CHAPTER 5 MINI CASE: SCANDI HOME FURNISHINGS, INC.

 
Kaj Rasmussen founded Scandi Home Furnishings as a corporation during mid-2007.
Sales during the first full year (2008) of operation reached $1.3 million. Sales increased
by 15 percent in 2009 and another 20 percent in 2010. However, However, after
increasing in 2009 over 2008, profits fell sharply in 2010, causing Kaj to wonder what was
happening to his “pride and joy” business venture. After all, Kaj has continued to work as
close as possible to a 24/7 pace beginning with the startup of Scandi and through the first
three full years of operation.

Scandi Home Furnishings, located in eastern North Carolina, designs, manufactures, and
sells to home furnishings retailers Scandinavian-designed furniture and accessories. The
modern Scandinavian design has a streamlined and uncluttered look. While this furniture
style is primarily associated with Denmark, both Norway and Sweden designers have
contributed to the allure of Scandinavian home furnishings. Some say that the inspiration
for the Scandinavian design can be traced to the “elegant curves” of art nouveau from
which designers were able to produce aesthetically pleasing, structurally strong modern
furniture. Danish, and the home furnishings produced by the other Scandinavian
countries—Sweden, Norway, and Finland, are made using wood (primarily oak, maple, and
ash), aluminum, steel, and high-grade plastics.

Kaj grew up in Copenhagen, Denmark and received a college degree from a technical
university in Sweden. As is typically in Europe, Kaj began his business career as an
apprentice at a major home furnishings manufacturer in Copenhagen. After “learning the
trade,” he quickly moved into a management position in the firm. However, after a few
years, Kaj realized that what he really wanted to do was to start and operate his own
Scandinavian home furnishings business. At the same time, after traveling throughout
the world including the U.S., he was sure that he wanted to be an entrepreneur in the
United States. Thus, while it was hard to give up the Tivoli Gardens with its many
entertainment and dining activities, as well as the other attractions in Copenhagen, Kaj
moved to the U.S. in early 2007. With $140,000 of his personal assets, and $210,000
from venture investors, he began operations in mid-2007. Kaj, with a 40 percent
ownership interest and industry-related management expertise, was allowed to operate
the venture in a way that he thought was best for Scandi. Four years later, Kaj is sure he
did the right thing.

Following (see 2 of 10) are the three years of income statements and balance sheets for
the Scandi Home Furnishings Corporation. Kaj has felt that in order to maintain a
competitive advantage that he would need to continue to expand sales. After first
concentrating on selling Scandinavian home furnishings in the northeast in 2008 and
2009, he decided to enter the west coast market. An increase in expenses associated
with identifying, contacting, and selling to home furnishings retailers in California, Oregon,
and Washington. Kaj Rasmussen was hoping that you could help him better understand
what has been happening to Scandi Home Furnishings both from operating and financial
standpoints.

1
I HOME FURNISHINGS, INC.

me Furnishings as a corporation during mid-2007.

08) of operation reached $1.3 million. Sales increased
r 20 percent in 2010. However, However, after
fits fell sharply in 2010, causing Kaj to wonder what was
usiness venture. After all, Kaj has continued to work as
eginning with the startup of Scandi and through the first

in eastern North Carolina, designs, manufactures, and

Scandinavian-designed furniture and accessories. The
a streamlined and uncluttered look. While this furniture
Denmark, both Norway and Sweden designers have
navian home furnishings. Some say that the inspiration
e traced to the “elegant curves” of art nouveau from
uce aesthetically pleasing, structurally strong modern
urnishings produced by the other Scandinavian
inland, are made using wood (primarily oak, maple, and
ade plastics.

ark and received a college degree from a technical

ly in Europe, Kaj began his business career as an
hings manufacturer in Copenhagen. After “learning the
anagement position in the firm. However, after a few
ally wanted to do was to start and operate his own
siness. At the same time, after traveling throughout
as sure that he wanted to be an entrepreneur in the
hard to give up the Tivoli Gardens with its many
s, as well as the other attractions in Copenhagen, Kaj
With $140,000 of his personal assets, and $210,000
operations in mid-2007. Kaj, with a 40 percent
lated management expertise, was allowed to operate
ght was best for Scandi. Four years later, Kaj is sure he

ee years of income statements and balance sheets for

oration. Kaj has felt that in order to maintain a
uld need to continue to expand sales. After first
vian home furnishings in the northeast in 2008 and
t coast market. An increase in expenses associated
elling to home furnishings retailers in California, Oregon,
was hoping that you could help him better understand
di Home Furnishings both from operating and financial

