Case Name: Bigger Isn’t Always Better!

Submitted to:

Sir Rodrigo D. Casiano Jr. MBA, US CMA, CPA, CIA, CRMA, CLSSYB

Facilitator, FINMA1_B

USLS

Submitted by:

John Lester Cartel

John Arsenio De Tomas

Philip Anthony Maquiran

Dhannalee Pabalinas

Zg Zern Ramoran

Dnand Fran Tolentino

Brief Background

Andre appears to be experiencing difficulties with the future expansion of Quickfix Auto

Parts. Although the company’s development prospects are positive, it has spent much of its own

money expanding the firm and must now take on additional debt to do so. While Quickfix’s sales

have been high, its profits have been declining. Andre hasn’t seen the kind of results he needs, to

persuade his suppliers and bank that Quickfix is a worthwhile investment. Andre may have a strong

understanding of the competitive automotive service industry, but he lacks experience in finance

and accounting. Andre finds it difficult to determine the course of his problems, which is why he

employs Juan, a MBA student. With good planning and Juan’s financial analysis aid, he can

discover the underlying reason for Quickfix's problems and take the required steps to better their

situation so that they may develop their business.

Statement of the Problem

This study concerns the setting about the causes of the Quickfix Auto Parts financial

situation, as well as how to resolve the identified financial issues utilizing the systematic and

detailed financial analysis.

Specifically it aims to answer the following:

a). Why were the net income figures, negative for the past two years?

b). Why was the Earnings per Share (EPS) negative for the past two years?

c). How can the company stabilize the situation without the awareness of their suppliers?

d). How would Andre generate funds for the future growth of the company?
Areas of Consideration

Andre’s Company Might Be Shut Out by Suppliers and Creditors

Suppliers might hesitate to continue business relations with the company if they found out

about its current financial situation. It would be detrimental for the company if it will lose its

suppliers, especially that Andre is planning to raise bigger funds for future growth. The company

must double its efforts in improving its financial status in order to keep supplier credit time or else

the business may suffer a huge blow in the long run. Aside from its suppliers, reporting the current

financial condition of the firm might leave a bad taste to creditors and become a major turn-off for

potential investors.

Accounting Ethics and Integrity Standards

Since the company is in dire need of external sources of funds, there is a high chance that

Andre will resort to fraud and manipulation of figures in order to cover the declining performance

of the business. As the owner of the company who has established connections with a lot of dealers

and suppliers, he has the duty to uphold the virtues of integrity and transparency if he wants to

become credible and nurture business relations with outside parties. It would make things worse if

creditors and suppliers found out that Andre used underhanded tricks to acquire the necessary

financing for the business.

Lack of Financial Management in the Business Organization

The firm clearly lacks a solid foundation in financial management as evidenced by Andre’s

limited knowledge of finance and accounting and the absence of a professional

accountant/financial manager in the company. Due to this factor, the company cannot determine

the causes of the decline in the business performance. As a result, the owner had to resort to hiring

an intern in order to sort things out. The absence of financial management in the business caused
the gradual downfall of its financial figures to become unnoticed. Hence, by the time that the

company realized them, it was already too late because it is currently in a situation where it has to

report its financial statements to suppliers and creditors in order to have access to credits.

Unable to Pay the Current Debts of the Business

There is a risk that the firm would not be able to pay the debts to their creditors which can

result in bankruptcy. There is an issue in the liquidity of the firm since their cash decreases every

year while their current liabilities increase and there is also a risk that the total amount of accounts

receivable would not be collected. The firm’s current cash is insufficient to pay its current

liabilities which would hinder the firm’s ability to operate as it would be harder to pay its debts.

The expansion plans would not also help the firm since there is an insufficiency in cash.

Considering also that the firm incurred a net loss, this indicates that they are losing money rather

than earning.

The Firm’s Declining Profit

The financial status of the firm is not performing well based on the data as it had a net loss

for the last two years. The firm also had negative and zero earnings per share which obviously

means that it is losing money. Despite having a huge amount of sales each year, the cost and

expenses also go high and there is still a decline in profit. It is important to consider that the sales

do not cover up or counteract the costs and expenses of the firm.

Alternative Courses of Action

1. The firm may start to seek out a new loan. Banks may not lend the company additional

funds. If so, then it would likely be for a very unfavourable interest rate. However, seeking

out a new loan will improve the company's cash situation, but it does not increase the

profitability because then it will need more interest payments.

2. Improve Inventory management. Since the company's inventory is growing, it should start

to sell its inventory and adopt the FIFO method. It is selling the older inventories and

keeping newer stacks. Adapting new inventory management will help increase the cash

situation, which will offer immediate profitability.

3. Collect Receivables. Collecting receivables will find a means to convert these receivables

to cash. As we all know, receivables are unrealized gains unless these will be converted to

cash. Moreover, the company should instil a timely collection of receivables so that cash

liquidity will be.

4. Delay payment of payable. Delaying payment of payables will allow the company to have

more cash liquidity but in the sense that these payments are paid to suppliers on time.

