Although the drop in ROE could from 1994 to 1995 did not come as a result of falling margins, in the the slip from 1995 to 1996 profit margin certainly contributed and is worth exploring further. To do this, we would next look at the company's operating margin, a ratio of the operating earnings to the revenues. Operating earnings tell you how the company's operations were doing, outside of the effect of changes in tax liability or interest payments. Otherwise, operating earnings actually improved. Since profit margin or any other ratios from the income statement do not really explain the shortfall, we next move to the left side of the balance sheet, or the assets.
Asset turns is simply sales over total assets.
Asset turnover in 1994 was 2.8 times, in 1995 was 2.6 times, and in 1996 plummeted to only 1.8 times. Looking deeper into the asset side of the balance sheet, the huge build up in inventories and accounts receivable seem to be the cause. Both lower inventory turns and higher days sales outstanding meant that although the company was booking plenty of sales, it was building up cash-sucking inventories faster, and it was not as efficient at collecting money from its sales. By looking at trends in return on equity and analyzing the components, the investor is forced to not only examine the much overlooked Statement of Operations, or the Income Statement, but also to balance this against the left and right sides of the Balance Sheet. The Motley Fool.