2
 Scandi Home Furnishings, Inc.
Comparative Income Statements
2006-2008

2008 % Rev 2009 % Rev 2010 % Rev

Net Sales $ 1,300,000 100.0% $ 1,500,000 100.0% $ 1,800,000 100.0%
Cost of Goods Sold 780,000 60.0% 900,000 60.0% 1,260,000 70.0%
Gross Profit 520,000 40.0% 600,000 40.0% 540,000 30.0%
Marketing 130,000 10.0% 150,000 10.0% 200,000 11.1%
General & Administrative 150,000 11.5% 150,000 10.0% 200,000 11.1%
Depreciation 40,000 3.1% 53,000 3.5% 60,000 3.3%
EBIT 200,000 15.4% 247,000 16.5% 80,000 4.4%
Interest 45,000 3.5% 57,000 3.8% 70,000 3.9%
Earnings Before Taxes 155,000 11.9% 190,000 12.7% 10,000 0.6%
Income Taxes (40%) 62,000 4.8% 76,000 5.1% 4,000 0.2%
Net Income $ 93,000 7.2% $ 114,000 7.6% $ 6,000 0.3%

Scandi Home Furnishings, Inc.

Comparative Income Statements
2006-2008

2008 2009 2010

Assets
Cash $ 50,000 $ 40,000 $ 10,000
Accounts Receivables 200,000 260,000 360,000
Inventories 450,000 500,000 600,000
Total Current Assets 700,000 800,000 970,000
Fixed Assets, Net 300,000 400,000 500,000
Total Assets $ 1,000,000 $ 1,200,000 $ 1,470,000

Liabilities & Equity

Accounts Payable $ 130,000.0 $ 170,000.0 $ 180,000
Accruals 50,000 70,000 80,000
Bank Loan 90,000 90,000 184,000
Total Current Liabilities 270,000 330,000 444,000
Long-Term Debt 300,000 400,000 550,000
Common Stock ($10 par)* 300,000 300,000 300,000
Capital Surplus 50,000 50,000 50,000
Retained Earnings 80,000 120,000 126,000
Total Liabilities & Equity $ 1,000,000 $ 1,200,000 $ 1,470,000

* Note: 3350,000 shares of common stock were issued to Kaj Rasmussen and the venture
investors when Scandi Home Furnishings was incorporated in mid-2007.

2
Chapter 5 Mini Case Question A: Liquidity Ratios

A. Kaj was particularly concerned by the drop in cash from $50,000 in 2008 to $10,000 in 2010.
Calculate the average current ratio, the quick ratio, and the networking capital (NWC) to total assets
ratio for 2008-2009 and 2009-2010. What has happened to Scandi’s liquidity position?
 
Note: Ratio calculations involving asset items on the balance sheet are averages of the prior and
current years. For example, the ratios for 2009 use average balance sheet account amounts for 2008
and 2009. Likewise, ratios for 2010 use average balance sheet account amounts for 2009 and 2010.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Summary for Liquidity Ratios (see below for the calculations):

2009 2010 Change*
Current Ratio 2.50 2.29 Worse
Quick Ratio 0.92 0.87 Worse
NWC-Total-Asset Ratio 0.41 0.37 Worse
* Note that "Change" should show one of the following options: "Better" or "Worse"

Narrative Comment: The company looks like they had a worse year in 2010. There debt is increasing
more so then their assests.

