Comparison of Selected Financial Ratios for the Pallet Industry by Bruce G. Hansen 1 and Cynthia D. West Abstract This paper presents the results of a financial ratio survey conducted by the National Wooden Pallet and Container Association (NWPCA) in 1997 for the 1996 tax year. Financial information obtained from NWPCA member and nonmember firms was used to construct financial ratios and measures of business performance for the wood pallet industry. Ten ratios common to the NWPCA survey, Robert Morris Associates, and Dunn and Bradstreet were analyzed to determine similarities and differences among the three sources. Respondents reported combined sales in 1996 of $871 million 1996, or about 30% of the total value of shipments of $3,018.8 million reported for Wood Container and Pallet manufacturers (SIC 2448) in the 1996 Annual Survey of Manufactures. Respondents had combined assets of $314 million. Median sales were $3.0 million with median assets $1.1 million. The product mix of all respondents included new pallets (57%) used/rebuilt pallets (16%), boxes (11%), lumber (8%), byproducts, composites and other 7%. INTRODUCTION In this paper we discuss results of a 1997 financial ratio survey of wooden pallet and container manufactures for the 1996 tax year. Data for this study are from tax forms filed with the Internal Revenue Service. The use of tax returns by the National Wooded Pallet and Container Association s (NWPCA) Industry Demographics and Performance Information Task Force greatly simplified the survey and provided a degree of standardization among respondents not readily available by other means. Although ratio information is compiled and published by Robert Morris Associates (RMA) and Dunn and Bradstreet (D&B) among others, many NWPCA members believed that such information did not accurately or adequately represent their industry. As a result, we compared ratios from NWPCA respondents with those published by RMA (1997) and D&B (1997). THE SURVEY The NWPCA survey for the 1996 tax year was the most recent of three; the other two were conducted for 1994 and 1995 for the previous tax year. The 1994 survey was restricted to NWPCA membership, while the 1995 and 1997 surveys included both members and nonmembers. Because of the sensitive nature of the information collected, the NWPCA made no effort to identify respondents. Thus, it was not possible to sample nonrespondents to determine what, if any, bias might have been imposed on the results by respondents. Consequently, it is not possible to make definitive statements about differences across years, differences between members and nonmembers, or about the industry at large. RMA has stated that the ratios it publishes may not be fully representative of a given industry, and suggests, that they should be used only as general guidelines and in addition to the other methods of financial analysis. Readers should exercise the same precautions with the NWPCA ratios in this study. Although more than 20 financial, employment, and capital investment ratios and measures were generated from survey data, comparison of NWPCA results with those of RMA and D&B focuses on ten ratios common to all three sources. Four of these are profitably ratios, one is a finance or leverage ratio, two are liquidity ratios, and three are activity ratios. All measures are reported as median values. The median represents that value about which respondents are equally divided, that is, half of the respondents reported larger values and half reported smaller values. A significant advantage of the median is that it is not unduly affected by very large or very small values. 1 Project leader, USDA, Forest Service, Princeton, WV, and Head, Department of Wood Products, Mississippi State University, Starkville, MS, and formerly Senior Research Forest Products Technologist, USDA, Forest Service, Princeton, WV.
RESPONDENTS Questionnaires mailed to all active NWPCA members (390) and to about 2000 nonmembers in the spring of 1997 requested information from the firms 1996 tax return. Usable responses from both groups totaled 157; of these, 98 were from NWPCA members, and 59 were from nonmembers. More than 30% of the respondents are located in the North Central region (Fig.1). The Southeast region was next (24.8%), Median sales of respondents by region ranged from $2.8 million in the North Central region to $3.5 million in the West. The median asset size of respondents ranged from $831,000 in the Northeast to $1,260,000 in the Southeast. There are several ways to report a firm s income. One is to report total income, which includes both operating and nonoperating income. Another is to report only operating income. Keown et al. (1994) suggested that net operating income is the best reporting method because it eliminates any effects that a firm s financial structure may have on income by placing all respondents on an equal footing. Net operating income is calculated as: Net operating income = Total income - nonoperating income + interest expense (1) Figure 1. Survey Regions. followed by the Northeast (19.1%), the South Central (8.3%), and the West (3.2%). Only two responses (1.3%) were received from the Intermountain region. These were combined in subsequent analyses with Response Assets Sales Income 0 20 40 60 80 100 Northeast Southeast North Central South Central West Other Figure 2. Distribution of response, assets, sales, and income reported by respondents, by region. 