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Question 1 The financial manager needs your help in analyzing the financial position of the company.

He generated the following ratio ba sed on the company’s financial statements. Analyze the ratio using both trend and cross-sectional analyses. Highlight important strengths and weaknesses of the company and recommend suggestions to improve the company’s financial position. 2009 1.54 0.62 2010 1.47 0.67 2011 1.55 0.61 2012 1.33 0.56 TREND INDUSTRY AVERAGE 2012 1.20 0.66 CONCLUSION Good Below Average

A 1 2 B 3 4 5 C 6 7 D 8 9 10

Liquidity Ratio Current Ratio Quick Ratio Asset Utilization Inventory Turnover Average Collection Period Total Asset Turnover Debt Utilization Debt Ratio Time Interest Earned Profitability Gross Profit Margin Net Profit Margin Return On Assets

3.60 33.00 2.35

3.84 38.00 2.20

2.88 47.00 1.80

2.56 65.00 1.50

8.22 33.00 2.72

Below Average Below Average Below Average

0.48 45.40

0.56 33.00

0.59 14.10

0.66 12.20

0.62 12.90

Slightly More Debt Below Average

0.44 0.18 0.43

0.37 0.15 0.32

0.32 0.07 0.13

0.32 0.06 0.09

0.28 0.08 0.21

Good Below Average Below Average

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thus stocks are excluded as it’s assumed to be the most illiquid among the current assets. Inventory turnover of 2. indicate that the company did not collect its receivables as quickly as the industry average.46 in 2012 indicate that the company turn its inventory only 2. serving as warning signals or benchmarks from which meaningful conclusions may be reached on operational issues. indicates inefficiency in controlling inventory levels that may be an indication of over-stocking which may pose risk of obsolescence and increased inventory holding costs.Answer Financial position also referred to as balance sheet. inventory. Average collection period measure how long on the average it takes to collect a receivable after a sale has been made. the company has between RM1.20. Current Ratio is a liquidity ratio that measures company's ability to pay its debt over the next 12 months or its business cycle. b) Assets utilization ratios The asset utilization ratio measures management's ability to make the best use of its assets to generate revenue. Page | 2 . lower than industry average (0. reports on company’s assets. These ratios serve as a guide to critical factors concerning the use of the firm's assets. Analyzing and understanding financial position of the company will give better frame of mind to further assess profit and loss statements. In 2012. Inventory turnover measure the inventory management efficiency of a business. From every ringgit of its current liabilities in 2011 and 2012.e. and accounts receivable collections in day-to-day operations. Asset utilization ratios are especially important for internal monitoring concerning performance over multiple periods.60) to 2012 (2. Quick ratio effectively assesses the same aspect as current ratio but more stringent test. Quick ratio or acid-test measures ability of the company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. 33 days. Even though company current ratio was better than industry average.66) in 2012.33 of current assets available to cover the liabilities. the company took about 65 days to collect cash after sale was made. Current ratios shows ups and downs trend from 2009-2011 but within acceptable range and even better than industry average of 1.22). its measure the ability of company to meet its short term obligation from liquidation of its current assets as they come due. Inventory turnover also showed a declining trend from 2009 (3. liabilities and ownership equity at given point of time.46).46 times in a year which is way below industry average (8. The low quick ratio probably indicate a very low figure after taking off the value of inventories but leaving in the very high amounts owed to trade creditors. To analyze the financial position of the company. Quick ratio less than 1 indicate that company would not be able to repay all its debts by using its most liquid assets.56 versus 0. analysis on ratios generated will be divided into 4 primary categories. a) Liquidity ratios Liquidity ratio is also known as solvency ratios. quick ratio was vice versa i.55 and RM1.

