Question

Evaluate the financial statement data and the financial ratios for these two firms and answer the questions. Your answers should be based on the numbers given. Show your work to ensure credit.

1. Compute the Cash Conversion Cycle for both firms. Which firm has the shorter CCC? Provide evidence for your answer.
2. Which of these two firms has the highest average annual Earnings Per Share ratio? Explain your answer (show your work)
3. If you were a bank lending officer specializing in short-term loans to businesses, which of the two firms would you rather do business with? Explain your answer.

		Firm A				Firm B
Income Statement	2016	2015	2014		2016	2015	2014
Revenues	58,811	63,740	49,853		350,052	347,379	349,894
Cost of Goods Sold	35,830	38,206	30,616		258,040	257,846	260,776
Gross Profit	22,981	25,534	19,237		92,012	89,533	89,118
Operating Expenses	6,611	6,116	4,923		72,752	69,315	66,727
Operating Income	16,370	19,418	14,314		19,260	20,218	22,391
Interest & Other Non-Oper Exp	368	350	267		1,090	1,105	1,251
Earnings Before Taxes	16,002	19,068	14,047		18,170	19,113	21,140
Income Tax	4,278	5,215	3,811		6,389	6,572	7,642
Net Income	11,724	13,853	10,236		11,781	12,541	13,498
Number of shares outstanding	18,000	18,000	18,000		25,000	25,000	25,000
Balance Sheet
Cash & Cash Equiv	47,409	45,133	29,134		11,397	11,287	12,929
Accounts Receivable	29,299	30,343	31,527		10,699	10,557	11,343
Inventory	12,133	12,355	18,199		22,328	23,290	24,426
Total Current Assets	88,841	87,831	78,860		44,424	45,134	48,698
Net Property, Plant, & Equipment	25,119	22,471	20,624		71,066	71,970	74,672
Intangible Assets	8,941	8,816	8,744		11,513	11,246	10,203
Total Assets	122,901	119,118	108,228		127,003	128,350	133,573
Accounts Payable	51,161	49,661	47,559		41,912	49,147	53,440
Short-Term Debt	11,605	10,999	4,308		33,341	17,095	16,738
Long-Term Debt	16,477	4,399	987		11,430	16,814	18,703
Shareholders Equity	43,658	54,059	55,374		40,320	45,295	44,692
Total Liabilities & Equity	122,901	119,118	108,228		127,003	128,351	133,573
Dupont Analysis:
Net Profit Margin	19.9%	21.7%	20.5%		3.4%	3.6%	3.9%
Total Asset Turnover	0.48	0.54	0.46		2.76	2.71	2.62
Equity Multiplier	2.82	2.20	1.95		3.15	2.83	2.99
Return on Equity	26.9%	25.6%	18.5%		29.2%	27.7%	30.2%
Current Ratio	1.42	1.45	1.52		0.59	0.68	0.69
Quick Ratio	1.22	1.24	1.17		0.29	0.33	0.35
Cash Ratio	0.76	0.74	0.56		0.15	0.17	0.18
Inventory Turnover (Sales basis)	4.8	5.2	2.7		15.7	14.9	14.3
Accounts Receivable Turnover	2.0	2.1	1.6		32.7	32.9	30.8
Fixed Asset Turnover	2.3	2.8	2.4		4.9	4.8	4.7
Debt Ratio	64%	55%	49%		68%	65%	67%

Answer 1

Cash conversion cycle = Days of inventory + Days of sales - Days of payables = 365 / Accounts receivable turnover + 365 / Inventory turnover (Sales Basis) - Days of payable (sales basis)

So, in order to calculate cash conversion cycle we need to calculate days of payables. Other two ratios are already available.

Days of payable (sales basis) = Payables / Sales x 365

Hence, for firm A: Days of payable in 2016 = 51161 / 58811 x 365 =  317.52 days

for firm B: Days of payable in 2016 = 41192 / 350052 x 365 = 42.95 days

Firm A: CCC in 2016 = Days of inventory + Days of sales - Days of payables = 365 / Accounts receivable turnover + 365 / Inventory turnover (Sales Basis) - Days of payable (sales basis) = 365 / 2 + 365 / 4.8 - 317.52 =  - 58.98 = - 59 days

Firm B: CCC in 2016 = 365 / 32.7 + 365 / 15.7 - 42.95 = - 8.54 = - 9 days

Both the firms have negative CCC. Firm A has shorter CCC.

Please see the table below for EPS calculation:

		Firm A
	Linkage	2016	2015	2014	Average	2016	2015	2014	Average
Net Income	A	11,724	13,853	10,236		11,781	12,541	13,498
Number of shares outstanding	Base Case	18,000	18,000	18,000		25,000	25,000	25,000
Annual EPS	C = A / B	0.65	0.77	0.57	0.66	0.47	0.50	0.54	0.50

Firm A has higher EPS.

A bank specializing in short-term loans to businesses, would prefer to do business with a firm which has:

• Higher or better liquidity ratio evidenced by current ratio, quick ratio and cash rtio.
• Firm A scores over firm B in all the three ratios.
• Hence, I will prefer to do business with Firm A.