Solution to Case 2
Financial Analysis Ratio
2. Bigger Isn’t Always Better! - TEACHING NOTE
Table IQuickfix Autoparts
Balance Sheet
2000 / 2001 / 2002 / 2003 / 2004
ASSETS
Cash and marketablesecurities / $155,000 / $309,099 / $75,948 / $28,826 / $18,425
Accounts receivable / 10,000 / 12,000 / 20,000 / 77,653 / 90,078
Inventory / 250,000 / 270,000 / 500,000 / 520,000 / 560,000
Current assets / $415,000 / $591,099 / $595,948 / $626,480 / $668,503
Land, buildings, plant,
and equipment / $250,000 / $250,000 / $500,000 / $500,000 / $500,000
Accumulated depreciation / (25,000) / (50,000) / (100,000) / (150,000) / (200,000)
Net fixed assets / $225,000 / $200,000 / $400,000 / $350,000 / $300,000
Total assets / $640,000 / $791,099 / $995,948 / $976,480 / $968,503
LIABILITIES AND EQUITIES
Short-term bank loans / $50, 000 / $145,000 / $140,000 / $148,000 / $148,000Accounts payable / 10,000 / 10,506 / 19,998 / 15,995 / 16,795
Accruals / 5,000 / 5,100 / 7,331 / 9,301 / 11,626
Current liabilities / $65,000 / $160,606 / $167,329 / $173,296 / $176,421
Long-term bank loans / $63,366 / $98,000 / $196,000 / $190,000 / $183,000
Mortgage / 175,000 / 173,000 / 271,000 / 268,000 / 264,000
Long-term debt / $238,366 / $271,000 / $467,000 / $458,000 / $447,000
Total liabilities / $303,366 / $431,606 / $634,329 / $631,296 / $623,421
Common stock (100,000 shares) / $320,000 / $320,000 / $320,000 / $320,000 / $320,000
Retained earnings / 16,634 / 39,493 / 41,619 / 25,184 / 25,082
Total equity / $336,634 / $359,493 / $361,619 / $345,184 / $345,082
Total liabilities
and equity / $640,000 / $791,099 / $995,948 / $976,480 / $968,503
Table II
Quickfix Autoparts
Income Statement
2000 / 2001 / 2002 / 2003 / 2004Net sales / $600,000 / $655,000 / $780,000 / $873,600 / $1,013,376
Cost of goods sold / 480,000 / 537,100 / 655,200 / 742,560 / 861,370
Gross profit / $120,000 / $117,900 / $124,800 / $131,040 / $152,006
Admin and selling exp / $30,000 / $15,345 / $16,881 / $43,680 / $40,535
Depreciation / 25,000 / 25,000 / 50,000 / 50,000 / 50,000
Miscellaneous expenses / 2,027 / 3,557 / 5,725 / 17,472 / 15,201
Total operating exp / $57,027 / $43,902 / $72,606 / $111,152 / $105,736
EBIT / $62,973 / $73,998 / $52,194 / $19,888 / $46,271
Interest on ST loans / $15,000 / $15,950 / $14,000 / $13,320 / $13,320
Interest on LT loans / 8,000 / 7,840 / 15,680 / 15,200 / 14,640
Interest on mortgage / 12,250 / 12,110 / 18,970 / 18,760 / 18,480
Total interest / $35,250 / $35,900 / $48,650 / $47,280 / $46,440
Before-tax earnings / $27,723 / $38,098 / $3,544 / ($27,392) / ($169)
Taxes / 11,089 / 15,239 / 1,418 / (10,957) / (68)
Net income / $16,634 / $22,859 / $2,126 / ($16,435) / ($102)
Dividends on stock / 0 / 0 / 0 / 0 / 0
Additions to
retained earnings / $16,634 / $22,859 / $2,126 / ($16,435) / ($102)
EPS (100,000 shares) / $0.17 / $0.23 / $0.02 / ($0.16) / ($0.00)
Questions
1. How does Quickfix’s average compound growth rate in sales compare with its earnings growth rate over the past five years?
