Buenaflor, Raymond L.

08-00741

July 15, 2011 THW 1:00-2:30

Machine Problem #1 Financial Statements Analysis Report

In evaluating the ratios computed.0% 0.0 1.5 38.2 57.7 1.0 50.6 2.0% 24. it becomes more logical to interpret the values of the ratios when they are of the same category. it only focuses on internal factors. Due to the lack of information about the company. and instead. the company’s ratio values for 2007 and 2008 (supplied) are compared with the 2009 ratio values.7% 1.9 27.6 2.5 43.Financial Statements Analysis Financial ratios would be an important tool in assessing the financial condition and performance of Martin Manufacturing Company during 2009.7 55.1 Actual 2009 Industry average 2009 2. it also makes it easier to have comparisons when the ratios are analysed by type.2% 34.1% 1. Martin Manufacturing Company Historical and Industry Average Ratios Ratio Current ratio Quick ratio Inventory turnover (times) Average collection period (days) Total asset turnover (times) Debt ratio Times interest earned ratio Gross profit margin Net profit margin Return on total assets (ROA) Return on common equity (ROE) Price/earnings (P/E) ratio Market/book (M/B) ratio Actual 2007 Actual 2008 1.0% 26.5% 3. debt.1% 2. it is also important to know the industry that the company is in.1% 3.3 1.4% 2.3 10.0% 1. profitability.7 1.7% 1. and market.8 1.5 27. the 2009 industry average ratios (also given) are compared with the company’s ratio values for 2009. Lastly. With this division. the analysis focuses only on the values of the ratios computed.5% 28.5 1.0 0. It sets aside the external factors that can affect the company.5 1. Also.4 2.5 1.8 1.5% 1. With the time-series analysis.2 5.3% 2.6% 3.5 45.8 1.2 5. With the cross-sectional analysis. The analysis made is based on time-series and cross-sectional.0 1.2% 1.2 . it becomes easier to pinpoint problems with regards to the financial performance of the company. The summary of the financial ratios of Martin Manufacturing Company including the industry average for 2009 is given below.2 1. activity. The analysis is divided into the five distinct types of ratios namely liquidity.9 46.0 57.8% 54.0% 1.9 5.3% 33.

343.00 $1.000.781. 2009 2008 $25.250.00 Price per share Par value Outsatnding shares of common stock $11.000.00 $805.093.00 $1.593.445.895.00 $50.000.250.00 $75.00 $1.00 $593.00 $1.00 $152.343.Martin Manufacturing Company Income Statement for the Year Ended December 31.218.00 $2.000.704.402.00 $700.000.571. 2009 Sales Revenue Less: Cost of goods sold Gross profits Less: Operating Expenses Selling expense General and administrative expenses Depreciation expense Total operating expense Operating profits Less: Interest expense Net profits before taxes Less: Taxes (rate = 40%) Net profits after taxes Less: Preferred stock dividends Earnings available for common stockholders Earnings per share (EPS) $5.00 $593.00 $50. $1.402.895.00 $2.819.000.00 $616.551.00 $1.075.000 .100.750.000.00 $400.00 $500.125.000.20 dividend) Common stock (100.707.500.33 Martin Manufacturing Company Balance Sheet December 31.00 $1.531.000.000.000.000.000.500 shares.00 $2.00 $1.902.819.000.750.000.00 $348.000.750.371.00 $3.00 $60.900.000.000.625.00 $100.691.00 $416.000.00 $1.000.000.000 shares at $4 par) Paid-in capital in excess of par value Retained earnings Total stockholders' equity Total liabilities and stockholders equity $230.00 $1.556.00 $33.00 $300.00 $763.00 $650.00 $370.000.000.165.445.00 $24.00 $1.00 $280.00 $0.181.000.00 $311.152.00 $24.323.00 Assets Current assets Cash Accounts Receivable Inventories Total current assets Gross fixed assets (at cost) Less: Accumulated depreciation Net fixed assets Total assets Liabilities and Stockholders' Equity Current liabilities Accounts payable Notes payable Accruals Total current liabilities Long-term debt Total liabilities Stockholders' equity Preferred stock (2.125.000.000.00 $36.000.00 $3.00 $400.00 $3.000.38 $4.152.00 $700.00 $871.00 $153.00 $1.00 $3.00 100.000.00 $1.00 $93.00 $763.000.707.00 $400.000.750.

8 for the years 2007 and 2008 respectively. (More will be discussed in the activity ratios portion of the analysis. according to L. What does this indicate? It means that the company is not depending much on loans/credits/advances to finance its operations.5 for 2009. there is an enormous decrease in current liabilities specifically in accounts payable and accruals. It has a current ratio of 1. This could be caused by an increase in current assets and/or a decrease in current liabilities. and a current ratio of 2. . The company might be foregoing some opportunities because it is investing a lot of its cash to its current assets.) In addition. The company wouldn’t have a hard time fulfilling its short-term obligations. Also. the company has a relatively higher current ratio. It means that the company is very liquid. it is advisable for a manufacturing company to have a current ratio that is near to one.J. Based on the comparative balance sheet (2008 and 2009). Cross-sectional: Comparing the company’s current ratio to the industry average. But. Cash flows for a manufacturing company are predictable and the company wouldn’t have problems in fulfilling its short-term obligations because it can easily forecast how much money it will be receiving/disbursing for the year. This shows that current ratio is increasing in trend. It means that the company has the ability to meet its short-term obligations with its current resources available. Gitman.LIQUIDITY RATIOS  Current Ratio Time-series: From 2007 to 2009 the company has a current ratio greater than one.7 and 1. there is an implication with having a very liquid condition – low profitability. it can be observed that there is an enormous increase in the current ratio from 2008 to 2009.

