Question

Project red Industries after an expansion program. A large loss occurred in 2016, rather than the expected profit. As a result, its investors, board of directors, and managers concern about the firm’s survival.
You are brought in as assistant to the Project red's chairman, who had the task of getting the company back into a sound financial position. Project's red 2015 and 2016 balance sheets and income statements, together with projections for 2017, are shown in the following tables. The tables also show the 2015 and 2016 financial ratios, along with industry average data. The 2017 projected financial statement data represent CFO’s best guess for 2017 results, assuming that some new financing is arranged to get the company “over the hump.”

	2017E	2016	2015
Sales	$7,035,600	$5,834,400	$3,432,000
COGS except depr.	5,800,000	4,980,000	2,864,000
Other Expenses	612,960	720,000	340,000
Deprec.	120,000	116,960	18,900
Tot. op. costs	6,532,960	5,816,960	3,222,900
EBIT	502,640	17,440	209,100
Int. expense	80,000	176,000	62,500
EBT	422,640	-158,560	146,600
Taxes (40%)	169,056	-63,424	58,640
Net income	$253,584	($95,136)	87,960
Cash	$14,000	$7,282	$9,000
S-T invest.	71,632	20,000	48,600
AR	878,000	632,160	351,200
Inventories	1,716,480	1,287,360	715,200
Total CA	2,680,112	1,946,802	1,124,000
Gross FA	1,220,000	1,202,950	491,000
Less: Depreciation	383,160	263,160	146,200
Net FA	836,840	939,790	344,800
Total Assets	$3,516,952	$2,886,592	$1,468,800
Accts. payable	$359,800	$324,000	$145,600
Notes payable	300,000	720,000	200,000
Accruals	380,000	284,960	136,000
Total CL	1,039,800	1,328,960	481,600
Long-term debt	500,000	1,000,000	323,432
Common stock	1,680,936	460,000	460,000
Ret. earnings	296,216	97,632	203,768
Total equity	1,977,152	557,632	663,768
Total L&E	$3,516,952	$2,886,592	$1,468,800
Stock price	$12.17	$6.00	$8.5
# of shares	250,000	100,000	100,000
EPS	$1.01	($0.95)	$0.88
DPS	$0.22	$0.11	$0.22
Book Val. Per Share	$7.91	$5.58	6.64
Lease payments	$40,000	$40,000	$40,000
Tax rate	0.4	0.4	0.4

You must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.

a. Calculate the following financial ratios for 2017E. Assume 80% sales are credit sales. This step is very important to note for credit sales.

	Formula	2017E	2016	2015	Industry Average
Liquidity Ratios
Current ratio	CA/CL		1.5	2.3	2.7
Quick ratio	(CA - Inv.)/CL		0.5	0.8	1
Average collection period	Acc. Rec. / (credit sales/365)		49.4	46.7	36.5
Accounts receivable turnover	Credit sales/acct rec		7.38	7.82	11.5
Days payable outstanding	365/(sales/acct payable)		20.3	15.5	30
Asset Management Ratios
Inventory turnover ratio	COGS/Inv		4.5	4.8	6.1
Days inventory held	365/Inv turnover		81.1	76	40
Days sales outstanding	Acct Rec/(sales/365)		39.6	37.3	32
Fixed assets turnover	Sales/FA		6.2	10	7
Total assets turnover	Sales/TA		2	2.3	2.5
Debt Management Ratios
Debt Ratio	(Note payable + LT Debt)/TA		59.59%	35.64%	32%
Liabilities ratio	TL/TA		80.7	54.80%	50.0%
Time interest earned	EBIT/Int Exp		0.1	3.3	6.2
EBIDTA Coverage	(EBIT + Dep + Lease)/(Int exp + Lease + loan payment)		0.8	2.6	8
Profitability Ratios
Profit margin	NI / Sales		-1.60%	2.60%	3.60%
Operating margin	EBIT / Sales		0.30%	6.09%	7.10%
Gross profit margin	(sales-COGS) / Sales		14.60%	16.6%	15.50%
Basic earning power	EBIT / TA		0.60%	14.20%	17.80%
Return on assets	NI / TA		-3.30%	6%	9%
Return on equity	NI / Common equity		-17.10%	13.30%	18%
Operating ROA	EBIT / TA
Market value ratios
Price/earnings ratio	Share price / EPS		-6.30	9.7	14.2
Price/cash flow ratio	Share price / [(NI + Depr.) / shares outstanding]		27.50%	8	7.6
Market/ Book ratio	Market share price per share / book value per share		1.10%	1.3	2.9

After filling out the 2017 above, help her answer the following questions. Where is the company now and how it can get better. Provide clear explanations, not yes or no answers. Based on the data gathered from the 5 sections, Liquidity ratios, Asset mangement ratios, Debt mangement ratios, profitability ratios, and market value ratios, what you would suggest in each section to improve the company.

b) General Interpretation and suggestion you would provide based on the analysis for - LIQUIDITY RATIOS: c) General Interpretation and suggestion you would provide based on the analysis for - ASSET MANAGEMENT RATIOS: d) General Interpretation and suggestion you would provide based on the analysis for - DEBT MANAGEMENT RATIOS: e) General Interpretation and suggestion you would provide based on the analysis for - PROFITABILITY RATIOS: f) General Interpretation and suggestion you would provide based on the analysis for - MARKET VALUE RATIOS:

