Question

Earnings per share, and accounts payable Turns??? in part 2. Please proofread if you get the chance for inaccuracies.

Questions

Part 1.

Locate and read the following article located from the Library:

Faello, J. (2015). Understanding the limitations of financial ratios. Academy of Accounting & Financial Studies Journal, 19(3), 75–85.

Refer to pages 75 and 76 of Faello’s (2015) work. In four separate paragraphs (one for each question), summarize four of the benefits of financial analysis mentioned in the journal article. In one paragraph, describe which one of the four benefits you consider to be most significant.

All the benefits of the financial ratios are important, but in my opinion the most important feature is that it provides meaning to the financial statement. A stakeholder, or anyone without a complete knowledge of finance, or without a financial background cannot easily decode a financial statement. Ratios help in simplifying it’s meaning and make the figures more relevant to the reader. This is the most important use of ratios because the other benefits only come into the picture after this one. Financial analysis and financial ratios play an important role in overall understanding of the financial statements and figures mentioned within the statement. Financial ratios play an important part in financial reporting they help explain financial statements quickly. A single figure of revenue or profit makes less sense as compared to a net profit ratio, helping understand the percentage of profit as part of overall sales.

Financial rations assist in benchmarking a firm’s performance with other firms, in the same industry. This is important because no single firm / company works in isolation, each belongs to an industry type and it is very important to evaluate their performance with respect to the industry standards to gauge its performance. There is a large amount of competition in the market and it becomes important to see how well a company is growing/ performing as per overall standards. A company could be growing, but also performing poorly. A company could show a growth in net profit from 15% to 20%, and on paper that looks pretty good. If the industry standard is closer to 35% the company would know that there is a problem with its performance.

Financial ratios help financial statement users identify problem areas within a company’s operation. Being able to compare the financial ratios from different years can help in understanding areas that need improvement, and the problems within the company. It helps management decide what areas need more focus, and what departments are underperforming.

Financial ratios help in assisting overall risk. It can be used as a means to limit activities such as loan contracts and help forecast financial futures.

Review the following financial data, and then answer the questions below.

Company X Income Statement
FYE 2014 and 2015
Period Ending	31-Jan-15	31-Jan-14
Total Sales	$ 485,651,000	$ 476,294,000
Cost of Goods	365,086,000	358,069,000
Gross Profit	120,565,000	118,225,000
Selling General and Administrative	93,418,000	91,353,000
Operating Profit	27,147,000	26,872,000
Total Other Income/Expenses Net	113,000	119,000
Earnings Before Interest and Taxes	27,034,000	26,753,000
Interest Expense	2,461,000	2,335,000
Income Before Tax	24,573,000	24,418,000
Income Tax Expense	7,985,000	8,105,000
Net Income from Continuing Ops	16,588,000	16,313,000
Discontinued Operations	285,000	144,000
Net Income (Net Profit)	$   16,303,000	$   16,169,000
14,000,000 shares outstanding
Market Share price per share	$10.00	$9.00

Company X Balance Sheet
FYE 2014 and 2015
Period Ending	31-Jan-15	31-Jan-14
Assets
Current Assets
Cash and Cash Equivalents	$9,135,000	$7,281,000
Net Receivables	6,778,000	6,677,000
Inventory	45,141,000	44,858,000
Other Current Assets	2,224,000	2,369,000
Total Current Assets	63,278,000	61,185,000
Property Plant and Equipment	116,655,000	117,907,000
Goodwill	18,102,000	19,510,000
Other Assets	5,671,000	6,149,000
Total Assets	203,706,000	204,751,000
Liabilities
Current Liabilities
Accounts Payable	58,583,000	57,174,000
Short/Current Long Term Debt	6,689,000	12,082,000
Other Current Liabilities	-	89,000
Total Current Liabilities	65,272,000	69,345,000
Long Term Debt	43,692,000	44,559,000
Deferred Long Term Liability Charges	8,805,000	8,017,000
Minority Interest	4,543,000	5,084,000
Total Liabilities	122,312,000	127,005,000
Miscellaneous Stocks Options Warrants	0	0
Common Stock	323,000	323,000
Retained Earnings	85,777,000	76,566,000
Capital Surplus	2,462,000	2,362,000
Other Stockholders Equity	-7,168,000	-1,505,000
Total Stockholders’ Equity	81,394,000	77,746,000
Total Liabilities + Stockholders’ Equity	$ 203,706,000	$ 204,751,000
Number of Shares Outstanding	14,000,000	14,000,000
Market Share price per share	$10.00	$9.00

Part 2.

