Financial Management

Case study: Assessing a Firm’s Future Financial Health

1. Work through the programmed text on financial ratios. Answer each of the questions, and be
sure you understand the calculation and the meaning of each of the ratios.

Profitability Ratios
The information necessary to determine a company’s profit as a percentage of sales can be found in the company’s
income statement.
1. Magnetronics’ profit as a percentage of sales for 1999 was $1,307 divided by $48,769 or 2.68%.
(Profit as a percentage of sales: (1,307 ÷ 48,769) = 2.68%)
2. This represented a decrease from 3.60% in 1995 (Profit Margin = (1,171 ÷ 32,513) = 3.60%)
3. COGS/ Net Sales (1995) = (19,183 ÷ 32,513) x 100 = 59.00%
COGS/ Net Sales (1999) = (29,700 ÷ 48,769) x 100 = 60.90%
Increasing by 1.90%
Op. Expense/ Net Sales (1995) = (10,758 ÷ 32,513)x 100 = 33.09%
Op. Expense/ Net Sales (1999) = (16,541 ÷ 48,779)x 100 = 33.92%
Increasing by 0.83%
Therefor the only favorable factor was the decrease in the income taxes.
4. Magnetronics had a total of $15,249 of capital at year-end 1999
and earned before interest but after taxes (EBIAT) $1,824 during 1999.
In 1999 this figure was 11.96% which presented a decrease from 14.67% earned in 1995.
(ROIC (1999) = (1,824 ÷ 15,249)x 100= 11.96%)
(ROIC (1995) = (1,532 ÷ 10,442)x 100= 14.67%)
5. Magnetronics had $12,193 of owner’s equity and earned $1,307 after taxes in 1999. In return on equity was
10.72%, a deterioration from the 15.22% earned in 1995.
(ROE (1999) = 1,307 ÷ 12,193= 0.1072)
(ROE (1995) = 1,171 ÷ 7,692= 0.1522)

Activity Ratios
1. Total asset turnover for Magnetronics in 1999 can be calculated by dividing $48,769 into $22,780. The turnover
deteriorated from 2.17 times in 1995 to 2.14 times in 1999.
TA Turnover (1995) = 32,513 ÷ 14,949 = 2.17 times
TA Turnover (1999) = 48,769 ÷ 22,780 = 2.14 times
2. Magnetronics had $7,380 invested in account receivables at year-end 1999. Its average sales per day were $133.614
during 1999 and its average collection period was 55.23 days. This represented an improvement from the average
collection period of 58.68 days in 1995.
Avg. Sales per day (1995) = 32,513 ÷ 365 = 89.08
Avg. Sales per day (1999) = 48,769 ÷ 365 = 133.61
Avg. Collection Period (1995) = 5,227 ÷ 89.08 = 58.68
Avg. Collection Period (1999) = 7,380 ÷ 133.61 = 55.23
3. Magnetronics apparently needed $8,220 of inventory at year-end 1999 to support its operations during 1999. Its
activity during 1999 as measured by the cost of goods sold was $29,700. It therefore had an inventory turnover of 3.61
times. This represented a deterioration from 4.76 times in 1995.
Inventory Turnover (1999) = 29,700 ÷ 8,220 = 3.61
Inventory Turnover (1995) = 19,183 ÷ 4,032 = 4.76
4. Magnetronics had net fixed assets of $5,160 and sales of $48,769 in 1999. Its fixed asset turnover ratio in 1999 was
9.45 times, an improvement from 7.98 times in 1995.
Fixed Asset Turnover (1999) = 48,769 ÷ 5,160 = 9.45
Fixed Asset Turnover (1995) = 32, 513 ÷ 4,073 = 7.98
5. So far, we have discussed three measures of profitability: They are (a)net profit margin, (b)ROIC, and (c)ROE. We have
also discussed four activity ratios which measure the effectiveness of the company in utilizing its assets: They are
(d)Total Asset Turnover, (e)Average collection period, (f)Inventory turnover, and (g)Fixed Asset turnover.
6. The deterioration and Magnetronics’ operating profits as a percentage of total assets between 1995 and 1999
resulted primarily from the increase in COGS and Inventory.
ROTA (1999) = (1307++517+704) ÷ 22,780 = 2528 ÷ 22,780=0.11.1=11.10%
ROTA (1995) = (1171+361+1040) ÷ 14,949 = 2572÷ 14,949 =0.1721=17.21%

Leverage Ratios
1. The total liabilities of Magnetronics as of December 31, 1999, were $10,587 or 46.47% of total assets. This
represented a decrease from 48.55% as of December 31, 1995.
Debt Ratio (1999) = (10,587/22,780)*100 = 46.47%
Debt Ratio (1995) = (7,257/14,949)*100 = 48.55%
2. The market value of Magnetronics’ equity of $14,275,000 at December 31, 1999. Its total debt ratio at market was
43%. (Total Debt Ratio at Market = 10,587/(10,587+14,275) = 0.43)
3. Magnetronics’ earnings before interest and taxes were $2,528 in 1999 and its interest charges were $517. Its times
interest earned was 4.89 times. This represented a deteriorated from the 1995 level of 7.12 times.
Time Interest Earned Ratio (1999) = 2,528/517 = 4.89
Time Interest Earned Ratio (1995) = 2,572/ 361 = 7.12
4. Magnetronics owed its suppliers $2,820 at year-end 1999. This represented 9.49% of cost of goods sold and was an
increased from 8.42% at year-end 1995. The company appears to be less prompt in paying its suppliers in 1999 than it
was in 1995.
1999 = (2,820/29,700)*100 = 9.49%
1995 = (1,615/19,183)*100 = 8.42%
5. The deterioration in Magnetronics’ profitability, as measured by its return on equity, from 15.2% in 1995 to 10.7% in
1999 resulted from the combined impact of lower increasing rate of profit after taxes and higher increasing rate of
owner’s equity.
6. The financial riskiness of Magnetronics increased between 1995 and1999.
a. Decreasing ROE and times interest earned ratio
b. Increasing account payable % of COGS

Liquidity Ratios
1. Magnetronics held $17,620 of current assets at year-end 1999 and owed $7,531 to creditors due to be paid within
one year. Its current ratio was 2.34, a deteriorated from the ratio of 2.41 at year-end 1995.
Current Ratio (1999) = 17,620/7,531 = 2.34
Current Ratio (1995) = 10,876/ 4,507 = 2.41
2. The quick ratio for Magnetronics at year-end 1999 was 1.25, a deteriorated from the ratio of 1.52 at year-end 1995.
Quick Ratio (1999) =(17,620-8,220)/7,531 = 1.25
Quick Ratio (1995) = (10,876-4,032)/4,507 = 1.52

2. Using any approach you find helpful, see how many of the unidentified industries you can
identify. Why does each of the industries have its particular pattern of asset use? Particular
pattern of financing sources? Particular pattern of profitability?