Question

1. You have been hired as an analyst for Bank WA and your team is working on an independent assessment of Duck Food Inc. (DF Inc.). DF Inc. is a firm that specializes in the production of freshly imported farm products from New Zealand. Your assistant has provided you with the following data about the company and its industry.

Ratio	2018	2017	2016	2018- Industry Average
Long-term debt	0.45	0.40	0.35	0.35
Inventory Turnover	62.65	42.42	32.25	53.25
Depreciation/Total Assets	0.25	0.014	0.018	0.015
Days’ sales in receivables	113	98	94	130.25
Debt to Equity	0.75	0.85	0.90	0.88
Profit Margin	0.082	0.07	0.06	0.12
Total Asset Turnover	0.54	0.65	0.70	0.40
Quick Ratio	1.028	1.03	1.029	1.031
Current Ratio	1.33	1.21	1.15	1.25
Interest coverage Ratio	0.9	4.375	4.45	4.65

1. What can you say about the firm's overall management in terms of the following?

(Be as complete as possible given the above information, but do not use any irrelevant information).

1. Liquidity                                                                                                      [2 marks]
2. Efficiency (operational efficiency)                                                                 [2 marks]
3. Performance (profitability, margins)                                                               [2 marks]
4. Leverage                                                                                                    [2 marks]

2. If current liabilities of the company was 2.75 million in 2018 and daily cash expenditure was 0.013million, using the data provided in the table, calculate the defensive interval ratio.         

[2 marks]

Answer 1

a.

i. Liquidity: It means the ability of the business to pay its short-term liabilities.

The current ratio and quick ratio are used to highlight the business's liquidity.

A generally acceptable current ratio is 2:1. But a ratio of less than 1 often a cause of concern, particularly if it persists for a long time.

A quick ratio of 1:1 is considered satisfactory unless the majority of quick assets are in accounts receivable.

But not all assets can be turned into cash quickly. So, a ratio of less than 1 would start to send out danger signals.

In this question, in all three consecutive years company has a good liquidity position as it has both current and quick ratios are in satisfactory position of more than one.

ii. Efficiency: These ratios gives us an insight of how efficiently the business is employing its resources i which are invested into fixed assets and working capital.

The following are the efficiency ratios:

a. Inventory turnover ratio : An increasing inventory turnover figure or one which is higher than the average of the industry indicates the poor inventory management.

In this question, the management is not doing well with inventory management as it is increasing year by year and the yearly figure is larger than the industry average.

b. Day's Sales in receivable : It indicates whether debtors are being allowed excessive credit. A high figure, more than industry average, indicates the lack in debt collection.

In this question, the management is good at debt collection as the days credit allowed to its customers is less than the industry's average.

c. Total asset turnover ratio: It measures the efficiency with which the firm uses its total assets.

In this question, the management is quite satisfactory for total assets turnover ratio as it is higher than the industry's average but not good from its own past records.

iii. Performance : These ratios reflect the final results of the business operations. Management always attempts to maximize these ratios to maximize the firm's value.

In this question, the company is not good at the profit as compared from the industry's average. But it's satisfactory if we compare it with its own past records.

v).Leverage : These measures the long term stability and structure of the firm.

These ratios includes:

Debt to equity ratio: A high ratio indicates less protection to creditors and a low ratio means wider safety cushions.

In this situation, company provides wider safety cushion to its creditors in the long term.

It is the good indicator of firm's financial leverage.

Interest coverage ratio: It indicates the firm's ability to meet interest obligations. A high ratios means that the firm can easily meet its interest obligations and a low ratio indicates excessive use of debt.

In this question the company is unable to meet its interest obligations as it may have excessive debt or has insufficient operations.

vi. Current liabilities = 2.75 million

Daily cash expenditure = 0.013 million

Liquid Assets = Quick ratio * current liabilities

= 1.028*2.75

= 2.827 million

Defensive interval ratio would be calculated as

= Liquid assets ÷ Estimated daily cash expenditure

= 2.827÷ 0.013

= 217.46

Thus the defensive interval ratio is 217.46 for the year 2018.