Define the ten financial ratios below.

Financial Ratios:

Current Ratio is equal to Current assets / Current Liability

2014: 61,185,000 / 69,345,000 = 88.23%

2015: 63278000 / 65272000 = 96.95

Quick Ratio) (Cash and cash equivalents + Current receivable) / Current Liability

2014: 7,281,000 + 6,677,000 / 69,345,000 = 20.13%

2015: 9,135,000 = 6,778,000 / 65,272,000 = 24.38%

Accounts Receivable Turns) Net Credit Sales / Average Accounts Receivable

485651000 / 6,727,500 = 72.19

Accounts Payable Turns***

Return on Equity) Net Income / Shareholder’s equity

16,303,000/81,394,000 = 20.03%

Return on Assets = Net income / Total Assets

2014: 16169000 / 204751000 = 7.9%

2015: 16303000 / 203706000 = 8.0%

Operating Profit Margin = Operating Profit / net sales

2014: 26872000 / 476294000 = 5.6%

2015: 27147000 / 485651000 = 5.6%

Net Profit (after tax) Margin = net income / net sales

2014: 16313000 / 476294000 = 3.4

2015: 16588000 / 485651000 = 3.4

Earnings per Share ***

Price to Earnings = Price per share / Earning per share

2014: 9 / 1.17 =7.72

2015: 10 / 1.18 = 8.44

Part 3. Classify, calculate, and assess a) Liquidity, b) Profitability, and c) Market Value Ratios

Liquidity

In this section, properly classify which of the above (from Part 2) are the liquidity ratios Then, using the data from the Income Statement and Balance Sheet, provide the correct calculation of these four liquidity ratios and an assessment of the company’s ability to maintain liquidity. Include the proper assessment of outcomes as positive or negative trends given the four ratio outcomes.

Liquidity Ratios:

·         Current Ratio

·         Quick ratio

·         Accounts receivable Ratio

1.)    Current Ratio:    Current Assets/Current Liabilities

= 63,278,000/65,272,000

= 0.9694

Significance: This ratio is an indicator of firm’s commitment to meet short-term Liabilities. An ideal ratio is 2. A higher ratio would indicate inadequate employment of funds. In this case Current ratio is a danger signal to management.

Quick Ratio: Liquid Assets (Current assets excluding Inventory & Prepaid Expenses)/ Current Liabilities

                       = 18,137,000/65,272,000

                        = 0.2778

Significance:   This ratio is an indicator of short term solvency of the company. A lower liquid ratio indicates over- stocking by the concern which is true in this case.

Accounts Receivable Ratio: Credit Sales/Average accounts Receivable

      = 485,651,000/6,727,500**

      = 72.18 Times

Significance: This ratio indicated Speed with which money is collected from Debtor. The higher the ratio, the better it is. In this particular case this ratio is very good as debt collection period would come to be around 5 days.

** Average receivable is calculated by adding opening closing receivable divided by 2.

    So (6,778,000+6,677,000)/2= 6,727,500

b. Profitability

In this section, properly classify which of the above (from Part 2) are the profitability ratios. Then, using the data from the Income Statement and Balance Sheet, provide the correct calculation of these four profitability ratios and an assessment of the company’s ability to maintain profitability. Include the proper assessment of outcomes as positive or negative trends given the four ratio outcomes.

Profitability Ratios:

·         Operating profit margin

·         Net profit

·         Return on equity

·         Return on assets

Operating Profit Margin: Operating profit/Net Sales*100

= 27,147,000/485,651,000

= 5.58%

Significance: This ratio is a complimentary of net profit ratio. The ratio is attest of operational efficiency with which the business has carried on.

Net profit ratio: Net profit / Net sales*100

                                 = 16,303,000/485,651,000*100

                                 = 3.35%

Significance: The ratio indicates net margin earned on a sale of $100.This ratio helps in determining the efficiency with which the affairs of the business are being managed. Constant increase year after year in the net profit ratio is an indication of improving conditions of a business, which in this case is not found so.