Calculations for 2008-2009:

Current Ratio = Avg Current Assets / Avg Current Liabilities

Current Ratio = $ 750,000 / $ 300,000
Current Ratio = 2.50

Quick Ratio = Avg CA-Avg Inventories / Avg Current Liabilities

Quick Ratio = $ 275,000 / $ 300,000
Quick Ratio = 0.92

NWC-to-Total-Asset Ratio = Avg CA-Avg CL / Avg Total Assets

NWC-to-Total-Asset Ratio = $ 450,000 / $ 1,100,000
NWC-to-Total-Asset Ratio = 0.41

C. Calculatefor
Calculations leverage ratios (pp. 187-189).
2009-2010:
.
Current Ratio = Avg Current Assets / Avg Current Liabilities
Current Ratio = 800000+970000/2=88500 / 330000+444000/2=387000
Current Ratio = 2.29

Quick Ratio = Avg CA-Avg Inventories / Avg Current Liabilities

Quick Ratio = 885000-550000 / $ 387,000
Quick Ratio = 0.87

NWC-to-Total-Asset Ratio = Avg CA-Avg CL / Avg Total Assets

NWC-to-Total-Asset Ratio = $ 498,000 / $ 1,335,000
NWC-to-Total-Asset Ratio = 0.37

3
Chapter 5 Mini Case Question B: Cash Conversion Cycle

B. An analysis
Using the two years
of the of
cash
financial
conversion
statement
cycle data
should
foralso
the Munich
help KajExport
understand
Corporation
what has
shown
beeninhappening
Problem 3,tomake
the operations
the
following
of Scandi.calculations
Prepare an analysis
for 2008.of the average conversion periods for the three components of the cash conversion cycle
for 2008-2009 and 2009-2010. In a brief narrative paragraph, explain was has happened in terms of each component of
the cycle.
 
Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Summary for Cash Conversion Cycle in Days (see below for the calculations)
2009 in Days 2010 in Days Change*
Inventory-to-Sale 192.64 159.30 -33.34
Sale-to-Cash 55.97 62.90 6.93
Less Purchase-to-Payment (85.17) (72.42) -12.75
Cash Conversion Cycle (Total Days) 163.44 149.78 -13.66

* Note that "Change" should show one of the following options: "Better" or "Worse"

Narrative explanation of change:

All of the changes are to shorter periods except for in sale to cash.

Calculations for Average Conversion Periods for 2009

Inventory-to-Sale Conversion Period = Average Inventories / Cost of Goods Sold/365

Inventory-to-Sale Conversion Period = $ 475,000 / $ 2,465.75
Inventory-to-Sale Conversion Period = 192.64 [days]

Sales to Cash Conversion Period = Average Receivables / Net Sales/365

Sales to Cash Conversion Period = $ 230,000 / $ 4,109.59
Sales to Cash Conversion Period = 55.97 [days]

Average Payables +
Average Accrued
Purchase-to-Payment Conversion Period = Liablities / Cost of Goods Sold/365
Purchase-to-Payment Conversion Period = $ 210,000 / $ 2,465.75
Purchase-to-Payment Conversion Period = 85.17 [days]

Calculations for Average Conversion Periods for 2010

Inventory-to-Sale Conversion Period = Average Inventories / Cost of Goods Sold/365

Inventory-to-Sale Conversion Period = $ 550,000 / $ 3,452.10
Inventory-to-Sale Conversion Period = 159.30 [days]

Sales to Cash Conversion Period = Average Receivables / Net Sales/365

Sales to Cash Conversion Period = $ 310,000 / $ 4,931.50
Sales to Cash Conversion Period = 62.90 [days]

Average Payables +
Average Accrued
Purchase-to-Payment Conversion Period = Liablities / Cost of Goods Sold/365
Purchase-to-Payment Conversion Period = $ 250,000 / $ 3,452.10
Purchase-to-Payment Conversion Period = 72.42 [days]

4
Chapter 5 Mini Case Question C: Cash Build Versus Cash Burn

C. Kaj should be interested in knowing whether Scandi has been building or burning cash. Compare the cash build, cash burn,
and the net cash build/burn positions for 2009 and 2010. In a brief narrative paragraph, describe what, if any, changes have
occurred?.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Cash Build (Source of Cash) = 2009 2010

Net Sales $ 1,500,000 $ 1,800,000
Less Increase in Receivables (60,000) 100,000
Cash Build = $ 1,440,000 $ 1,700,000