Extending short-term debts to long-term debt might be an option. However, this will

contradict the idea of profitability for the company.

5. Control the firm's cost, given that the company's continuing growth of cost over five years

and hoarding of inventories. The firm's cash can move freely, addressing that inventories

need not be replenished yearly for the sake of new inventories but with the demand for a

new stack of inventories.

 6. We are downsizing the firm. The firm needs to downsize because of the overpopulated

inventories. Although the business increases in sales, profits are still negative. That is why

reducing inventory might be a viable option in restoring profit.

Recommendation

This study revealed that Andre's firm had increased significantly over the years, and by the end

of year three, he had more than increased the size of his shop. However, Andre had spent the

majority of his available funds trying to expand the business and was well aware that potential

development would have to be funded by outside sources. What worried Andre was that the store's

net income had been negative for the past two years, and his cash flow situation had deteriorated

significantly. Thus the following recommendations are hereby presented.

1. Reduce operating costs- Andre should conduct an audit of his current operating expenses

to see if any can be lessened. Evaluate that he is not overpaying for the goods and services

he requires to run his business. He should shop around to see if he can get a good offer

from another vendor.

2. Payment terms should be negotiated- Andre should discuss payment terms with the

vendors. Certain distributors may be willing to give you more time to pay your purchase

orders. Alternatively, ask the vendor if you can set up a payment plan and divide the

balance owed into lower amounts.

3. Increase sales- Increasing sales will also improve cash flow. Andre can sell out-of-date

inventory at a reduced price. Hold sales and occasions that inspire customers to buy in

bulk. He can also grow his company's operations. For instance, Andre could expand his

product line or start selling online.

 Guide Questions

● How does Quickfix’s average compound growth rate in sales compare with its earnings

growth rate over the past five years?

In order to analyze the average compound growth rate compared to the earnings

growth rate over the years, we need first to find out each rate using the following formulas:

Average Compound Growth Rate

1
𝐸𝑛𝑑𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒 ( ) 𝐶𝐴𝐺𝑅
𝐶𝐴𝑅𝐺 = (𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒) 𝑛 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 −1 Average CAGR = 𝑁 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠

1
1,013,376 ( ) 0.1105
= ( 600,000 ) 5 −1 = 5

= 0.1105 = 0.0221 or 2.21%

Earnings Growth Rate

1
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 (𝑛 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠) 𝑠𝑢𝑚 𝑜𝑓 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑔𝑟𝑜𝑤𝑡ℎ
Growth Rate = (𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠) −1 Ave. Earnings Growth = ( 5
)

−100
= (−102 − 16,634) =( )
5

= -20%

As we have presented here, we can now analyze how Quickfix did over the five

years of operation, comparing the compound growth average with earnings growth rate.

Furthermore, we should make sure that both sales and earnings growth are increasing.

However, the earnings growth should increase much faster than the sales. If the result

shows otherwise, the firm should cut down or reduce the cost to provide more income.
● Which statements should Juan refer to and which ones should he construct so as to

develop a fair assessment of the firm’s financial condition? Explain why?

In order to develop an assessment on the firm’s financial condition, Juan should

refer to both income statement and balance sheet over the 3-5 years period. For the reason

that it completely illustrates the firm’s performance and gives a snapshot of the company's

assets and liabilities at a specific point in time which is appropriate for evaluating the

business’ condition. In addition, he should also prepare a cash flow statement, common

size income statement and common size balance sheet to have more determining factors in

making decisions.

● What calculations should Juan do in order to get a good grasp of what is going on with

Quickfix’s performance?

Financial ratio analysis can be extremely useful in contrasting patterns from past

execution or from other comparable firms. It simplifies complex accounting statements and

financial data into simple ratios of operating efficiency, financial efficiency, solvency,

long-term positions etc. Ratio analysis helps identify problem areas and bring the attention

of the management to such areas. With that being referenced, Juan should calculate the

liquidity, leverage, profitability, average and coverage ratios within at least a three-year

period. Furthermore, a DuPont analysis could help Juan in determining the factors which

had affected the profitability and the liquidity problems of the firm.
● Juan knows that he should compare Quickfix’s condition with an appropriate

benchmark. How should he go about obtaining the necessary comparison data?

Juan can compare Quickfix’s financial data throughout the years with similar firms

from the same industry with similar products, market, and operations. He can check and

refer to the financial ratios of businesses in the automobile servicing industry. This can

help in determining the strengths and weaknesses of Quickfix Auto Parts compared to the

industry ratios of other firms. This can give Juan an idea on what aspects that need

improvements and areas on where to focus on. Aside from comparing with other firms in

the same industry, Juan can compare Quickfix’s own data from previous and current years

to know and analyze the trends in their changes and ratios. Trend Analysis can be useful in

estimating the chance of improvement in the firm’s financial condition. Juan can get a

grasp on the reasons on why the firm has a poor financial condition.

● 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.