Quickfix’s sales have increased by an average compound rate of 14% per year over the past five years. In comparison, its net income has declined from over $16,600 in 2000, to a loss of $102 in 2004.
2. Which statements should Juan refer to and which one’s should he construct so as to develop a fair assessment of the firm’s financial condition? Explain why?
Juan should refer to the income statement and the balance sheet over the past 3-5 year period. In addition, he should prepare a cash flow statement, common size income statement and common size balance sheet. The accounting statements provide the raw data from which the other statements can be prepared. The cash flow statement helps determine where the cash came from and where it wasit was spent during a year. The common size statements provide useful information regarding the relative trends of the various assets, liabilities, revenue sources, and expense items. They also help the analyst make meaningful comparisons between firms of varying sizes.
3. What calculations should Juan do in order to get a good grasp of what is going on with Quickfix’s performance?
Juan should calculate the various liquidity, leverage, profitability, activity, and coverage ratios for at least a three-year period. In addition, a Du Pont analysis of the return on equity will help determine what has affected the profitability of the company.
4. Juan knows that he should compare Quickfix’s condition with an appropriate benchmark. How should he go about obtaining the necessary comparison data?
Based on Quickfix’s industry classification code, Juan should collect industry averages of the key financial ratios. Some useful sources for industry ratios include: Value Line, Moody’s, Standard & Poor, and Dun & Bradstreet. In addition to the industry average, the industry leaders (within the size category) ratios could also be collected from the Internet (e.g. Marketguide.com) and used for comparison.
5. Besides comparison with the benchmark what other types of analyses could Juan perform to comprehensively analyze the firm’s condition?
Perform the suggested analyses and comment on your findings.
Besides comparison with the benchmark, Juan could perform common size analyses of the financial statements and a DuPont analysis of the return on assets and the return on equity.
Quickfix AutopartsCommon Size Income Statement
2000 / 2000% / 2001 / 2001% / 2002 / 2002% / 2003 / 2003% / 2004 / 2004%
Net sales / $600,000 / 100.0% / $655,000 / 100.0% / $780,000 / 100.0% / $873,600 / 100.0% / $1,013,376 / 100.0%
Cost of goods sold / 480,000 / 80.0% / 537,100 / 82.0% / 655,200 / 84.0% / 742,560 / 85.0% / 861,370 / 85.0%
Gross profit / $120,000 / 20.0% / $117,900 / 18.0% / $124,800 / 16.0% / $131,040 / 15.0% / $152,006 / 15.0%
Admin and selling exp / $30,000 / 5.0% / $15,345 / 2.3% / $16,881 / 2.2% / $43,680 / 5.0% / $40,535 / 4.0%
Depreciation / 25,000 / 4.2% / 25,000 / 3.8% / 50,000 / 6.4% / 50,000 / 5.7% / 50,000 / 4.9%
Miscellaneous expenses / 2,027 / 0.3% / 3,557 / 0.5% / 5,725 / 0.7% / 17,472 / 2.0% / 15,201 / 1.5%
Total operating exp / $57,027 / 9.5% / $43,902 / 6.7% / $72,606 / 9.3% / $111,152 / 12.7% / $105,736 / 10.4%
EBIT / $62,973 / 10.5% / $73,998 / 11.3% / $52,194 / 6.7% / $19,888 / 2.3% / $46,271 / 4.6%
Interest on ST loans / $15,000 / 2.5% / $15,950 / 2.4% / $14,000 / 1.8% / $13,320 / 1.5% / $13,320 / 1.3%
Interest on LT loans / 8,000 / 1.3% / 7,840 / 1.2% / 15,680 / 2.0% / 15,200 / 1.7% / 14,640 / 1.4%
Interest on mortgage / 12,250 / 2.0% / 12,110 / 1.8% / 18,970 / 2.4% / 18,760 / 2.1% / 18,480 / 1.8%
Total interest / $35,250 / 5.9% / $35,900 / 5.5% / $48,650 / 6.2% / $47,280 / 5.4% / $46,440 / 4.6%
Before-tax earnings / $27,723 / 4.6% / $38,098 / 5.8% / $3,544 / 0.5% / ($27,392) / -3.1% / ($169) / -0.02%
Taxes / 11,089 / 1.8% / 15,239 / 2.3% / 1,418 / 0.2% / -10,957 / -1.3% / -68 / -0.01%
Net income / $16,634 / 2.8% / $22,859 / 3.5% / $2,126 / 0.3% / ($16,435) / -1.9% / ($102) / -0.01%
The common size income statement indicates that the firm’s cost of goods sold has increased quite a bit since 2000. Miscellaneous expenses have also increased from .3% of sales to 1.5% of sales. On the other hand, selling and administrative expenses and interest charges have come down a bit. The firm needs to look into its cost structure and try and reduce the overall costs of doing business.
