Question

The Protek Company is a large manufacturer and distributor of electronic components. Because of some successful new products marketed to manufacturers of personal computers, the firm has recently undergone a period of explosive growth, more than doubling its revenues during the last two years. However, the growth has been accompanied by a marked decline in profitability and a precipitous drop in the company’s stock price.

You are a financial consultant who has been retained to analyze the company’s performance and find out what’s going wrong. Your investigative plan involves a series of in-depth interviews with management and doing some independent research on the industry. However, before starting, you want to focus your thinking to be sure you can ask the right questions. You’ll begin by analyzing the firm’s financials over the last three years, which are presented in the supplemental datasheet. Assume the company sold no property, plant, or equipment during the time periods presented. Also assume the company did not repay any long-term debt. The company’s normal credit terms extended to its customers is net 30.

Complete the following using Microsoft Excel and Word. All quantitative analysis should be done in Excel, while all qualitative analysis should be completed in Word. Construct horizontal analysis (year-over-year growth) on the financial statements for 2019 and 2020. Analyze the trend in each line; what does the trend analysis reveal? What are strengths, and areas for concern? Construct common size balance sheets for 2018 - 2020, respectively, and common size income statements for 2018 - 2020, respectively. Analyze the trend in each line. What appears to be happening? What are your significant findings? Construct Statements of Cash Flows for 2019 and 2020 using the indirect method. Also compute Free Cash Flow for each year. Where is the company’s cash going to and coming from? What are strengths, and areas for concern? Calculate all the financial ratios discussed in chapter 15 (use exhibit 15-6 as a guide) for 2019 and 2020. Analyze trends in each ratio. What can you infer from this information? Make specific statements about liquidity, asset management, debt management, profitability, and market performance. Do not simply say that ratios are higher or lower (or that they are going up or down); instead, think about what might be going on in the company and propose reasons why the ratios are acting as they are. Finally, based on all of your analysis, what two (or more) specific actionable items should the company do to improve its situation? Be specific in your response and discuss the implication of your recommendation.

EXHIBITS: SUPPLEMENTAL DATA (for Protek Company)
All values, except stock price, are in millions ($000,000)
Table 1 Balance Sheets	2018	2019	2020
Assets
Cash	$30	$40	$62
Accounts receivable	175	351	590
Inventory	90	151	300
Gross Property, Plant, & Equipment	1,565	2,373	2,718
Accumulated depreciation	-610	-860	-1,135
Total assets	$1,250	$2,055	$2,535
Liabilities and equity
Accounts payable	$56	$81	$134
Accruals	15	20	30
Long-term debt	630	1,260	1,600
Total equity	549	694	771
Total liabilities and equity	$1,250	$2,055	$2,535
Table 2 Income Statements	2018	2019	2020
Sales	$1,578	$2,106	$3,265
Cost of goods sold	631	906	1,502
Operating expenses:
Depreciation	200	250	275
Administration	126	179	294
Research & Development	158	211	327
Sales and Marketing	116	245	607
Operating Income	347	315	260
Interest expense	63	95	143
Pre-tax Profit	$284	$220	$117
Income Tax Expense (34% tax rate)	97	75	40
Net Income	$187	$145	$77
Table 3 Other Information	2018	2019	2020
Dividends Paid	$0	$0	$0
Stock Issuance	$0	$0	$0
Stock price	$39.27	$26.10	$11.55
Avg. Shares outstanding	100	100	100
Avg. Interest Rate on Long-term debt	10.00%	10.00%	10.00%

