Question

Chapter 4 Mini Case 2 Ratios and Financial Planning at S & S Air

Chris Gumede was recently hired by S&S Air to assist the company with itsfinancial planning and to evaluate the company’s performance. Chris graduatedfrom university five years ago with a finance degree.S&S Air was founded 10 years ago by friends Mark and Thandi. Thecompany has manufactured and sold light aeroplanes over this period and thecompany’s products have received high reviews for safety and reliability. Thecompany has a niche market in that it sells primarily to individuals who own andfly their own aeroplanes. The company has two models, the Birdie which sells forR2 530 000 and the Eagle which sells for R5 780 000.While the company manufactures aircraft, its operations are different fromcommercial aircraft companies. S&S Air builds aircraft to order. By usingprefabricated parts, the company is able to complete the manufacture of anaeroplane in only five weeks. The company also receives a deposit on each order,as well as another partial payment before the order is complete. In contrast, acommercial aeroplane may take one and a half to two years to manufacture oncethe order is placed.Mark and Thandi have provided the following financial statements. Chris hasgathered the industry ratios for the light aeroplane manufacturing industry.

S&S Air2008 Financial Statements

Income Statement

Sales R128 700 000

Cost of goods sold 90 700 000

Other expenses 15 380 000

Depreciation 4 200 000

PBIT 18 420 000

Interest 2 315 000

PBT 16 105 000

Tax (40%) 6 442 000

NPAT R 9 663 000

Dividends 2 898 900

Add to retained profits 6 764 100

2008 Balance sheet

Ordinary shares 1 000 000 Net non-current assets R72 280 000

Retained profits 41 570 000

Shareholders equity R42 570 000 Inventory 4 720 000

Long-term debt R25 950 000 Accounts receivable 4 210 000

Cash 2 340 000

Accounts payable 4 970 000 Current assets R11 270 000

Short-term debt 10 060 000

Current liabilities R15 030 000

R83 550 000 R83 550 000

Light Aeroplane Industry Ratios

Lower Quartile Median Upper Quartile

Current ratio 0,50 1,43 1,89

Quick ratio 0,21 0,38 0,62

Cash ratio 0,08 0,21 0,39

Total asset turnover 0,68 0,85 1,38

Inventory days 74,6 59,3 33,5

Receivables days 58,2 37,2 25,9

Total debt ratio 0,44 0,52 0,61

Debt-equity ratio 0,79 1,08 1,56

Equity multiplier 1,79 2,08 2,56

Times interest earned 5,18 8,06 9,83

Cash coverage ratio 5,84 8,43 10,27

Profit margin 4,05% 6,98% 9,87%

Return on assets (after tax) 6,05% 10,53% 13,21%

Return on equity 9,93% 16,54% 26,15%

Questions

1. Calculate the following ratios for S&S Air: current ratio, quick ratio, cashratio, total asset turnover, inventory days, receivables days, total debt ratio,debt-equity ratio, equity multiplier, times interest earned, cash coverage,profit margin, return on assets and return on equity.

2. Mark and Todd agree that a ratio analysis can provide a measure of thecompany’s performance. They have chosen Boeing as an aspirantcompany. Would you choose Boeing? Why or why not?

3. Compare the performance of S&S Air to the industry. For each ratio,comment on why it might be viewed as positive or negative relative to theindustry. Suppose you create an inventory ratio calculated by inventorydivided by current liabilities. How do you think S&S Air’s ratio wouldcompare to the industry average.

4. Calculate the internal growth rate and sustainable growth rate for S&S Air.What do these numbers mean?

5. S&S Air is planning for a growth rate of 20 per cent next year. CalculateEFN assuming the company operated at full capacity in 2008.

6. Although most assets can be increased as a percentage of sales, net non-current assets often must be increased in specific amounts since it isusually impossible or impractical to buy part of a new plant or machine.So, assume S&S Air cannot increase net non-current assets as a percentageof sales. Instead, whenever the company needs to purchase newmanufacturing equipment, it must purchase in the amount of R30 000 000. Calculate the new EFN with this assumption. What doesthis imply about capacity utilization for the company next year?

Answer 1

1. Current Ratio = Current Assets/Current Liablities 11270000/15030000 = 0.75

Quick Ratio = Quick Assets/ Current liablities 6550000/15030000 = 0.44

Cash Ratio = Cash / Current Liablities 2340000/15030000 = 0.16

Total asset turnover = Net Sales/Total Assets = 128700000/83550000 = 1.54

Inventory Days = Days in a year/COGS * Inventory = 365/90700000*4720000 = 19 days

Receivable Days = Days in a year/Credit Sales*Average Receivables = 365/12870000*4210000= 119.39 days

Total Debt Ratio = Total Debt/Total Assets = 36010000/83550000 = 0.43

Debt Equity Ratio = Total Debt/ Equity = 36010000/42570000= 0.85

Equity Multiplier = Total Assets/ equity = 83550000/36010000 = 0.23

Time Interest Earned = PBIT/Interest = 18420000/2315000 = 7.96

Cash Coverage = PBIT+Depreciation/Interest = 18420000+4200000/2315000= 8.13

Profit Margin = Profit/ Sales *100 = 9663000/128700000*100 = 7.50

Return on Assets = Net Income / Total Assets = 9663000/83550000*100= 11.56%

Return on Equity = Net Income/ Equity = 9663000/42570000*100 = 22.69%

2. No we will not chose boeing. Because boeing manufactures commercial aero planes and this company is maufacturing personal aero planes.

3. Short term liquidty(current Ratio, Quick ratio,Cash Ratio) ratios are not good as compare to industry.

Total asset turnover is high as compare to industry. It is good sign for company.

Inventory ratio is low it means company keeping low amount of stock as compare to industry. The main reason for same is that company manufacturing only on order.

Receivable ratio is high as compare to industry. Which indicates that company allowing more credit to its customer.

Total debt ratio and debit equity ratio are similar to industry.

Company's ability to pay its interest is similar to industry as concluded from interest ratio and cash coverage ratio.

Proit margin and return on assets are also similar to industry.