Recommendation: It is advisable for the company to decrease its current ratio by reducing the cash invested to its current assets especially accounts receivable and inventories. Having a quick ratio that is greater than one means that the company has the ability to meet its current liabilities using its most liquid asset. a build-up in the least liquid portion (inventories) of current assets is an indication of poor marketing strategy of the company. a build-up in the least liquid portion of a company’s current assets might be a bad indication for profitability of the company. its quick ratio increased to 1. and it is also risky to have a large amount of . It means that there is a build-up in the least liquid portion of its current assets (its inventories). Is it good or bad? Basically. But by the year 2009. It is because of the decrease in the company’s current liabilities for the year 2009. Quick Ratio Time-series: The firm has a normal/good quick ratio. and a ratio of 0.3. Also. The company’s current ratio is very high compared to its quick ratio. Cross-sectional: Having a quick ratio that is very near to the industry average means that the company is in line with its industry. Less risk for the company because it can pay its debt/liabilities as they come due.9 by 2008 – basically. This ratio is to be compared with the current ratio. there is a tremendous increase from the value of the ratio from 2008 to 2009. It has a ratio of 1. Aside from the threat of not being able to convert it into the most liquid asset which is cash. It is a good indication as for the liquidity of the company. Again. etc. the trend is decreasing. the company might also be incurring irrelevant cost because of storage. It is very expensive to store a lot of inventories because of theft and obsolescence. The marketing department might not be achieving its quota when it comes to sales or there is a poor forecasting of the demand for the product.0 for the year 2007.

the company is over-stocking which leads to additional cost for the company. It is an unfavourable remark for the company in terms of the industry that it is in. By reducing the cash invested to these assets.2 industry average.3 for the past three years of its operations.0 to 5. it is not advisable to store excessive amount of inventory because of cost issues. In addition. an inventory turnover of 5.3 for normal inventory management because it is the normal ratio for the company as observed with its previous years.3 for 2009 is very low compared to 10. the company can earn more by investing it to marketable securities that will yield dividends or interest. It can convert its inventory into sales only half of what the industry can. Stated previously.  Average Collection Period . Cross-sectional: The company’s inventory turnover of 5.accounts receivable due to default risk. excessive inventory stock indicates poor sales and poor logistics. ACTIVITY RATIOS  Inventory Turnover Time-series: The company’s turnover ratio plays around 5. but at least it is also not performing badly – just right. Instead of responding to the demand of the product. It indicates a poor inventory management than the industry and that the company holds excessive inventory stock. On 2009 a regular indicates basis. The company is not performing very well in turning inventory into sales.

the company works the opposite way. the better. the company might end up increasing its debt in order to continue its operations. Aside from encountering more and more bad debts. Since the credit policy of the company is not given. Although a relaxed credit collection policy can induce sales. Receivables form part of the sales and profit of the company. we cannot be certain whether the collection period is reasonable or not.  Total Asset Turnover . When receivables are not collected as they come due. This can lead to an increase in bad debts and a change in credit policy of the company. For the past three years of operation of the company. there is an increasing trend on its average collection period.0 days. a high average collection period is bad for a company especially in the manufacturing industry. But on the onset. it can also affect the future operation of the company. Cross-sectional: The company’s 2009 average collection period of 57. We will leave the final judgment to the cross-sectional analysis because it becomes significant to compare the company’s collection period to the industry average. It is bad for the company because instead of reducing the time for the collection of the receivable. The company is becoming lenient with its credit customers. When it is not monitored properly. It is an indication of problems in the collection period of the company.9 days is relatively high compared to the industry average of 46. delayed in the payments of the company’s obligations will follow. it is still not advisable going far beyond the industry average.Time-series: The shorter the collection time.

it is clear that it is generating less sales revenue per dollar of asset investment than the industry. tighten its credit policy or build relationship with its customers to encourage customer loyalty in paying their necessary obligations/debt to the company.5 while for 2009 it was 1. The causes might be overinvestment in accounts payable. It has a large amount of accounts payable and inventory and it might have been buying/keeping fixed assets beyond what the company can use to produce its products. It is just normal for the company to generate same amount of sales with a minimal change in its assets.6 ratio. and in the case of Martin Manufacturing. More assets require more workers and also more administrative and operating expenses. Cross-sectional: The industry has a total asset turnover of 2.0. The company is less efficient than the industry. If there is excessive investment in the assets. A good demand forecasting is also important in this aspect. It can restrict issuance of credit to customers. This means that there is not much improvement in the utilization of assets to generate sales. it is a combination of those three. And so other operating expenses will follow leaving the company less profit than it should be generating. Compared with the company’s 1. Also. the company will end up paying more workers than it generally needs. in inventories and/or in fixed assets.Time-series: Total asset turnover for 2007 and 2008 were 1. But before doing such things. There might be a problem in the efficiency on utilizing the company’s assets. Recommendation: It is recommended that the company increases its inventory turnover by reducing its inventory to lower its cost or by generating more sales through extra marketing efforts. Excessive investment in assets can also affect the profitability of the company. . The values were almost the same for the past three years. it is advisable to take into consideration its collection period and collection policy.6.

