Financial Health of the American Furniture Industry
17th July 2008
A comparison of the rate of return on investment in US manufacturing in general and in US manufacturing of furniture in particular portrays the furniture industry in a generally favorable light. Profitability is defined three different ways:
* profits before tax expressed as a rate of return on sales
* profits before tax expressed as a rate of return on shareholders’ equity
* profits plus interest payments on debt expressed as a rate of return on assets
Only on the basis of the first method of calculation - profits as a share of sales - is the furniture industry?s performance below the one for manufacturing as a whole. In 2005, the furniture industry?s rate was 6.0% compared to 6.5% for manufacturing overall. But this measure of return on investment is insufficient as it does not take into account the required size of the investment.
When profits are expressed as a return on shareholder?s equity, furniture achieves a rate of 20.7% compared to 14.6% for manufacturing. However, this measure is also lacking. It includes the equity, but not the debt portion of the investment producing the return.
In our view a more reliable measure expresses net profits plus interest expenses as a rate of return on total investments. This rate is computed as follows:
ROI = ((Net Profit Before Tax + Interest Expenses) / Assets) X 100
This measure gauges companies’ capacity to generate both profit and interest payments on borrowed funds. It is therefore not influenced by the chosen capital source (e.g., equity or debt capital).
We estimate furniture? rate of return based on this definition at 9.5% in 2005 compared to 5.9% for overall manufacturing. Again, furniture producers produced a stronger rate of return compared to manufacturers as a whole.
The rates of return prevailing in furniture and throughout the manufacturing sector also compare favorably with the rates of return prevailing on typical financial instruments (Commercial Papers or Government Bonds).
In spite of the still healthy financial state of the American furniture industry, the trend points toward a deterioration. The rate of return for furniture producers has been rising until 1999 but dropped in the years thereafter with the exception of a short reprieve in 2002. In 2005, before tax profits as a return on shareholder?s equity for furniture producers reached 20.7%, compared to a peak of 31.9% in 1999. Nevertheless, the rate of return for furniture has been above the one for manufacturing overall in recent years.
It is interesting to note that the rate of return within the furniture and fixtures industry ? measured as profit before taxes as a percent of shareholders’ equity ? was marginally lower for small furniture companies than for large companies in 2005.
