Question

Donna Jamison was recently hired as a financial anaylst by Computeon Industries, a manufacturer of electronic components. Her first task was ri cinduct a financial analysis of the firm covering the last two years. To begin, she gathered the following financial statements and other data.

Balance sheets 2015 2016

Assets

Cash $52,000. 57,600

Accounts receivable. $402,000. 351,200

Inventories. 836,000. 715,200

Total current assets. $1,290,000. 1,124,000

Gross fixed assets. 527,000. 491,000

Less accumlated

depreciation. $166,200. 146,200

Net fixed assets. 360,800. 344,800

Total assets. $1,650,800. 1,468,800

Liabilities and equity

Accounts payable. $175,200. 145,600

Notes payable. 225,000. 200,000

Accurals. 140,000. 136,000

Total current liabilities. 540,200. 481,600

Long term debt. 424,612. 323,432

Commonstock (100,000

shares. 460,000. 460,000

Retained earnings. 225,988. 203,768

Total equity. 685,988. 663,768

Total liabilities and equity. 1,650,800. 1,468,800

Income statements. 2016. 2015

Sales. $3,850,000. 3,432,000

Cost of goods sold. (3,250,000). (2,864,000)

Other expenses. (430,300). (340,000)

Depreciation. (20,000). (18,900)

Total operating costs. $3,700,300. 3,222,900

EBIT. 149,700. 209,100

Interest expense. (76,000). (62,500)

EBIT. 73,700. 146,600

Taxes (40%). (29,480). (58,640)

Net income. 44,220. 87,960

EPS. 0.442. 0.880

Statement of cash Flows (2016)

Operating Activities

Net income. 44,220

Other additions (source of

cash

Depreciation. 20,000

Increase in accounts

payable. 29,600

Increase in accruals. 4,000

Subtractions (uses of cash)

Increase in accounts receivable (50,800)

Increase in inventorties. (120,800)

Net cash flow from operations (73,780)

Long Term Investing Activities

Investment in fixed assets. (36,000)

Financing Activities

Increasebin notes payable. $25,000

Increase in long-term debt. $101,180

Paymentbof cash dividends. (22,000)

Net cash flow from financing. $104,180

Net reductionbin cash accoont. (5,600)

Cash at beginning of year. 57,600

Cash at end of year. 52,000

Other Data. 2016. 2015

Decenber 31 stock price. $6.00. $8.50

Number of shares. 100,000. 100,000

Dividends per share. $.0.22. $0.22

Lease payments. $40,000. $40,000

Industry average data for 2016.

Ratio. Industry Average

Current. 2.7x

Quick. 1.0x

Inventory turnover. 6.0x

Days sales outstanding (DSO). 32.0 days

Fixed assets turnover. 10.7x

Total assets turnover. 2.6x

Debt ratio. 50.0%

TIE. 2.5x

Fixed charge coverage. 2.1x

Net profit margin. 3.5%

ROA. 9.1%

ROE. 18.2%

Price/earnings. 14.2x

Market/book. 1.4x

Assume that you are Donna Jamison’s assistant and that she has asked you to help her prepare a report that evaluates the company’s financial condition. Answer the following questions:

a. What can you conclude about the cimpany’s financial condition from its statement of cash flows?

b. What is the purpose of financial ratio analysis, and what are the five major categories of ratios?

c. What are Computrons current and quick ratios? What do they tell you about the company’s liquidity position?

d. What is Computron’s inventory turnover, day’s sales outstanding, fixed assets turnover and total assets turnover ratios? How doesnthe firm’s utilization of assetz stack up against that of the industry?

e. What are the firm’s debt, times-interest-earned, and fixed charge coverage ratios? How does Computron comparebto the industry with respect to financial leverage? What conclusions can you drawnfrom these ratios?

f. Calculate and discussnthe firm’s profitability ratios- that is, its net profit margin, return on assets (ROA), and return on equity (ROE).

Answer 1

A) AS PER THE STATEMENT OF CASH FLOW , THE MANAGEMENT OF THE COMPANY IS NOT ABLE TO WORK EFFECTIVELY AND EFFICIENTLY WITH REGARDS TO GENERATING CASH FLOWS FROM OPERATIONS. ONE OF THE CORE REASON IS LOW PROFIT ACCOMPANIED WITH THE LOOSE CREDIT POLICY WHICH HAVE RESULTED INTO LARGE DEBTORS.SUBSEQUENTLY INCREASING THE RISK OF BAD DEBTS. OTHER PROMINENT REASON FOR LOW NEGATIVE CASH FLOW IS THE INCREASE IN INVENTORY HIGHLIGHTING THE MANAGEMENTS INEFFICIENCY TO SELL THE GOODS IN THE MARKET.