Cash Burn (Use of Cash) =

Operating Expenses $ 1,200,000 $ 1,660,000 [Cost of Goods Sold+Mktg+Gen & Admin
Interest 57,000 70,000
Income Taxes 76,000 4,000
Total Cash Burn from Income Statement 1,333,000 1,734,000
Change in Inventories 50,000 100,000 Increase/(Decrease)
Change in Payables (40,000) (10,000) (Increase)/Decrease
Change in Accrued Liabilities (20,000) (10,000) (Increase)/Decrease
Change in Gross Fixed Assets 100,000 100,000 Increase/(Decrease)
Add Back Depreciation Expense 53,000 60,000 [Non Cash Expense on Inc Statement]
Cash Burn = $ 1,476,000 $ 1,974,000

Notes:

1. The increase in receivables represents a use of cash since credit is extended and no cash is collected.
2. The increases in inventories and gross fixed assets reflect a use of cash for inventory purchases and capital
expenditures.
3. The increases in payables and accrued liabilities represent a source of cash since purchases were made on account
(without cash).

2009 2010
Net Cash Burn =
Cash Burn $ 1,476,000 $ 1,974,000
Less Cash Build 1,440,000 1,700,000
Net Cash Build/(Burn) = $ (36,000) $ (274,000)

Narrative explanation of change:

the net cash burn from 2009 to 2010 has increased a substantial amount.

B. If your answer in Part A resulted in a net cash burn position, calculate the net cash burn monthly rate and indicate the
number of months remaining “until out of cash.” If your answer in Part A resulted in a net cash build position, calculate the net
cash build monthly rate and indicate the expected cash balance at the end of 2009.

2009 2010
Monthly Cash Burn = $ 3,000.00 $ 22,833.30
Cash Balance at End of Period = $ 40,000.00 $ 10,000.00
Months remaining = 13.33 0.44 "until out of cash"

5
 Chapter 5 Mini Case Question D: Financial Leverage

D. Creditors, as well as management, are also concerned about the ability of the venture to meet its debt
obligations as they come due, the proportion of current liabilities to total debt, the availability of assets to
meet debt obligations in the event of financial distress, and the relative size of equity investments to debt
levels. Calculate average ratios in each of these areas for the 2008-2009 and 2009-2010 periods. Interpret
your results and explain what has happened to Scandi.

Summary of Calculations (see below for calculations):

Financial Leverage: 2009 2010 Change*
Total-Debt-to-Total-Assets 0.59 0.65 higher
Equity Multiplier 2.44 2.82 HIgher
Debt-to-Equity Ratio 1.44 1.82 higher
Current Liability-to-Total-Debt 0.46 0.45 lower
Interest Coverage 5.26 2.00 lower

*Note that change is indicated by "Higher" or "Lower"

His debt has become larger and his assets have not raised. Similar things are happening in all of
these ratios. However in the past year his current liability to total debt is smaller then the previous
year.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Calculations for leverage ratios for 2009:

Total Debt to Total Assets Ratio = Avg Total Debt / Avg Total Assets
Total Debt to Total Assets Ratio = $ 650,000 / $ 1,100,000
Total Debt to Total Assets Ratio = 0.59

Equity Multiplier = Avg Total Assets / Avg Owner's Equity

Equity Multiplier = $ 1,100,000 / $ 450,000
Equity Multiplier = 2.44

Debt to Equity Ratio = Avg Total Debt / Avg Owner's Equity

Debt to Equity Ratio = $ 650,000 / $ 450,000
Debt to Equity Ratio = 1.44

Current Liability-to-Total Debt = Avg Current Liabilities / Avg Total Debt

Current Liability-to-Total Debt = $ 300,000 / $ 650,000
Current Liability-to-Total Debt = 0.46

Interest Coverage Ratio = EBITDA / Interest

Interest Coverage Ratio = $ 300,000 / $ 57,000
Interest Coverage Ratio = 5.26

Calculations for leverage ratios for 2010:

Total Debt to Total Assets Ratio = Avg Total Debt / Avg Total Assets
Total Debt to Total Assets Ratio = $ 862,000 / $ 1,335,000
Total Debt to Total Assets Ratio = 0.65

