.34 0.34 0.34 Constant Net income to sales Revenue / Total assets 0.21 0.13 0.11 0.10 0.10 0.10 0.10 0.11 Incremental revenue to total assets Total assets / Shareholder equity 8.41 14.16 18.40 21.32 23.10 23.94 24.04 23.56 Constant total assets to shareholder value ROE 59% 65% 69% 73% 77% 80% 83% 85% Increasing ROE when compared due to debt inclusion