19 other firms that failed to disclose their location. Respondents in the Southeast accounted for the largest percentage of sales (Fig.2). This figure was considerably larger than the percentage of respondents from this region. The North Central region was next, followed by the Northeast and Other. The Southeast, North Central, Northeast and Other also ranked 1, 2, 3, and 4 on the basis of total assets reported by respondents. With respect to income, the North Central, South Central, and Southeast regions ranked 1, 2, and 3, respectively. Net operating income for respondents ranged from $80,139 in the Southeast to $196,000 in the West. Respondents in the Northeast and North Central regions were similar to those in the Southeast with net operating income of $81,000 and $82,000, respectively. Subsequent comparisons of NWPCA, RMA, and D&B measures include both total and net operating income. PRODUCT MIX New wood pallets accounted for over 57.1% of the total sales reported by respondents (Fig. 3). This was followed by sales of used and rebuilt pallets, boxes and shook, lumber and byproducts, composites, and unspecified products accounting for the remainder. NWPCA members were more heavily engaged in the production of new or used/rebuilt pallets than nonmembers. New wood and used/rebuilt pallets accounted for nearly 80% of the revenue of NWPCA respondents versus roughly 64% for nonmember respondents. New wood 57.1% Used/rebuilt 16.0% Other 4.1% Composites 1.5% By-products 1.6% Lumber 8.4% Boxes 11.3% Figure 3. Product mix of respondents. RATIOS AND MEASURES Table 1 lists the ratios and related measures from all 157 respondents. Most are self explanatory. In
addition, data were analyzed on the basis of selected business and product types, region, and asset size (NWPCA 1998). These more detailed analyses are not included in this paper. Table 1. Financial ratios and other measures, all respondents, 1996 Ratio/measure Value Ratio/measure Value Gross margin 20.8 Collection period (days) 30.9 Return on sales 3.6 Inventory turnover 12.3 Return on assets 9.8 Inventory (days) 29.3 Return on equity 22.9 Asset turnover 2.9 Equity ratio 0.44 Fixed asset turnover 6.2 Fixed assets to equity 0.98 Sales per employee ($000) 94.6 Current liabilities to equity 0.61 Payroll per employee ($000) 19.0 Debt equity 1.19 Average employment 30.0 Times-interest-earned 3.0 Employee turnover 1.3 Current ratio 2.1 Asset additions ($000) 84.0 Quick ratio 1.3 Asset additions / depreciation 1.11 Accounts receivable turnover 11.8 Asset additions / net sales 0.03 RATIO COMPARISONS Ratios can do one or a combination of three things. First, they can convey an immediate message. For example, the value of 1.3 for employee turnover tells us immediately that on average, 130 employees are hired for each 100 persons employed throughout the year. Stated differently, about one-third of all employees are replaced annually. Initially, we might say that this portrays a negative situation because of the considerable costs required to train new employees and because production is lower while new employees are learning their job. If one-third of the work force is replaced each year, significant costs likely are being incurred. Second, ratios can be used for comparison with others in the business. For instance, a labor turnover rate of 1.3 may be low compared with other pallet manufacturers. In this case, the rate may actually be positive. Third, ratios can be used to study trends. In this application, changes in the value may be more telling than the actual value itself. For instance, suppose the employee turnover rate for pallet manufacturers last year was 1.5. Again, in this case, a rate of 1.3, represents a positive improvement over the previous year. However, if the rate a year ago was 1.2, a rate of 1.3 might indicate a worsening situation. A number of ratios can be used in all three ways to convey an immediate message, for intraindustry comparisons, and for trend analysis. COMPARISON WITH PUBLISHED SOURCES Because of the nature of the data and the lack of knowledge about nonrespondents, statistical comparison of the ratios/measures was not possible, so we established the following rules of thumb for making a determination of similarity or difference. Ratios/measures, hereafter referred to only as ratio or ratios, were considered to be similar if: (1) the NWPCA ratio was within +/- 10% of the RMA value, (2) the NWPCA ratio was within +/- 10% of the D&B value, or (3) the NWPCA ratio fell
between the RMA and D&B measures. If none of these criteria were met, the ratios were considered dissimilar. Table 2 compares NWPCA respondent ratios with those published in RMA and D&B. Return on sales, assets, and equity cells for NWPCA respondents contain bracketed and nonbracketed values. The bracketed values represent ratios derived from total income; the nonbracketed values represent ratios derived using net operating income. Recall that net operating income excluded nonoperating income but included interest expense. Table 2. Comparison of NWPCA respondent ratios with RMA and D&B for selected measures, 1996 Ratio/Measure NWPCA RMA D&B Criteria met a Gross margin 20.8 27.2 30.0 4 Return on sales 3.6 (2.9) 3.1 2.7 4 (1,2,3) Return on assets 9.8 (8.2) 7.7 8.0 4 (1,2) Return on equity 22.9 (20.2) 23.9 15.9 1,3 (3) Debt/equity 1.2 1.4 0.7 3 Current ratio 2.1 1.7 2.2 2,3 Quick ratio 1.3 1.0 1.2 2 Collection period 30.9 29 27.7 1 Inventory 29.3 30 20 1,3 Asset turnover 2.9 2.9 3.1 1,2 a 1:NWPCA value within +/- 10% of RMA; 2: NWPCA value within +/- 10% of D&B; 3: NWPCA value between RMA and D&B; 4: NWPCA value failed to meet any of the criteria established in 1, 2 and 