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4. Sky Metals, Inc. is a metal fabrication firm that manufactures prefabricated metal parts for customers...

4. Sky Metals, Inc. is a metal fabrication firm that manufactures prefabricated metal parts for customers in a variety of industries. The firm’s motto is “If you need it, we can make it.” The CEO of Sky Metals recently held a board meeting during which he extolled the virtues of the corporation. The company, he stated confidently, had the capability to build any product and could do so using a lean manufacturing model. The firm would soon be profitable, claimed the CEO, because the company used state-of-the-art technology to build a variety of products while keeping inventory levels low. As a business press reporter, you have calculated some ratios to analyze the financial health of the firm. Sky Metals' current ratios and quick ratios for the past 6 years are shown in the following table: 2010 2011 2012 2013 2014 2015 2015 Current ratio 1.2 1.4 1.3 1.6 1.8 2.2 2.2 Quick ratio 1.1 1.3 1.2 0.8 0.6 0.4 0.4 What do you think of the CEO’s claim that the firm is lean and soon to be profitable?

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Expert Solution

Year Current ratio Quick ratio
2010                               1.20                                  1.10
2011                               1.40                                  1.30
2012                               1.30                                  1.20
2013                               1.60                                  0.80
2014                               1.80                                  0.60
2015                               2.20                                  0.40

We know that current ratio = current assets/current liabilities and quick ratio = (current assets - inventories)/current liabilities

From the table and the graph we can see that while the current ratio is experiencing an upward trend for Sky Metals the quick ratio is going in the opposite direction and witnessing a downward trend. This means that the inventory levels are falling and this is causing the numerator of the quick ratio to decline and thus causing the ratio to decline as well.

Declining levels of inventory definitely indicates that the firm is lean and most probably and in all likelihood the firm might be using principles of lean manufacturing and JIT (just in time) to ensure that inventories are kept at optimal levels. Also lower levels of inventories frees up working capital and increases profitability as well.

Thus I agree with the CEO’s claim that the firm is lean and soon to be profitable.

jeff jeffy answered 1 year ago
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