Answer 1

horizontal analysis

Balance Sheet	2018 ($)	2019 ($)	2020 ($)	2019 (% change)	2020 (% change)
assets
cash	30	40	62	33.33%	55.00%
accounts receivable	175	351	590	100.57%	68.09%
inventory	90	151	300	67.78%	98.68%
gross property, plant and equipment	1565	2373	2718	51.63%	14.54%
accumulated depreciation	-610	-860	-1135	40.98%	31.98%
total assets	1250	2055	2535	64.40%	23.36%
liabilities and equity
accounts payable	56	81	134	44.64%	65.43%
accruals	15	20	30	33.33%	50.00%
long-term debt	630	1260	1600	100.00%	26.98%
total equity	549	694	771	26.41%	11.10%
total liabilities and equity	1250	2055	2535	64.40%	23.36%
Income Statement	2018 ($)	2019 ($)	2020 ($)	2019 (% change)	2020 (% change)
sales	1578	2106	3265	33.46%	55.03%
cost of goods sold	631	906	1502	43.58%	65.78%
operating expenses
depreciation	200	250	275	25.00%	10.00%
administration	126	179	294	42.06%	64.25%
research and development	158	211	327	33.54%	54.98%
sales and marketing	116	245	607	111.21%	147.76%
operating income	347	315	260	-9.22%	-17.46%
interest expenses	63	95	143	50.79%	50.53%
pre-tax profit	284	220	117	-22.54%	-46.82%
income tax expenses	97	75	40	-22.68%	-46.67%
net income	187	145	77	-22.46%	-46.90%

Sales has increased but at the same time even cost of goods sold has increased in 2020. Also, all the operating expenses has increased significantly in 2020. As a result net income declined significantly in 2020.

common size balance sheets

Balance Sheet	2018 ($)	2018 (%)	2019 ($)	2019 (%)	2020 ($)	2020 (%)
assets
cash	30	2.40%	40	1.95%	62	2.45%
accounts receivable	175	14.00%	351	17.08%	590	23.27%
inventory	90	7.20%	151	7.35%	300	11.83%
gross property, plant and equipment	1565	125.20%	2373	115.47%	2718	107.22%
accumulated depreciation	-610	-48.80%	-860	-41.85%	-1135	-44.77%
total assets	1250	100.00%	2055	100.00%	2535	100.00%
liabilities and equity
accounts payable	56	4.48%	81	3.94%	134	5.29%
accruals	15	1.20%	20	0.97%	30	1.18%
long-term debt	630	50.40%	1260	61.31%	1600	63.12%
total equity	549	43.92%	694	33.77%	771	30.41%
total liabilities and equity	1250	100.00%	2055	100.00%	2535	100.00%

common size income statements

Income Statement	2018 ($)	2018 (%)	2019 ($)	2019 (%)	2020 ($)	2020 (%)
sales	1578	100.00%	2106	100.00%	3265	100.00%
cost of goods sold	631	39.99%	906	43.02%	1502	46.00%
operating expenses
depreciation	200	12.67%	250	11.87%	275	8.42%
administration	126	7.98%	179	8.50%	294	9.00%
research and development	158	10.01%	211	10.02%	327	10.02%
sales and marketing	116	7.35%	245	11.63%	607	18.59%
operating income	347	21.99%	315	14.96%	260	7.96%
interest expenses	63	3.99%	95	4.51%	143	4.38%
pre-tax profit	284	18.00%	220	10.45%	117	3.58%
income tax expenses	97	6.15%	75	3.56%	40	1.23%
net income	187	11.85%	145	6.89%	77	2.36%

Statements of Cash Flows for 2019 and 2020

Cash flow statement
For the period 2019 (amounts in $)
cash flow from operating activities
net income		145
adjustments to reconcile net income
depreciation	250
increase in accounts receivables	-176
increase in inventory	-61
increase in accounts payable	25
increase in accruals	5	43
net cash flow from operating activities		188
cash flow from investing activities
purchase of assets	-808
net cash flow from investing activities		-808
cash flow from financing activities
borrowings long-term debt	630
net cash flow from financing activities		630
net change in cash flow		10
cash at the beginning		30
cash at the end		40
Cash flow statement
For the period 2020 (amounts in $)
cash flow from operating activities
net income		77
adjustments to reconcile net income
depreciation	275
increase in accounts receivables	-239
increase in inventory	-149
increase in accounts payable	53
increase in accruals	10	-50
net cash flow from operating activities		27
cash flow from investing activities
purchase of assets	-345
net cash flow from investing activities		-345
cash flow from financing activities
borrowings long-term debt	340
net cash flow from financing activities		340
net change in cash flow		22
cash at the beginning		40
cash at the end		62

The main source of cash for the company is borrowings under long-term debt and used for capital expenditure for both the periods.

free cash flow	operating cash flow - capital expenditure
	2019 ($)	2020 ($)
operating cash flow	188	27
capital expenditure	-808	-345
free cash flow	-620	-318