Question

Gardems was recently hired as a financial analyst by Taylor, Inc., which is a Pennsylvania based company. His first task is to conduct a financial statement analysis of firm covering the past 2 years as in the table below:

Q:Assess the firm's liquidity position.

Balance Sheets	2012	2011
Cash	$52,000	$57,000
Accounts Receivable	$402,000	$351,200
Inventory	$836,000	$715,200
Total Current Assets	$1,290,000	$1,124,000
Gross Fixed Assets	$527,000	$491,000
Less: Accumulated Depriciation	$166,200	$146,200
Net Fixed Assets	$360,800	344,800
Total Assets	$1,650,800	$1,468,800
Accounts Payable	$175,200	$145,600
Notes Payable	$225,000	$200,000
Accruals	$140,000	$136,000
Total current liabilities	$540,200	$481,600
Long-term debt	$424,612	$323,432
Common Stock	$460,000	$460,000
Retained Earnings	$225,988	$203,768
Total Equity	$685,988	$633,768
Total Claims	$1,650,800	$1,468,800
INCOME STATEMENTS
Sales	$3,850,000	$3,432,000
Cost of Goods Sold	$3,250,000	$2,864,000
Other expenses	$430,300	$340,000
Depreciation	$20,000	$18,900
EBIT	$149,700	$209,100
Interest expense	$76,000	$62,500
Taxes (40%)	$29,480	$58,640
Net Income	$44,220	$87,960
OTHER DATA
December 31 stock price	$6.00	$8.50
Number of Shares Outstanding	100,000	100,000
Dividend per Share	$0.22	$0.22
Annual Lease Payment	$40,000	$40,000
Earnings per Share	$0.442	$0.880

Gardems also developed the following industry average data for 2012:

Ratio	Industry Average
Current	2.7
Quick	1.0
Inventory Turnover	7.0
Days sales outstanding (DSO)	32.0 days
Fixed asset turnover	10.7
Total asset turnover	2.6
Debt ratio	50.0%
Times Interest Expense	2.5
Profit margin	3.5%
Basic earning power	19.1%
ROA	9.1%
ROE	18.2%
P/E	14.2

Answer 1

Liquidity ratios measure a company's ability repay its short-term debt. This information is useful to creditors when deciding how much debt, if any, they would be willing to extend to the company.

We generally analyse three kinds of liquidity ratios-

Current Ratio- calculated as Total Current assets/ Total current liabilities.

Quick ratio- Also known as the acid-test ratio, it can be calculated as follows: (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities.

Cash ratio- Calculated as total cash and cash equivalents/ current liabilities.

Analysis can be done in two ways-

Internal Analysis- We compare the ratios for the company across different years

External Analysis- We compare the ratios to the industry average

We are provided with only two years data of the company and when we do an internal analysis with these two years, we find no significant difference- current ratio has marginally increased, quick ratio and cash ratio have slightly decreased. However, when we compare the ratios to the industry average we find that both current ratio and quick ratio are lower than those of the industry averages. The company should try to improve its current ratio to around 2.7 and quick ratio to around 1.

If we look at the DSO cycle, we find that the company’s sales are converted to cash in 37-38 days compared to 32 days in the industry. Similarly, Inventory cycle shows that company’s inventory is converted to finished good in 90-95 days range compared to 52 days in the industry. Company needs to improve in both these. We are however unable to determine creditor cycle as raw material cost is not given. Thus we can not find the Cash Cycle.