Question

Question: Based upon the financial ratio analysis you will have performed on Milan Fashions, would do you recommend that there should be an approval of the loan request? I want you to state your analysis in a detailed memorandum to me by Monday of next week. I would like to discuss your analysis and hear your ideas on Milan Fashions in a meeting on Tuesday. The clients will be in our offices next Friday to discuss their loan request. Please feel free to contact me if there are any questions on this matter.

Industry Financial Radio Standards

Ratio	Industry Norm	Milan Fashions Ratios 2015	Evaluation*
Current ratio	4.5 times	13.25	Good
Long-term debt-to-Equity ratio	12%	5.36%	Good
Debt-to-Equity ratio	30%	10.08%	Good
Total Debt ratio	20%	9.16%	Good
Financial leverage ratio	1.10	1.1	Fair
Inventory turnover	7 times	6 times	Poor
Fixed asset turnover	1.8 times	2.99 times	Good
Debt-to-Capital ratio	43.4%	10.32%	Good
Interest coverage ratio	5.0 times	18 times	Good
Return on Assets	8.4%	2.15%	Poor

Ratio	Industry Norm	Milan Fashions Ratios 2016	Evaluation*
Current ratio	4.5 times	21.54	Good
Long-term debt-to-Equity ratio	12%	6.92%	Good
Debt-to-Equity ratio	30%	9.86%	Good
Total Debt ratio	20%	8.97%	Good
Financial leverage ratio	1.10	1.1	Fair
Inventory turnover	7 times	6 times	Poor
Fixed asset turnover	1.8 times	2.6 times	Good
Debt-to-Capital ratio	43.4%	10.17%	Good
Interest coverage ratio	5.0 times	20 times	Good
Return on Assets	8.4%	2.22%	Poor

Answer 1

Answer: I have presented the comparison as per below picture which will make analysis more easy:

Now based on ratio, we can say that as the ratio related to Loans seems good and are appropriately covered, the loan approval can be taken into consideration.

First, we need to more focus on Interest Coverage ratio first which shows the company interest payment capacity or how easily company can pay interest on outstanding Loan. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period which is good in the given scenario.

Secondly, we need to look for Debt related ratio and let's start as below:

Long-term debt-to-Equity ratio: This ratio is calculated by taking the company's long-term debt and dividing it by the book value of common equity. The greater a company's leverage, the higher the ratio. as this is lower as compared to Industry then it's a good symbol. However it has increased as compared to previous year but still holds good.

Debt-to-Equity ratio: The formula for the debt to equity ratio is total liabilities divided by total equity. This is also good in the given situation.

Total Debt ratio: This is calculated by dividing total liabilities by total assets. which is again good in given situation.

Debt-to-Capital ratio: This is calculated by taking the company's interest-bearing debt, both short- and long-term liabilities and dividing it by the total capital and seems again good for Milan Fashion.

However being it's a fashion industry, we have to look for Inventory turnover and return on asset ratio too.

Inventory turnover ratio is not good which is calculated by dividing the cost of goods sold for a period by the average inventory for that period. Which means inventory is not moving as per industry standard. Being a fashion industry, it s necessary to have this ration good otherwise, repayment capacity may become threat in Long term.

Return on asset ratio is calculated by dividing net income by average total assets. This ratio can also be represented as a product of the profit margin and the total asset turnover. This is very poor in given case.

Conclusion: As a conclusion, it can be said that short term loan can be considered however it is recommended to avoid long term loans. As mainly all debts related ratios are good but profitability and inventory turnover ratio are poor.