Question

In2017, HPT Company was struggling due to poor management. Since 2017, the management team has been replaced and a new streamline focused strategy has been implemented. HPT is a retailer of Jewelry with stores across Canada. Since 2017, HPT has reduced the number of retail locations in hope of saving costs and improving its financial health.

	HPT Company
	2019	2018	2017	Industry Ratios 2019
Current ratio	1.88	1.36	0.93	1.90
Inventory turnover	4.89	4.68	3.78	6.08
Average Collection Period	45.45	38.45	15.45	30.00
Capital asset turnover	2.56	1.93	1.34	3.19
Total asset turnover	1.72	1.46	1.07	2.00
Debt to total assets	35.00%	60.53%	75.25%	30.00%
Times interest earned	8.87	3.06	1.08	14.63
Gross margin	40.00%	39.00%	39.00%	42.00%
Profit margin on Revenue	5.90%	3.56%	0.25%	6.71%
Return on Total Assets	10.17%	5.21%	0.27%	13.42%
Return on Equity	15.65%	13.19%	1.09%	19.17%
Days in working capital	43.8	40.58	39.55724	N/A
Cash Conversion Efficiency	6.29%	6.18%	N/A	N/A
Cash Conversion Cycle	70.30	64.04	61.44	N/A

Required:

a. Identify 2 ratios for each category:

Liquidity, Solvency, Productivity, and Profitability (2 marks for each category)

b. Provide an overall trend assessment of each category (do not explain each individual ratio but instead, provide an assessment of the category):

Liquidity , Solvency , Productivity , Profitability

c) The following information for HPT is provided:

	HPT Company
	2019	2018	2017
Z-Score	2.53971	1.5562	1.2341
Sustainable Growth	0.0267	(0.0180)	(0.0240)

What do the Z-score and sustainable growth numbers in the above chart mean? Has management been able to “turn around” the company since 2017? Explain.

Answer 1

A) Ratio Identification

Liquidity ratio -
1) Current ratio
2) Days in working capital

Solvency ratio -
1) Debt to total assets
2) Times interest earned

Productivity ratio -
1) Capital asset turnover
2) Total asset turnover

Profitability ratio -
1) Gross margin
2) Profit margin on revenue

B) Assessment

Liquidity – Over the years the company has improved on the current ratio front implying that the coverage of the company’s short term debt in terms of its current assets has started to improve but still lag behind the industry standards. On the other hand, the company’s working capital cycle appears to have worsened over the years implying that even though the amount of current assets has gone up but it is the credit money and that a substantial amount of company’s money is getting stuck in either receivables or inventory o both. So the company clearly needs to work on its credit policy.

Solvency – The company has significantly reduced its debt portion from the capital structure and has got in under the industry standard and as a result of which its interest coverage has also improved to several folds over the years but is yet to touch the industry ratio which means that the company is earning less of operating profit at a given amount of debt in comparison to its peers.

Productivity ratio – The company has been performing well on its asset turnover front. It means that the efficiency at which the company uses its asset (both total and fixed) to generate sales has improved over the years and is nearing the industry expectations. The company has been able to generate an increased amount of sales without deploying any additional assets.

Profitability ratio - Even on the profitability front, the company has not failed to impress. A rise in profit margins can be witnessed on a regular basis. This can be a result of reduced costs or being able to command more profits or both.

C)

Z-score is an indicator of a company’s probability of facing bankruptcy. A ratio of below 1.8 means that the company is in a risky position and a ratio of over 3 presents the company in a safe light.
The company’s z-score has gone up being around to 1.2 to 2.5 in a duration of 3 years. It is a very healthy sign for the company as it shows that the company no longer stands on the verge of going bankrupt.

The sustainable growth rate is a rate at which a business can maximize its sales without using additional debt or equity finance.
This ratio has turned around from being negative in 2017 and 2018 to positive in 2019. This implies that now the company has gotten into a position of earning sales without deploying additional capital in the business.

On the basis of the information and analysis provided it can be concluded very firmly that the management has been successful in making the company more efficient and effective in its strategies and operations over the years.