Return on Equity: Net profit/ Average Total Equity

= 16,303,000/79,570,000

= 20.48%

Significance: This ratio measures the ability of a firm to generate profits from its shareholder’s investments in the company. It shows how much profit each dollar of common stockholder’s equity generates. In this case it’s 20%, which is a good rate of return.

In this case too average total equity is taken into consideration which is the average sum of opening and closing Equity

Return on Assets: Net income/ Total Assets

= 16,303,000/ 203,706,000

= 8%

Significance: It’s an indicator of how profitable a company is relative to its Total Assets. ROA gives an idea how efficient management is at using its assets to generate earnings. In this case it is 8%.

c. Market Value

In this section, properly classify which of the above (from Part 2) are the Market Value ratios. Then, using the data from the Income Statement and Balance Sheet, provide the correct calculation of these two Market Value ratios and an assessment of the company’s ability to maintain market valuation. Include the proper assessment of outcomes as positive or negative trends given the two ratio outcomes.

Market Value Ratios:

·        EPS

·        P/E Ratio

EPS (Earning per share): Profit Available to Equity stockholders/ Total No. of outstanding shares

= 16,303,000/14,000,000

= 1.1645/ Share

Significance: This ratio tells how much money the company is making in profits per every outstanding share of stock. The higher the EPS, better it is. Because investors are willing to pay more for higher profit.

2.)    P/E Ratio:   Market Price per equity share/ Earning Per Share

     = 10/1.1645

     = 8.58

Significance: This ratio indicates the no. of times Earning per share is covered by its market price. It helps the investor to decide whether to buy or not to buy share of a company at a price. In this P/E of 8.58 tells us that for every $1 of earnings investors are willing to pay $8.58.

Part 4. Overall Analysis

In this section, you will compose an analytical essay in a minimum of 350 words. Based on the above, provide a proper assessment of the company’s most significant negative trend and what corrective actions can be taken to improve results. You should search the Library, your textbook, and the internet using a variety of criteria to find academic sources that will support your assessment of the trends and actions that could be taken.

          The most significant trend of the business which is negative is the very bad liquidity ratios both the current ratio and the quick ratio are very poor and need to be addressed as soon as possible to maintain an operating business.

As we can see the current ratio is less than 1 and quick ratio is significantly lower than 1 as some liquidity was only due to the inventories

For the business to be sustainable in the long run and run as a "going concern" the firm must have enough liquidity or current assets to meet the current liabilities and to run day to day activities.

Corrective actions that could be taken would be:

1. The firm could take short term financing which will be available at higher interest rates to meet the current asset requirement. This is called maturity matching wherein short-term debt is taken to meet short term obligations. This will increase the company’s liquid assets.

2. The firm could also improve liquidity in the long term by retaining some of the profits that are generated from the efforts of the company that are normally paid out to shareholders in the form of dividends. These profits can be used as cash to meet the current liabilities and improve liquidity. The company as a whole would be in a much better financial position. Dividends could resume once the company has repaired their poor financial ratios.

3. The firm can reduce current liability by reducing the number of units produced or reducing the sales volume. Although this will have an impact, the firm can sell the inventory on hand and reduce current liabilities so as to improve liquidity and improve the quick ratio.

4. The firm can redeem a part of market investment in the form of marketable securities to meet these short term needs of liquidity. Marketable securities are liquid financial instruments that can be quickly converted into cash at a reasonable price. The liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.

Answer 1

1. Accounts Payable turnover = Total Supplier purchases / Average Accounts Payable
Total supplier purchases = Opening inventory + Cost of goods sold - Ending Inventory
Cost of goods	365,086,000
Beginning inventory	44,858,000
Ending inventory	45,141,000
Purchases	364,803,000
Average Accounts payable (Opening balance + Ending balance) / 2 = (57,174,000+58,583,000)/2	57,878,500
Accounts Payable turnover = 364,803,000 / 57,878,500	6.30

2. Earnings per share = (Net Income remaining for common stock holders )/ Average outstanding common shares

Net income available for common stock holders = 16,303,000 in 2015 and $16,169,000 in 2014

Average outstanding common shares = 14,000,000 both the years

EPS 2015 = 16,303,000 / 14,000,000 = 1.1645

EPS 2014 = 16,169,000 / 14,000,000 = 1.1549

P/E ratios = Market value per share / EPS

2015 = 10/ 1.1645 = 8.5873

2014 = 9 / 1.1549 = 7.7928