As mentioned in the introduction of the mini case, Hobby Horse Company, Inc. (HH) experienced a tough year in 2011. HH opened up a number of new stores but experienced a poor Christmas season. Christmas season is the biggest sale period for retail stores. As a result, bad Christmas sales performance played a big part of HH’s loss for year 2011. As we computed the financial ratios for HH, we can see the effects from new stores openings and poor sales performance.
First of all, return on asset (ROA) is a ratio used to measure how efficient a company generates profit using its assets, which is the invested capital. We noticed that HH’s ROA was increasing from 2006 to 2010. However, HH’s ROA for 2011 dropped dramatically from 18.41%(year 2010) to -1.57%. This shows that HH’s assets are not working efficiently enough to cover cost of assets. HH’ managers obviously failed to convert the money from investors into net income. This is not a good sign to the company because it means that the company is running to generate losses but not profits. Same pattern happens with HH’s return on capital(ROC) and return on equity(ROE). Both ROC and ROE were going up in the period of 2006 to 2010, however, in 2011, both dropped to -2.74% and -7.25% respectively. These datas show that HH was not generating profits but losses for every dollar from its investors. In other words, there is something wrong with the way HH’s managers manage business.
According to the Du Point System, we know that ROA consists of two components which are asset turnover and operating profit margin. It’s nearly impossible for company to have high asset turnover and high operating profit margin at the same time. There is a offset. Company has high asset turnover most likely has low operating profit margin, and vice versa. With HH’s efficiency ratios, its operating profit margin increased steadly from 2006 to