A common size analysis of the financial statements and a DuPont analysis of the

firm’s Return on Assets and Return on Equity may be done by Juan in order to assess the

firm’s condition. Analyzing the common size income statement, it can be observed that

there has been an increase in the Cost of Goods Sold since the year 2000. The firm’s

operating expenses rose up from 9.5% to 10.4% of net sales while the selling expenses,

administrative expenses, and interest expenses slightly went down. Hence, the company

must cut down expenses if possible in order to reduce business costs.

 The common size balance sheet revealed that there is a significant increase in both

inventory and accounts receivable, while the amount of cash declined. It also showed that

the capital became more leveraged due to the firm’s acquisition of large short-term and

long-term debts relative to its assets. Meanwhile, a DuPont analysis showed that the

declining profitability of the firm resulted in a negative ROA and a consistent declined in

its ROE since 2001. Nonetheless, the firm’s total asset turnover has improved since 2002.

● 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?

Liquidity Ratio

2000 2001 2002 2003 2004

Net Working Capital

350,000.00 430,493.00 428,619.00 453,184.00 492,082.00

Current Ratio 6.38 3.68 3.56 3.62 3.79

Quick Ratio (Acid Test) 2.54 2.00 0.57 0.61 0.62

Cash Ratio 2.38 1.92 0.45 0.17 0.10

 Activity Ratio (Asset Utilization)

2000 2001 2002 2003 2004

Inventory Turnover
1.92 1.99 1.31 1.43 1.54

Days sales in receivables 6.00 6.60 9.23 32.00 32.00

Fixed Assets Turnover 2.67 3.28 1.95 2.50 3.38

Total Assets Turnover 0.94 0.83 0.78 0.89 1.0

Solvency Ratio (long term-solvency)

2000 2001 2002 2003 2004

Debt ratio
47.40% 54.56% 63.69% 64.65% 64.37%

Debt to equity 0.90 1.20 1.75 1.83 1.81

Asset to equity 1.90 2.20 2.75 2.83 2.81

 Profitability ratio

2000 2001 2002 2003 2004

Net Profit Margin

2.77% 3.49% 0.27% -1.88% -0.01%

Gross Profit Margin 20% 18% 16% 15% 15%

ROA 2.60% 2.89% 0.21% -1.68% -0.01%

ROE 4.94% 6.36% 0.59% -4.76% -0.03%

Liquidity: With a current ratio of 3.79, the total liquidity of the company has improved

considerably in the last three years. But most of his existing assets are linked to inventories,

because his quick ratio is just 0.62. The company is also not capable of paying its existing cash

reserves responsibilities and has substantially worsened in the last five years.

Asset Utilization: Since 2000, the company's inventory sales have decreased significantly.

In 2004 there was a little improvement, and it still has enough to do. The turnover ratio for

receivables has also decreased. For a retail company an average 32-day collecting time is rather

high. Although not particularly high, the overall asset turnover in five years is at its greatest level.

Long-term solvency: The debt ratio of Quickfix Auto is 64 percent. Since 2000, its debt

level has grown by about 37%. As the coverage ratios of the company are quite low, the financial

structure of the company might be regarded as fairly risky

Profitability: In the last three years, the company's rates of profitability have fallen

considerably. The company is losing at present.

 Possible Arguments: A loan should be given to Quickfix Company, since their existing assets

are sufficiently fair. The company has more assets in place than existing liabilities.

● If you were the commercial loan officer and were approached by Andre for a short-term

loan of $25,000, what would your decision be? Why?

A loan is a promise from a lending institution that you will receive money and repay the

total borrowed, plus the interest, over a specified period of time. If I were the loan

commissioner, I would reject his proposal due to the inconsistency of the cash flow.

Lenders prefer firms that have a continuous source of revenue and profitability coming in

every month. I would not make the loan based on the firm's poor performance and low cash

flow inputs. Nevertheless, I would advise him that we will take into account the loan if he

can demonstrate progress in inventory management and financial performance in the

coming quarters.

● What recommendations should Juan make for improvement, if any?

The first thing that the firm must do is to halt the expansion of the business until its

cash flow condition becomes stable. The firm should also cut off unnecessary costs if

possible and focus on their receivable and inventory management. Specifically, the

business should improve its management of inventories since its turnover is low and

reinforce credit policies to improve its collection of receivables.

● What kinds of problems do you think Juan would have to cope with when conducting a

comprehensive financial statement analysis of Quickfix Auto Parts? What are the

limitations of financial statement analysis in general?

The problems that Juan would have to cope with are the preparation of cash flow

statement, statement of owner’s equity, and the selection of comparison benchmark. One

of the limitations of financial statement analysis is that it just provides a small glimpse of

the financial status of the business and not its overall performance. Moreover, financial

statements can be easily configured in order to come up with fraudulent financial ratios.

Also, the past performance of the business, whether good or bad, will have nothing to do

with the future transactions of customers. Lastly, the healthiness of a company does not

solely depend on the figures found in the financial statements since the nature and size of

the business must be taken into account.