Answer 1

RATIOS	Formula	2017 E		2016	2015	Industry Average	a..General Intrepretation
Liquidity Ratios							In general there is a slump in 2016
Current ratio	CA/CL	2680112/1039800=	2.58	1.5	2.3	2.7	Almost same as industry av.
Quick ratio	(CA - Inv.)/CL	(2680112-1716480)/1039800=	0.93	0.5	0.8	1	Almost same as industry av.
Average collection period	Acc. Rec. / (credit sales/365)	365/6.411=	57	49.4	46.7	36.5	Credit collection takes longer no.of days
Accounts rec. turnover	Credit sales/acct rec	(80%*7035600)/878000=	6.41	7.38	7.82	11.5	No.of times receivables are turned over is less than the Industry average.
Days payable outstanding	365/(sales/acct payable)	365/((80%*7035600)/359800)	23.33	20.3	15.5	30	Pays creditors earlier than the industry norm
Asset Management Ratios
Inventory turnover ratio	COGS/Inv	5800000/1716480=	3.38	4.5	4.8	6.1	No.of times inventory is converted is less than the Industry average.
Days inventory held	365/Inv turnover	365/3.38=	108	81.1	76	40	Inventory takes longer no.of days to get converted to sales.
Days sales outstanding	Acct Rec/(sales/365)	878000/((80%*7035600)/365)=	57	39.6	37.3	32	Credit collection takes longer no.of days
Fixed assets turnover	Sales/FA	7035600/836840=	8.41	6.2	10	7	Fixed Asset utilisation (conversion to sales) is improving & better than industry av.
Total assets turnover	Sales/TA	7035600/3516952=	2.00	2	2.3	2.5	With respect to total assets ,efficiency in conversion to $ sales is reduced because of inventory & receivables
Debt Management Ratios
Debt Ratio	(Note payable + LT Debt)/TA	(300000+500000)/3516952=	22.75%	59.59%	35.64%	32%	Has lower level of debt to total assets
Liabilities ratio	TL/TA	1539800/3516952=	0.44	80.7	54.80%	50.00%	Has lower level of debt to total assets
Time interest earned	EBIT/Int Exp	502640/80000=	6.28	0.1	3.3	6.2	No.of times interest expenses are covered is almost the same
EBIDTA Coverage	(EBIT + Dep + Lease)/(Int exp + Lease + loan payment)	(502640+120000+40000)/(80000+40000)=	5.52	0.8	2.6	8	No.of times of coverage is improving ,but still below industry norm.
Profitability Ratios
Profit margin	NI / Sales	253584/7035600=	3.60%	-1.60%	2.60%	3.60%	Profitability is almost same
Operating margin	EBIT / Sales	502640/7035600=	7.14%	0.30%	6.09%	7.10%	Profitability is almost same
Gross profit margin	(sales-COGS) / Sales	(7035600-5800000)/7035600=	17.56%	14.60%	16.60%	15.50%	Gross Profit % is better than ind.av.
Basic earning power	EBIT / TA	502640/3516952=	14.29%	0.60%	14.20%	17.80%	Slight decrease
Return on assets	NI / TA	253584/3516952=	7.21%	-3.30%	6%	9%	ROA is less than industry av. ,but improving over the 3 yrs.
Return on equity	NI / Common equity	253584/1977152=	12.83%	-17.10%	13.30%	18%	ROE is also less than industry av. ,but improving over the 3 yrs.
Operating ROA	EBIT / TA	502640/3516952=	14.29%
Market value ratios
Price/earnings ratio	Share price / EPS	12.17/1.01=	12.05	-6.3	9.7	14.2	Share price has increased but still below industry level
Price/cash flow ratio	Share price / [(NI + Depr.) / shares outstanding]	12.17/((253584+120000)/250000)=	8.14	27.50%	8	7.6	Cash flow is greater in all the 3 yrs.
Market/ Book ratio	Market share price per share / book value per share	12.17/7.91=	1.54	1.10%	1.3	2.9	M/B has always been less than industry average.

b. Liquidity

Needs faster credit collections

Reduce inventory levels to the optimum ,without affecting sales demands

Advantage to be taken of the full credit period offered by the suppliers --to maintain cash flow within the business

c. Asset Efficiency:

Both Receivables & inventory need revision in policies as to the level to be maintained for better cash flow

Fixed assets are being utilised comparatively more efficiently than in the overall industry.

It is because of the 2 components of current assets-- receivables & inventory that the total turnover has decreased.

D. Debt management

Can marginally increase the level of debt ,upto the industry level, so as to take tax-advantages of interest expenses & to bring down the cost of total capital.

e. Profitability:

All the Profitabilty ratios have reached the industry average .

When compared with total assets , EBIT/net income is decreasing ,as the inventory & receivables in the total assets are stagnating.Pruning them will improve the ratio.

The total ROA is less for the same reason.

ROE has to be improved ,to improve EPS .

f. Market value

Market value can be improved by improving the EPS to the level prevalent in the market.

Better working capital management, especially receivables & inventory , will improve cash flows within the business--- which in turn will improve the market prices.