3. Table 2 suggests a surprising degree of congruence between the ratios/measures derived from NWPCA respondents and those published by RMA and D&B. For net operating income, seven of the 10 ratios met the established criteria, and, four of these met two of the three criteria. When total income was used to compute return on sales, assets, and equity, nine of the 10 ratios/measures met one or more of the criteria established for agreement. Only gross margin failed to meet any of the established criteria. Further, five of the 10 ratios/measures meet two or more criteria, which suggests relatively strong agreement among all three sources. While Keown et al. (1994) recommended the use of net operating income because it eliminates financial structure impacts, it may be that RMA and D&B use the more traditional operating income measure, thus resulting in better agreement. An alternative method was used to make separate comparisons between NWPCA values and those published in RMA and D&B, and comparison of NWPCA values to a simple average of the RMA and D&B values. This method incorporated a formula used by the Bureau of Economic Analysis (BEA) to construct leading, coincident, and lagging indicators for the U.S. economy (Beckman and Tapscott 1987). The formula insures symmetrical treatment of positive and negative differences: 200 (B-A) / (B+A) (2) A 10 % differential, either positive or negative, will have the value of +/- 9.52, respectively. If the difference is less than 10% the value will be lower. Table 3 lists the derived values for comparisons of NWPCA survey and RMA and D&B measures and the combined RMA/D&B simple average. Alone, RMA and D&B each matched five measures derived from the NWPCA ratio survey based upon the cutoff value. When a simple average of the RMA and D&B figures was computed, seven of the ten ratios met the criteria.
Table 3. Alternative means of comparison using the BEA formula. Ratios/Measures Calculated conformance measure RMA D&B Combined RMA/D&B Gross margin 26.67 36.22 31.58 Return on sales 6.67-7.14 0.00 Return on assets -5.92-2.47-3.73 Return on equity 16.78-23.82-1.50 Debt/equity 15.39-52.63-8.70 Current ratio -21.05 4.65-4.88 Quick ratio -26.09-8.00-16.67 Collection period -6.34-10.92-8.43 Inventory 2.36-31.37-15.84 Asset turnover 0.00 6.67 3.39 The shaded area signifies meeting the cutoff criteria of +/- 9.52 (+/- 10%). DISCUSSION AND CONCLUSIONS Financial ratios are used widely to evaluate the performance of business and to identify possible trouble areas that could result in reduced profits or even business failure. Industry aggregates of financial performance are useful to those lending money or to those contemplating investment in that they allow comparison of the venture under consideration with the industry in general. Managers also, can use industry data to evaluate their own situation and performance, and to develop internal data on trends from which they might compare current and past performance. For instance, are inventories growing larger? Are accounts receivable taking longer to collect? Is additional debt being incurred? Is employee turnover becoming more or less of a problem? It would seem from this analysis that the published literature provides at least seven, and perhaps as many as nine, benchmarks for such comparison--at least with respect to pallet manufacturers. Thus, one might ask, are individual surveys conducted by the NWPCA necessary?, and are the costs worth the benefits? What about other association efforts of a similar nature? If one were interested in only the 10 measures evaluated in this paper, the answer may well be no. However, the ratios evaluated here are but half of the total derived from the NWPCA study. And, several measures generated in the NWPCA survey, for example, employee turnover and capital investment, are not available elsewhere. Further, the NWPCA was able to break down survey responses into subcategories such as asset size, business type, product manufactured, and regional location. Few of these are available elsewhere. As for other associations, there may be an even stronger argument that can be made for conducting in-house studies. Steve Lawser, Executive Director of the Wood Component Manufacturers Association (WCMA) suggests that the degree of agreement between the NWPCA survey and published ratios may be due largely to the fact that RMA and D&B published an explicit report for pallet manufacturers. According to Lawser, dimension and wood component manufacturers are consistently grouped with flooring moulding, and millwork manufacturers. Thus, past studies that he has conducted for his membership have failed to pruduce ratios that are close to those of D&B. In this instance, there would seem to be little choice but for the WCMA to survey its own membership and like firms. LITERATURE CITED
Beckman, A. and T. Tapscott. 1987. Composite indexes of leading, coincident, and lagging indicators. Survey of Current Business. 67(11):24-28. Dunn and Bradstreet, Inc. 1997. Industry norms and key business ratios. Desk-top edition SIC #0100-8999. Dunn and Bradstreet, Murray Hill, NJ. Keown, A., D.Scott, Jr., J. Martin and J.Petty. 1994. Foundations of finance the logic and practice of financial management. Prentice Hall, Englewood Cliffs, NJ. National Wooden Pallet and Container Association. 1998. Financial ratio survey report for the pallet industry-fy 1996. National Wooden Pallet and Container Association, Arlington, VA. Robert Morris Associates. 1997. Annual statement studies 1997. Robert Morris Associates, Philadelphia, PA.