Why is the accounts payable period not computed in the presentation? Isn't it an important factor to decide whether the company is a good credit risk?
Aside from the measures used in the presentation, are there other financial ratios that can be used in the appraisal of the company’s performance and financial position? If there are, how can these help?
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Another ratio for profitability would be net profit margin to determine further determine rofitbaility while accounting for operating expenses.
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Another financial ratio that may be used is the Days Sales of Inventory (DSI) ratio. Expressed as an equation, it is equal to Average Inventory divided by the Cost of Goods Sold (COGS), the quotient of which is multiplied by 365 days. What the DSI shows is the average time, in days, it takes for a company to turn both finished and in-process goods into sales.
It helps assess a company's performance by looking into how efficient sales are; that is, how long cash is in the form of inventory. A lower value generally means that the duration for inventory clearing is shorter, which then means a quicker turnover that could provide high profits.
However, there are certain cases when a high DSI does not necessarily mean that a company is performing poorly. For instance, a company may possibly be amassing its inventory for bumper sales on certain events, or it may be withholding its inventory in anticipation of a scarcity in a particular product.
Also, there are certain companies that may naturally show a higher DSI, like those dealing with vehicles.
All this being said, it is important to make DSI comparisons with other similar companies to more accurately determine whether sales are efficient or not.
It helps assess a company's performance by looking into how efficient sales are; that is, how long cash is in the form of inventory. A lower value generally means that the duration for inventory clearing is shorter, which then means a quicker turnover that could provide high profits.
However, there are certain cases when a high DSI does not necessarily mean that a company is performing poorly. For instance, a company may possibly be amassing its inventory for bumper sales on certain events, or it may be withholding its inventory in anticipation of a scarcity in a particular product.
Also, there are certain companies that may naturally show a higher DSI, like those dealing with vehicles.
All this being said, it is important to make DSI comparisons with other similar companies to more accurately determine whether sales are efficient or not.
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John Dawson, the president, said that they are going to have working capital needs for the next year. Assuming Springfield National Bank does not approve of the loan, what should he do to get the working capital that his company will need?
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Why is working capital omitted in the financial analysis of the case?
Since the company has more A/R than Cash, making it hard to pay its creditors, what can be some ways/methods the company can modify or adopt to improve its liquidity & solvency? Given the computed receivable turnover, what can be implied?
Since the company has more A/R than Cash, making it hard to pay its creditors, what can be some ways/methods the company can modify or adopt to improve its liquidity & solvency? Given the computed receivable turnover, what can be implied?
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1. Working capital was omitted because current ratio and quick ratio provide a much stricter indication of liquidity than working capital. Including it would be redundant.
2. Improving receivables collection is the best way to improve a company's liquidity. Reminding clients often about their outstanding payments regularly will help in collection and ultimately improve liquidity. Additionally, offering a discount upon prompt payment of receivables will also encourage clients to pay faster.
3. The receivable turnover ratio indicates that the company is becoming better at collecting its receivables. Unfortunately, we cannot make any assumptions about the actual efficiency of collection due to lack of an industry standard because of lack of information.
2. Improving receivables collection is the best way to improve a company's liquidity. Reminding clients often about their outstanding payments regularly will help in collection and ultimately improve liquidity. Additionally, offering a discount upon prompt payment of receivables will also encourage clients to pay faster.
3. The receivable turnover ratio indicates that the company is becoming better at collecting its receivables. Unfortunately, we cannot make any assumptions about the actual efficiency of collection due to lack of an industry standard because of lack of information.
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In the computation for the Return on Assets (ROA), why did you use the average total assets of 1974-1977 instead of just using the total asset of each year separately?
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By using average total assets in computing Return on Assets instead of the total assets for. given year, we can avoid any sudden increases or decreases in current assets that may distort the analysis. The formulas for Return on Assets vary, and we felt that the one that used average total assets as the denominator would be more representative of the actual financial position of the business. It should be noted however that our use of the average total assets of all 4 years is wrong. The proper way to do it would be to choose a baseline value (e.g. 1974) and add it to the total assets of the succeeding years and then averaging them to produce the proper average total assets. Rest assured that the mistake will be corrected in our written report.
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Asset turnover is a value that can indicate the efficiency of a business in using its assets to generate revenue. How come this was not included in the presentation since it can present significant information to the company's performance?
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As a measure of efficiency, we felt that Asset Turnover Ratio is not as necessary compared to the ratios we used in computing profitability, liquidity and solvency. As a lender, we are only concerned with liquidity and solvency to know if our debtors can pay their obligations timely. We are also concerned with their profitability because that will ultimately determine whether or not the company can pay us back. Efficiency is not directly related with the ability of the company to pay us back so we decided it was unnecessary to include it into our analysis.
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It was noticed that Tests for Efficiency were not computed. Now that we've tackled it in the lecture, what are the resulting values for Accounts receivable collection period, Inventory Turnover and Asset Turnover for each year and what can you conclude with the values computed?
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We believe that efficiency is not directly related with the ability of the company to pay back the credit as compared to liquidity, solvency and profitability, so we decided not to include it in our analysis. Furthermore, we would not be able to calculate these values since the values required in these tests are not available in the financial statements. For example, there was no information on inventory nor on the net credit sales per day in the financial statements of the case.
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Return on Equity was not included to evaluate the overall performance of the company. If this was factored in, would there be any changes in the credit risk status of the company?
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Return on equity measures earnings on the investment of shareholders. This profitability indicator is more interesting for shareholders to know if the company is still worth investing in. Therefore, it would not have contributed as much in terms of assessing whether the company is worthy of the credit risk.
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Another type of profitability ratio along with ROA and ROE is Basic Earning Power (BEP) ratio. For a company in this time period, how will using the BEP ratio affect the portrayal of the business compared to using ROA?
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BEP uses the raw income while accounting for taxes and interest while ROA uses operating income, which doesn't account for taxes and interests. BEP would be a better profitability ratio in that case because it measures the actual profitability of the business. In our case however, the net earnings used in the computation of ROA already had taxes accounted for, so the ROA we computed is essentially same thing as the BEP ratio.
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To answer the very first question, yes the accounts payable period would be a very good liquidity ratio. however the formula requires the number of working days of the business which was not indicated in the problem.
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What our group did the computation for the accounts payable period is we divided the accounts payable by the number of purchases per day which we got by dividing the annual purchases by 365. We used 365 days since in a period of the business, there is 365 days.
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It is good that the group did the vertical analysis of the current assets. It easily shows that the bulk of their current assets are on the accounts receivables. This also allowed the computation of the receivable turnover. Knowing these two is important since as you have stated in the presentation, the efficiency of the collection of the receivables would affect the company's liquidity.
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Ok, so one thing I'm gleaning from your analysis is this trend:
Profitability is going up, solvency going down. Solvency, aside from showing a business' capacity to pay a long term loan, also shows the willingness of a company to take high risks.
What are your insights on this trend? Though we know that this company is indeed doing quite badly right now, does this particular trend indicate any ability to recover?
Profitability is going up, solvency going down. Solvency, aside from showing a business' capacity to pay a long term loan, also shows the willingness of a company to take high risks.
What are your insights on this trend? Though we know that this company is indeed doing quite badly right now, does this particular trend indicate any ability to recover?
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