Equity Multiplier = Avg Total Assets / Avg Owner's Equity

Equity Multiplier = $ 1,335,000 / $ 473,000
Equity Multiplier = 2.82

Debt to Equity Ratio = Avg Total Debt / Avg Owner's Equity

Debt to Equity Ratio = $ 862,000 / $ 473,000
Debt to Equity Ratio = 1.82

D. Calculate
Current profitability and Debt
Liability-to-Total Efficiency ratios
= Avg(pp. 191-195).
Current Liabilities / Avg Total Debt
.
Current Liability-to-Total Debt = $ 387,000 / $ 862,000
Current Liability-to-Total Debt = 0.45

Interest Coverage Ratio = EBITDA / Interest

Interest Coverage Ratio = $ 140,000 / $ 70,000
Interest Coverage Ratio = 2.00

6
Chapter 5 Mini Case Question E: Profitability Ratios

E. Of importance to Kaj and the venture investors is the efficiency of the operations of the venture. Several
profit margin ratios relating to the income statement are available to help analyze Scandi’s performance.
Calculate average profit margin ratios for 2008-2009 and 2009-2010 and describe what is happening to the
profitability of Scandi Home Furnishings.

Summary of Calculations (see below for calculations):

Profitability Ratios: 2009 2010 Change*
Gross Profit Margin 40.0% 30.0% lower
Operating Profit Margin 16.5% 4.5% lower
Net Profit Margin 7.6% 0.0% lower
NOPAT Margin 9.9% 2.7% lower

*Note that change is indicated by "Higher" or "Lower"

Narrative explanation:
His profitability is lowering and it shows in all the profitability ratios.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Calculation of Profitability Ratios for 2009

Gross Profit Margin = Gross Profit / Net Sales

Gross Profit Margin = $ 600,000 / $ 1,500,000
Gross Profit Margin = 40.0%

Operating Profit Margin = EBIT / Net Sales

Operating Profit Margin = $ 247,000 / $ 1,500,000
Operating Profit Margin = 16.5%

Net Profit Margin = Net Income / Net Sales

Net Profit Margin = $ 114,000 / $ 1,500,000
Net Profit Margin = 7.6%

NOPAT Margin = [(EBIT)(1-tax rate) / Net Sales

NOPAT Margin = $ 148,200 / $ 1,500,000
NOPAT Margin = 9.9%

Calculation of Profitibility Ratios for 2010

Gross Profit Margin = Gross Profit / Net Sales

Gross Profit Margin = $ 540,000 / $ 1,800,000
Gross Profit Margin = 30.0%

Operating Profit Margin = EBIT / Net Sales

Operating Profit Margin = $ 80,000 / $ 1,800,000
Operating Profit Margin = 4.5%

Net Profit Margin = Net Income / Net Sales

Net Profit Margin = $ 6,000 / $ 1,800,000
Net Profit Margin = 0.0%

NOPAT Margin = [(EBIT)(1-tax rate) / Net Sales

NOPAT Margin = 80000(.60) / $ 1,800,000
NOPAT Margin = 2.7%

7
Chapter 5 Mini Case Question F: Efficiency and Return Ratios

F. Kaj and the venture investors are also interested in how efficiently Scandi is able to convert their equity
investment, as well as the venture’s total assets, into sales. Calculate several ratios that combine data from
the income statements and balance sheets and compare what has happened between the 2008-2009 and
2009-2010 periods.

Summary of Calculations (see below for calculations):

Efficiency & Return Ratios: 2009 2010 Change*
Sales-to-Total-Assets 1.36 1.35 lower
Operating Return on Assets 22.45% 6.00% lower
Return on Assets (ROA) 10.36% 0.45% lower
Return on Equity (ROE) 25.33% 1.30% lower

*Note that change is indicated by "Higher" or "Lower" or "Same"

Narrative explanation: This set of ratios shows the same trend as all the others. That the
company is struggling and needs some internal reform.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Calculation of Efficienty and Return Ratios for 2009

Sales-to-Total-Assets Ratio = Sales / Avg Total Assets

Sales-to-Total-Assets Ratio = $ 1,500,000 / $ 1,100,000
Sales-to-Total-Assets Ratio = 1.36

Operating Return on Total Assets = EBIT / Avg Total Assets

Operating Return on Total Assets = $ 247,000 / $ 1,100,000
Operating Return on Total Assets = 22.45%

