Question

1. In each of five focus areas (liquidity, profitability, …), provide your view/thoughts for the company's CEO consideration.
2. List, in order of priority (#1 being the highest), the three greatest concerns you have about the historical performance and explain your thoughts.
3. List, in order of priority, the three greatest concerns your group has with the one-year financial forecast (the year 2020 is forecast) provided by the CEO and explain your thoughts.
4. Use your answer in #4 (three greatest concerns about the forecast (the year 2020) to create your own forecast. In Excel, create a new, one-year forecast (balance sheet, income statement, and statement of cash flow) that combines the company’s forecast with your responses in #4 to reflect an adjusted forecast that you are more comfortable with.

Profitability	12/31/2018	12/31/2019	12/30/2020
Gross Profit Margin	24.93%	26.97%	33.31%
Operating Profit Margin	6.53%	4.70%	6.03%
Net Profit Margin	33.89%	2.13%	3.81%
Efficiency
A/R DOH	58.15	46.84	45.75
INVEN DOH	178.25	144.33	144.54
A/P DOH	60.03	50.00	59.32
Asset Turnover	1.17	1.45	1.46
Leverage
Debt/Equity	128.92%	171.43%	232.85%
LTD/Total Capital	36.93%	45.63%	53.79%
Debt/Total Capital	128.92%	171.43%	232.85%
Debt/EBITDA	5.92	6.22	5.76
Times Interest Earned	11.98	5.53	8.75
Fixed Charge Coverage	11.98	5.53	8.75
Liquidity
Current Ratio	2.42	2.21	2.07
Quick Ratio	1.03	0.91	0.97
Cash Conversion Cycle	176.37	141.18	130.98
Returns
Return on Equity	90.59%	8.36%	18.59%
Return on Assets	39.57%	3.08%	5.58%
Return on Capital

Answer 1

1. The leverage ratios of the company are of the utmost concern. Debt/ Equity and LTD / Total Capital ratios have been increasing year on year, and at the end of the latest accounting period, Debt / Equity stands at 232.85 %. High financial leverage also entails high financial risk, i.e the inability of the firm to service interest cost, and to repay principal. In fact, Times Interest Earned and Fixed Charge Coverage have been decreasing year on year.

Another difficulty the company is likely to face as a result of the high financial leverage is dwindling financial flexibility. Should the company need to borrow further for expansion or diversification, it would find it difficult to mobilise funds from the lenders without injection of fresh equity.

2. High leverage is normally associated with high profitability. But strangely, both Return on Equity and Return on Assets have decreased steeply over the three year period. This implies that net profit margin is falling.

Return on Assets = (Net Income / Sales) x ( Sales / Assets ) = Net Profit Margin x Asset Turnover = Net Profit Margin x 1.46 = 5.58

or Net Profit Margin = 5.58 / 1.46 = 3.81 %

In spite of increase gross profit margins, net profit margins are falling.

This is not surprising, since a large percentage of income is used up to service interest cost.

3. Another area of concern could be the declining liquidity ratios. A current ratio of 2.07 or a quick ratio of 0.97 are not very uncomfortable, but if these ratios fall any further, there could be liquidity concerns for the firm.