Question

Please give recommendations from this analysis of Trevor Industries for future to upper management.

For the period ending December 31, 2010, Trevor Industries produced a current ratio of 90% and the acid test of 24%, both ranging below the industry standard. According to the results of these ratios, it can be concluded that the firm’s liquidity is between moderate and low levels of liquidity. The evaluation bases its conclusion on the results of the current ratio which suggests that the firm is capable of meeting approximately 90% of its short-term obligations through liquidation of all its current assets. Firms operating in similar industries possess current ratios two times greater than what currently exists for Trevor Industry.

Since Trevor Industry’s inventories account for almost 60% of the current assets, the acid test was used to produce a clearer picture of the financial position of the firm with regards to liquidity. Recall, Gitman, L.J& Zutter, C.J. (2015, pg 120) affirms that inventories are the least liquid current assets since it is made-up of partially completed products or special purposes items and are sold generally on credit (means inventories sold become accounts receivables before it can be converted to cash). The inventory turnover ratio for the past two financial periods indicates a slowing down of inventory turnover. The acid-test ratio according to Hayes (2020) uses a firm’s balance sheet data as an indicator of whether it has enough short-term assets to cover its short-term liabilities. The acid test ratio of 0.24 as of December 31, 2010, is 65% lower than the industry average – therefore, Trevor Industries must conduct a deeper investigation into its ability to finance short-term obligations to prevent cash flow problems or possible business failure.

Trevor Industries was successful in maintaining its gross profit margin of 40% at year end. However, these profits were significantly reduced after operating expenses were deducted. As at December 31, 2010 variable operating expenses and depreciation expenses (owing to the purchase of additional fixed assets) grew exponentially leaving an operating Profit margin of 10.63%. Once interest expense was deducted from Operating Profit and taxation deducted from Net Profit before tax- a Net Profit Margin of 3% of sales was retained- lower than 2009. This means as at December 31, 2010 Trevor industry was only able to retain 3% his revenues generated from sales.

Potential as well as present stockholders will be interested in knowing Trevor Industry’s earning per share (EPS). Observing Trevor Industry’s 2009 EPS it is noted that the firm’s financial position is improving; as it stands (as at December 31, 2010) Trevor Industry’s EPS is $1.09 which means that for every dollar earned in profits, $1.09 is earned for its stockholders. Based on the firm’s current trajectory it is becoming more attractive to outside investors and would encourage its current common stockholders to invest additional capital into the firm. Especially with return on equity improvements as December 31,2010. Common stockholders now earn approx. 9 cents for every dollar invested in Trevor Industries

As at December 31, 2010 Trevor Industry held a Debt ratio of 60% which was slightly above that of the industry average. This ratio suggests that 60% of the firm’s assets are financed through debt which lends to some degree of financial leveraging. The Debt to equity ratio of 158.4% confirms the implied use of financial leveraging by increasing the firm’s indebtedness (risk) to generate prospective returns on investment. It is to be noted however that a significant portion (approx. 75%) of the firm’s Debt is in short-term lending which will create significant pressure on the firm to meet its obligations in the short- term. Against this backdrop, coverage was examined. Trevor Industries' ability to service its interest payments as at December 31, 2010 was moderately sufficient however limited. As at the date aforementioned, Trevor industry’s times interest-earned ratio is 2.78 which means that Earnings before interest and tax can fall by 64% and the firm will still be able to meet its interest expense. It means therefore Trevor industry has a moderately sufficient however limited margin of safety.

Answer 1

Recommendations from the analysis of Trevor Industries Limited

Liquidity Position

The firm’s liquidity position is not good as compared to its peers. The Current Ratio and Acid Test Ratio of 90% and 24% respectively shows the same. The industry current ratio is 2:1

The firm should look towards:

· Ensuring that the inventory is sold for cash basis rather than credit basis. This will ensure that the current assets are converted to cash quickly. The cash conversion cycle will improve

· As the inventory consists of 60% inventory which is large, the company should set aside cash or marketable securities for rainy days. The company can avail sweeping in facilities from the bank. This will automate the process

· The company has 75% of the debt in short term. This has increased the current liabilities. Short term liabilities must be sourced to fund the current assets. Here, it looks like the current liabilities are used to fun non-current assets. This is a recipe for disaster

Profitability Position

The company looks to have a healthy gross profit although it should be compared with the peers. Although, the company is failing to translate the gross profit to operating as well as net profit.

· The company looks to be in an expansion phase with the influx of fixed assets. But the return on these assets must be looked at as this is not translating in better Net and Operating profits.

· Although the depreciation provides tax shield, but it is also decreasing the profits. The company can look for alternate sources of acquiring assets such as lease

· Other operating expenses such as SG&A, Employee cost must be studied historically to understand the trend. The SG&A expenses must be reduced to the minimum level

Shareholder’s Position

The ROE is higher because of the leverage the company has taken. Doing a DU Pont analysis will show that the leverage is one of the biggest reasons for the increase in the ROE. The company has to focus more on the Return on Assets and The Net Profit for the ROE to sustain and grow