THE COMPANY IS INVESTING IN THE FIXED ASSETS HIGHLIGHTING THE COMPANY'S GOING CONCERN IN FUTURE.

TO MEET THE FINANCIAL GAP CREATED DUE TO INEFFICIENCY OF THE MANAGEMENT IN SELLING THE FINISHED GOODS AND MAINTAINING LARGE INVENTORIES THE RAISING FUNDS FROM DEBTS BECOME MANDATE.

THE DIVIDENDS ARE NOT PAID WHICH SYMBOLIZE THE INSUFFICIENT PROFITS.

B) RATIO ANALYSIS HELP IN THE ANALYTICAL REVIEWING OF THE FINANCIAL STATEMENTS. IT HELPS THE USER TO ANALYSIS THE FINANCIAL AS WELL AS NON FINANCIAL INFORMATION. THIS CAN BE DONE BY-

1- COMPARING THE PRIOR PERIOD ELEMENTS OF FINANCING STATEMENTS WITH CURRENT PERIOD ELEMENT

2- SIMILAR INFORMATION OF THE INDUSTRY

3- BUDGETED STATEMENTS

RATIO ANALYSIS HELPS TO LOCATE THE FLUCTUATIONS, IDENTIFY THE ROOT CAUSE, ENABLE MANAGEMENT TO FORM SOLUTIONS.

CATEGORIES FOR THE RATIOS ARE-

1. PROFITABILITY RATIO
2. SOLVENCY RATIO
3. TURNOVER RATIO
4. LIQUIDITY RATIO
5. MARKET RATIO

C) CURRENT RATIO AND QUICK RATIO ARE THE RATIO TO JUDGE THE SHORT TERM SOLVENCY OF THE COMPANY.

• CURRENT RATIO IS CURRENT ASSETS DIVIDED BY CURRENT LIABILITY.
  • COMPANY - 2.388 AND INDUSTRY 2.7
• QUICK ASSET IS QUICK ASSETS DIVIDED BY CURRENT LIABILITY.
  • COMPANY - 0.84 AND INDUSTRY - 1

QUICK ASSETS INCLUDES ALL CURRENT ASSETS EXCEPT PREPAID EXPENSES AND STOCK.

THESE TELL US ABOUT WHETHER THE ASSETS BE CURRENT OR QUICK ARE SUFFICIENT ENOUGH TO COVER THE CURRENT LIABILITIES.

D)

1. INVENTORY TURNOVER RATIO= COST OF GOODS SOLD OR COST OF SALES / STOCK IN TRADE OR FINISHED GOODS
2. DAY SALE OUTSTANDING= NET CREDIT SALE / DEBTOR& BILLS RECEIVABLE
3. FIXED ASSET TURNOVER = NET SALES/NET FIXED ASSET
4. TOTAL ASSET TURNOVER = NET SALES/ TOTAL ASSETS

THE RATIO ARE COMPARED TO THE INFORMATION OF THE SIMILAR FIRM IN THE INDUSTRY TO GET THE IDEA OF THE EFFECTIVENESS AND EFFICIENCY OF THE OPERATIONS OD THE FIRM.

E)

firm’s debt = (EARNING AFTER TAX+INTEREST+DEPRECIATION+OTHER NON CASH EXPENDITURE) / (INTEREST ON LONG TERM DEBTS+ INSTALLMENT OF PRINCIPAL)

times-interest-earned =EBIT/ NTEREST ON LONG TERM ASSETS

fixed charge coverage ratios = EBIT / (INTERST ON LONG TERM DEBT + PREFERENCE DIVIDEND / (1-TAX) )

COMPARING THE FINANCIAL LEVERAGES OF THE FIRM IN THE INDUSTRY HELP TO HIGHLIGHT THE BURDEN OF THE INTEREST ON THE COMPANY AS COMPARED TO INDUSTRY.

CONCLUSION DRAWN CAN RANGE FROM CALCULATING THE INTEREST AMOUNT TO JUDGING THE EFFECTIVENESS OF THE MANAGEMENT TO EARN ENOUGH FOR REPAYMENT OF PRINCIPAL OT PAYMENT OF INTEREST. IT CAN ALSO HELP EVALUATE THE CREDIT WORTHINESS AND RECOVERABILITY STATUS.

F) NET PROFIT MARGIN = NET PROFIT / SALES *100 = 44200*100/3850000= 1.148

RETURN ON ASSET=NOPAT / OPERATING ASSET *100 = 44200*100 / 1650800 = 2.677

RETURN ON EQUITY = ROA+DEBT/EQUITY(ROA-COST OF DEBT)

=2.677 + 424612/685988 (2.677-10.74)

=(2.3138)