All of these issues could lower the total asset turnover ratio. cost structure. A low turnover than the industry average (33 versus 65) in 2012 may indicate poor management of the company's assets or idle assets. It is a long-term solvency ratio that measures the ability of a company to pay its interest charges as they become due. The company debt ratio was slightly below the industry average (0.32 respectively but slightly higher than the industry average in 2012 (0.2 times in 2012 indicates that interest expenses of the company are 12. The company gross profit margin shows a declining trend from year 2009 to 2012 with 0. Times interest earned ratio of 12.2 in 2012).50 in 2012) shows the more sluggish of the company’s sales. Debt ratio is a ratio that indicates the proportion of a company's debt to its total assets. In other word. d) Profitability ratios Profitability ratios measure the ability of the company to earn an adequate return on sales.35 in 2009 versus 1.28).4 in 2009 to 12.48 in 2009 to 0.The increased trend of debtor’s turnover period from 33 (2009) to 65 (2012) was also less favourable which reflected the company accounts receivables are not as liquid or are not being converted to cash as quickly as in the past. The average collection period should however be compared with the firm's credit policy to see how well the company is doing. which measure the prudence of the debt management policies of the firm.44 to 0.9. Increase trend in debt ratio (0. Downward trend of total asset for the past 4 years of analysis (2.66 versus 0. The higher the ratio. this ratio assesses the degree of profitability in relation to sales and investment. c) Debt Utilization ratios Debt utilization ratios are used to evaluate the firm's debt position with regard to its asset base and earning power.e. Gross profit margin shows how efficiently a business is using its materials and labours in the production process and gives an indication of the pricing. It shows how much the company relies on debt to finance assets. this may relate to a less favourable trend of inventory turnover and average collection period or could be due to fixed assets sitting idle instead of being used to their full capacity. Total asset turnover measures the efficiency in which the total assets (current and fixed) have been employed to generate sales. this ratio was still good and almost similar to industry average i. Even though showed declining trend (45.12. the greater the risk associated with the company’s operation as higher portion of company's assets are claimed by its creditor. total assets and invested capital.62) indicate that this industry is more capital intensive which need to rely more on debt to finance its assets.2 times covered by its EBIT. This trend indicates that the industry itself might have a high cost pressure or high competition resulting to mark down in sales price or higher cost of sales. and production efficiency of your business. it is acceptable if this activity ratio is the same or lower than company’s credit term.66 in 2012) signify that the more company’s assets are finance through debt rather than equity. It is computed by dividing the income before interest and tax by interest expenses. Times interest earned indicates how many times the interest expenses are covered by the net operating income (EBIT) of the company. Page | 3 .

On the other hand.06 in 2012) and lower than the industry average in 2012 (0. the company should check and develop good credit control system. net profit margin measures the overall efficiency of the business. it could also result from inefficiency of the company in turning its revenue into actual profit. to get rid unproductive assets which are not contributing towards income generation of the company. i. then measure should be taken to increase the revenue generated from the assets. Regular stock takes should be performed to indentify obsolete. Possible conclusion could be the industry itself is in the unfavourable trend due to intense competition which affects the assets utilization ratio and liquidity.Unlike the gross profit which measures the operating efficiency of the business. It shows the margin left for the equity and preference shareholders i. the company position even worse than industry average although both recorded the same declining trend in term of managing its assets which reflected in lower inventory turnover and higher average collection period.e. If the company decides to maintain these unproductive assets. The company net profit margin shows the declining trend (0.e.08). In addition. Overall. the company financial position shows an unfavourable trend within four years being analyze.18 in 2009 to 0. The declining trend of ROA was due to decrease in operating profit. iii) Assets strip The key to improving the total asset turnover ratio is to “asset strip”.43 in 2009 to 0.09 in 2012) and even lower than the industry average of 0. the owners. damaged and slow moving items. Return on assets ration measure the effectiveness in which assets have been employed to make profits. ii) Improves debtor collection period To assess and review its customer’s financial statements and only extended credit term to those good track record and performance. Page | 4 . Cash term should be the only option for new customers.21 (2012). Recommendations to improve the company’s financial position are as follows:i) Managing its inventory To maintain its inventory levels to match required production or sales volume or simply to reduce production of slow moving items. In addition. the company could probably increase its investment in assets which moves its ROA lower than the industry in the corresponding years (2012). the company recorded good debt service ability signifies a favourable times interest earned even though in a declining trend. In 2011. The profitability declining trend was parallel with the declining trend of gross profit margin. Furthermore. The company return on assets was deteriorating from one to another year being analyze (0.

How can this problem be resolved by market forces? What are the consequences of such solutions to shareholders? Answer Agency problem is a conflict of interest between a company's management and the company's stockholders.iv) Increase in paid up capital As a last resort. However. invest more in the company. Question 2 (c) ESME Company wants to evaluate its cash flow position in the year 2012 to determine its sources and use of cash. or principals. However. and pension funds. acting as the agent for the shareholders. the company should be able to improve its financial position by simply increase paid up capital. These holders of large block of a firm’s stock have begun in recent years to exert pressure on management to perform. i. is supposed to make decisions that will maximize shareholder wealth. such as mutual funds.e. Behaviour of security market participants One market force is major shareholders. There are two factors in market forces to prevent or minimize agency problems. ii. Prepare the cash flow statement of the company using the data provided below and analyze its cash flow from the aspect of operation. life insurance companies. operations. i. and financing. The constant threat of takeover tends to motivate management to act in the best interest of the firm’s owners by attempting to max imize share price. increasing paid up capital does not resolve the underlying problem facing by the company but only to show the shareholder’s commitment in getting the business better position. Hostile takeovers Another market force is the threat of takeover by another firm that believes that it can enhance the firm’s value by restructuring its management. it is in the manager's own best interest may differ from the principal's best interests which is to maximize his own wealth. The manager. particularly large institutional investors. investment and financing activities. Page | 5 . When necessary they exercise their voting rights as stockholders to replace underperforming management. Question 2 (a) Explain agency problem.