The common size balance sheet (shown below) shows that the firm’s inventory and accounts receivables levels have gone up sharply, while its cash balance has significantly declined. Fixed assets have increased over the past 5 years. The firm has taken on significantly larger amounts of short and long-term debt relative to its total assets. Equity has not increased proportionately with debt. As a result its capital structure has become more leveraged.
Quickfix AutopartsBalance Sheet
2000 / 2000% / 2001 / 2001% / 2002 / 2002% / 2003 / 2003% / 2004 / 2004%
ASSETS
Cash and marketable
securities / $155,000 / 24.22% / $309,099 / 39.07% / $75,948 / 7.63% / $28,826 / 2.95% / $18,425 / 1.90%
Accounts receivable / 10,000 / 1.56% / 12,000 / 1.52% / 20,000 / 2.01% / 77,653 / 7.95% / 90,078 / 9.30%
Inventory / 250,000 / 39.06% / 270,000 / 34.13% / 500,000 / 50.20% / 520,000 / 53.25% / 560,000 / 57.82%
Current assets / $415,000 / 64.84% / $591,099 / 74.72% / $595,948 / 59.84% / $626,480 / 64.16% / $668,503 / 69.02%
Land, buildings, plant,
and equipment / $250,000 / 39.06% / $250,000 / 31.60% / $500,000 / 50.20% / $500,000 / 51.20% / $500,000 / 51.63%
Accumulated depreciation / -25,000 / -3.91% / -50,000 / -6.32% / -100,000 / -10.04% / -150,000 / -15.36% / -200,000 / -20.65%
Net fixed assets / $225,000 / 35.16% / $200,000 / 25.28% / $400,000 / 40.16% / $350,000 / 35.84% / $300,000 / 30.98%
Total assets / $640,000 / 100.00% / $791,099 / 100.00% / $995,948 / 100.00% / $976,480 / 100.00% / $968,503 / 100.00%
LIABILITIES AND EQUITIES
Short-term bank loans / $50,000 / 7.81% / $145,000 / 18.33% / $140,000 / 14.06% / $148,000 / 15.16% / $148,000 / 15.28%
Accounts payable / 10,000 / 1.56% / 10,506 / 1.33% / 19,998 / 2.01% / 15,995 / 1.64% / 16,795 / 1.73%
Accruals / 5,000 / 0.78% / 5,100 / 0.64% / 7,331 / 0.74% / 9,301 / 0.95% / 11,626 / 1.20%
Current liabilities / $65,000 / 10.16% / $160,606 / 20.30% / $167,329 / 16.80% / $173,296 / 17.75% / $176,421 / 18.22%
Long-term bank loans / $63,366 / 9.90% / $98,000 / 12.39% / $196,000 / 19.68% / $190,000 / 19.46% / $183,000 / 18.90%
Mortgage / 175,000 / 27.34% / 173,000 / 21.87% / 271,000 / 27.21% / 268,000 / 27.45% / 264,000 / 27.26%
Long-term debt / $238,366 / 37.24% / $271,000 / 34.26% / $467,000 / 46.89% / $458,000 / 46.90% / $447,000 / 46.15%
Total liabilities / $303,366 / 47.40% / $431,606 / 54.56% / $634,329 / 63.69% / $631,296 / 64.65% / $623,421 / 64.37%
Common stock (100,000 shares) / $320,000 / 50.00% / $320,000 / 40.45% / $320,000 / 32.13% / $320,000 / 32.77% / $320,000 / 33.04%
Retained earnings / 16,634 / 2.60% / 39,493 / 4.99% / 41,619 / 4.18% / 25,184 / 2.58% / 25,082 / 2.59%
Total equity / $336,634 / 52.60% / $359,493 / 45.44% / $361,619 / 36.31% / $345,184 / 35.35% / $345,082 / 35.63%
Total liabilities
and equity / $640,000 / 100.00% / $791,099 / 100.00% / $995,948 / 100.00% / $976,480 / 100.00% / $968,503 / 100.00%