Return on Assets (ROA) = Net Profit / Avg Total Assets

Return on Assets (ROA) = $ 114,000 / $ 1,100,000
Return on Assets (ROA) = 10.36%

Return on Equity (ROE) = Net Profit / Avg Owners' Equity

Return on Equity (ROE) = $ 114,000 / $ 450,000
Return on Equity (ROE) = 25.33%

Calculation of Efficienty and Return Ratios for 2010

Sales-to-Total-Assets Ratio = Sales / Avg Total Assets

Sales-to-Total-Assets Ratio = $ 1,800,000 / $ 1,335,000
Sales-to-Total-Assets Ratio = 1.35

Operating Return on Total Assets = EBIT / Avg Total Assets

Operating Return on Total Assets = $ 80,000 / $ 1,335,000
Operating Return on Total Assets = 6.00%

Return on Assets (ROA) = Net Profit / Avg Total Assets

Return on Assets (ROA) = $ 6,000 / $ 1,335,000
Return on Assets (ROA) = 0.45%

Return on Equity (ROE) = Net Profit / Avg Owners' Equity

Return on Equity (ROE) = $ 6,000 / (300000+50000+120000)+300000+50000+126000/2
Return on Equity (ROE) = 1.30%

8
Chapter 5 Mini Case Question G: ROA Model and ROE Model

G. A ROA model consisting of the product of two ratios provides an overview of a venture’s efficiency and
profitability at the same time. A ROE model consists of the product of three ratios and simultaneously shows
an overview a venture’s efficiency, profitability, and leverage performance. Calculate ROA and ROE models
for the 2008-2009 and 2009-2010 periods. Provide an interpretation of your findings.

Summary of Calculations (see below for calculations):

Efficiency & Return Ratios: 2009 2010
ROA Model 10.26% 0.05%
ROE Model 25.03% 0.11%

Narrative explanation:
The models indicate that 2010 is less sucessfull than 2009.

Note: Using the examples of calculations for 2009, you should complete the ratios for 2010.

Calculations of ROA Model and ROE Model for 2009

ROA Model = Net Profit Margin X Sales-to-Total Assets

ROA Model = 7.6% X 1.35
ROA Model = 10.26%

Return on Equity = Net Profit Margin X Asset Turnover* X Equity Multiplier

Return on Equity = 7.6% X 1.35 X 2.44
Return on Equity = 25.03%

*Note the Asset Turnover = Sales-to-Total-Assets Ratio

9
Chapter 5 Mini Case Question H: Industry Comparables Analysis

Kaj has been able to obtain some industry ratio data from the home furnishings industry trade
association of which he is a member. The industry association collects proprietary financial informa
from members of the association, compiles averages to protect the proprietary nature of the
information, and provides averages for use by individual trade association members.

Over the 2008-2009 and 2009-2010 periods, the inventory-to-sale conversion period has averaged
days, while the sale-to-cash conversion period (days of sales outstanding) for the industry has avera
60 days.

In addition, trade association data for the home furnishings industry shows an average net profit m
of 6.5 percent, a sales-to-assets ratio of 1.3 times, and a total-debt-to-total-assets ratio of 55 perce
over the 2008-2009 and 2009-2010 time periods.

How did Scandi’s operations in terms of these ratios compare with these industry averages?
 

Scandi Home Furnishings Industry Comparable Analysis

2008
Industry
2008 Average
Conversion Period Ratios
Inventory-to-sale conversion period 192.64 200 days
Sale-to-cash Conversion period 55.97 60 days

Profitability Ratio
Net profit margin 0.03% 6.5%

Leverage Ratio
Total debt to total assets 65.0% 55.0%

Efficiency and Return Ratio

Sales to total assets 1.35 1.3

*Note that change is indicated by "Higher" or "Lower" or "Same"

10
io data from the home furnishings industry trade
ustry association collects proprietary financial information
verages to protect the proprietary nature of the
y individual trade association members.

the inventory-to-sale conversion period has averaged 200

d (days of sales outstanding) for the industry has average

me furnishings industry shows an average net profit margin

mes, and a total-debt-to-total-assets ratio of 55 percent
ods.

e ratios compare with these industry averages?

shings Industry Comparable Analysis

Comparison with
Industry*

lower
lower

lower

higher

higher

10