Negative aggregate (i.00 141. 2012 Cash Flow from Operating Activities Net profits after taxes Depreciation Increase in account receivable Increase in inventories Increase in account payable Increase in accruals Cash provided by operating activities Cash Flow from Investment Activities Increase in gross fixed assets Cash provided by investment activities Cash Flow from Financing Activities Increase in note payable Increase in long term debt Dividends paid Cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of year Cash and cash equivalents at the end of the year Cash flow analysis The statement of cash flows reveals how a company spends its money (cash outflows) and where the money comes from (cash inflows).00) (534.00 365.00 (4.00) (583. Page | 6 .Answer ESME Bhd Statement of Cash Flows (RM’000) For the Year Ended December 31. In this section of the cash flow statement.00) 232.e.00 230. ESME Company (ESME) recorded positive cash inflow of RM165.00 165. i) Cash flow from operating activities 861.operating assets and liabilities in the balance sheet's current position.00) 300. ii) investing and iii) financing activities of the business.e. i) operations. net income (income statement) is adjusted for non-cash charges and the increases and decreases to working capital items . application of cash) of RM926.000 from operating activities despite an increased in account receivable and inventories which reflected an increase in net working capital requirement.00 This is the key source of a company's cash generation.00 (716.00) 365.00) 342.00 338.000 indicates an increase in amount of net working capital needed by ESME in the financial year.00 (534.00 (300. It is divided into 3 sections i.

businesses and investment securities. such as capital expenditures for plant. Here again. It is also known to have a positive influence on the share price of the company. Page | 7 . The issuance of stock is much less frequent. property and equipment. the most important item in this category is capital expenditures. The presence of an active group of independent directors on the board contributes a great deal towards ensuring confidence in the market. accountability and responsibility towards the stakeholders and commitment to conducting business in an ethical manner. ESME generated positive cash flow from financing activities reflected by activity of sourcing additional fund through issuance of note payable and obtained long term debt. particularly income investors. Corporate governance have a pivotal roles in maximizing shareholder’s wealth in which could be achieved as follows:i) Good corporate governance is known to be one of the criteria that investors are increasingly depending on when deciding on which companies to invest in. Answer Corporate governance refers to the set of systems. It is based on principles such as conducting the business with all integrity and fairness.ii) Cash flow from investing activities This provides information about cash flow implications on non day-to-day strategic decisions.000 from investing activities suggested that ESME might acquired additional fixed assets in 2012. Its cash. there is a level of confidence that is associated with a company that is known to have good corporate governance. Negative cash flow of RM534.000 from investing activity. Cash dividend was paid during financial year 2012 but this amount relatively low as compared to retained earning recorded by ESME. Companies continuously borrow and repay debt. For investors. making all the necessary disclosures and decisions. complying with all the laws of the land. for investors. Inflows come from the sale of assets. a company's physical assets to support its efficient operation and competitiveness. Investing transactions generate cash outflows. iii) Cash flow from financing activities Cash Flow from financing debt and equity transactions dominate this category. that is used to pay dividends to shareholders. business acquisitions and the purchase of investment securities. principles and processes by which a company is governed. the most important item is cash dividends paid. not profits. and additions to. Additional long term debt is consistent with negative cash flow of RM534. Fundamentally. It's generally assumed that this use of cash is a prime necessity for ensuring the proper maintenance of. it suggested that ESME obtained the long term financing to partly financed for acquiring of additional fixed assets. being transparent with regard to all transactions. They provide the guidelines as to how the company can be directed or controlled such that it can fulfil its goals and objectives in a manner that adds to the value of the company and is also beneficial for shareholder in the long term. Question 3 (a) Discuss corporate governance and its role in maximizing shareholders’ wealth.

ii) Having a clean image on the corporate governance front could also make it easier for companies to source capital at more reasonable costs. It benefited shareholder in a way that less dependency on shareholder’s fund on further investment and expansion. weeding out and eliminating problems with extreme prejudice and this will protect shareholders to their best interest as well as their wealth In order to rebuild the trust of the individual shareholders. iii) Well-executed corporate governance should be similar to a police department’s internal affairs unit. Page | 8 . employees and the public at large. a company must focus less on maximizing shareholder value in the short-term and more on optimizing shareholder value through building strong relationships with all the stakeholders.