Du Pont Analysis / 2000 / 2001 / 2002 / 2003 / 2004
Net Profit Margin / 2.77% / 3.49% / 0.27% / -1.88% / -0.01%
Total Asset Turnover / 0.9375 / 0.827962 / 0.7831734 / 0.894642 / 1.046332329
Equity Multiplier / 1.901175 / 2.200596 / 2.7541363 / 2.828868 / 2.806587999
Return on Assets / 2.60% / 2.89% / 0.21% / -1.68% / -0.01%
Return on Equity / 4.94% / 6.36% / 0.59% / -4.76% / -0.03%
Quickfix Auto’s ROA has is currently negative but has improved since 2003. Most of the decrease has come from the deteriorating profit situation. The firm’s total asset turnover has improved consistently since 2002.
The firm’s ROE has suffered significantly since 2001. This has occurred largely due to the steep drop in net profit margin. Had the firm not had such a high equity multiplier (from its high level of debt), the ROE situation would have looked considerably worse.
6. Comment on Quickfix’s liquidity, asset utilization, long-term solvency, and profitability ratios. What arguments would have to be made to convince the bank that they should grant Quickfix the loan?
2000 / 2001 / 2002 / 2003 / 2004Current Ratio / 6.38 / 3.68 / 3.56 / 3.62 / 3.79
Quick Ratio / 2.54 / 2.00 / 0.57 / 0.61 / 0.62
Cash Ratio / 2.38 / 1.92 / 0.45 / 0.17 / 0.10
Total Debt Ratio / 0.47 / 0.55 / 0.64 / 0.65 / 0.64
Debt-Equity Ratio / 0.90 / 1.20 / 1.75 / 1.83 / 1.81
Equity Multiplier / 1.90 / 2.20 / 2.75 / 2.83 / 2.81
Times Interest Ratio / 1.79 / 2.06 / 1.07 / 0.42 / 1.00
Cash Coverage Ratio / 2.50 / 2.76 / 2.10 / 1.48 / 2.07
Inventory Turnover ratio / 1.92 / 1.99 / 1.31 / 1.43 / 1.54
Day's Days sales in Inventory / 190.10 / 183.49 / 278.54 / 255.60 / 237.30
Receivables Turnover / 60.00 / 54.58 / 39.00 / 11.25 / 11.25
ACP or Days' Sales in Receivables / 6.08 / 6.69 / 9.36 / 32.44 / 32.44
Total Asset Turnover / 0.94 / 0.83 / 0.78 / 0.89 / 1.05
Capital Intensity / 1.07 / 1.21 / 1.28 / 1.12 / 0.96
Profit Margin / 2.77% / 3.49% / 0.27% / -1.88% / -0.01%
ROA / 2.60% / 2.89% / 0.21% / -1.68% / -0.01%
ROE / 4.94% / 6.36% / 0.59% / -4.76% / -0.03%
Liquidity:
The firm’s overall liquidity is quite good with a current ratio of 3.79 and it has improved quite a bit over the past three years. However, much of its current assets are tied in inventory, since its quick ratio is only 0.62. The ability of the firm to pay off its current liabilities from its cash reserves is not very good either and has deteriorated significantly over the past five years.
Asset utilization:
The firm’s inventory turnover has declined considerably since 2000. There was some improvement in 2004, but there is still a lot of room for further improvement. The receivables turnover ratio has declined as well. An average collection period of 32 days is pretty high for a retail business. The total asset turnover although not very high is at its highest level in five years.