Cost-benefit analysis can be useful. the company should decrease its investment to the non-relevant assets of the company. the higher the debt ratio. There is a very wide disparity between the industry ratio and the company’s.3% in 2009.it is important to assess if a change in credit policy or restrictions in issuance of credit to customers will greatly affect future sales of the company. It by can debt be observed in the graph that the trend on the debt ratio is increasing. This only shows that more and more assets are being financed by debt as time goes on. From 45. DEBT RATIOS  Debt Ratio Time-series: The higher the debt. it can use its cash to invest to marketable securities rather than investing in additional assets which will only generate the same amount of sales. Cross-sectional: The debt ratio on the industry is 24. This means that 57% of the company’s assets are supported financing. It also shows that about 43% of the company’s assets are supported by shareholders wealth. its debt ratio increased to 57% by 2009.5%. The debt ratio for the year 2009 of the company is 57. Instead. What we can conclude here is that the company should monitor its debt ratio because the higher it is.0%.8% in 2008 to 54. Therefore having a ratio which is a lot larger than the industry would mean that the company is not in line with the industry. The company becomes very dependent . Lastly. the higher the interest expense and the less the profitability for the company. the greater the financial risk to the company. the higher the financial risk. As stated before. This means that the company is becoming more and more dependent to debt than to its shareholders in financing its assets.

Having a larger ratio than the industry would also mean that the company is not earning enough to meet its need on financing its assets. Second is that they are not utilizing the cash they get from debts to increase its sales and/or profit. Because it shows that it is becoming difficult for the company to pay debts and interest through the profit from its operations. it decreased to 1. The trend is decreasing. But with the trend in the company’s ratio. Cross-sectional: The company has a lower times interest earned ratio than the industry average which is 2. it might end up paying . If the company is earning well. It can pay its interest payments easily if it has a higher times interest earned ratio.5. Also. The probability that the company can pay its interest expenses using its profit becomes lower. The profit is becoming inadequate to pay the interest from its debt. it will not make such dependence on its creditors. Recommendation: It is recommended that the company analyse and screen its plan for future financing.  Times Interest Earned ratio Time-series: The higher this ratio is the better for the company. Having a large debt ratio than the industry increases the company’s risk on its finances. the company might be getting more debt than needed.9 by 2008. it seems that it becomes more and more difficult to pay interest payments as the years go by.2 on 2007. First. This would have two possible causes. a decreasing times interest earned ratio is a bad sign for future credit that the company would make. If the company won’t be able to assess whether its debt are still reasonable. From 2. and even diminished more by 2009 with a ratio of 1.with creditors rather than the owners.6.

The company is using much of the debts for its financing. It is advisable to reduce the debts that they have to reduce its interest expense and increase the times interest earned ratio. The gross profit margin for 2009 was 27%. The company is efficient not only with its operations but also with the pricing of its products. And therefore it won’t be useful for the future operation of the company. . PROFITABILITY RATIOS  Gross Profit Margin Time-series: Based on historical data. It is more effective and efficient in generating profits from its operations. The efficiency of the company’s operations did not change for the past three years. It is also recommended that they monitor their times interest earned ratio since a higher ratio will have an impact to the credibility of the company in terms of paying not only the interest expenses. it can be said that the company is better off with the industry in the operation and pricing of its products. This means that 27% of its sales are composed of its gross profit while the remaining 73% is the cost of goods sold. Cross-sectional: With an industry median of 26%. the profit company’s gross margin plays around 27% to 28%. It is reasonable percentage since it is its normal ratio based on previous years. In fact. most of its liabilities are long-term debt. but also the debt itself.interest which are not necessary or those that doesn’t contribute to its profitability.

The company might be overspending on its marketing (selling) and human resources (administrative) areas. it is best to monitor the operations especially in the selling of products. It is a bad sign for the company’s profitability. administrative and depreciation expense. Net Profit Margin Time-series: Based on the graph. the decrease in ROA was due to a decrease in net profit rather than an increase . This ratio is to be compared with the gross profit margin. From 1. It might also be due to a higher tax rate charged on the company’s profit.2. It indicates that Martin Manufacturing is not in line with the industry in terms of its expenditures with its selling and administrative expenses. The company’s gross profit margin is slightly unchanged from its previous years of operations while its net profit margin is decreasing. Either way. Only 0.7 cents of every sales dollar goes to the net profit. Based on the income statement and comparative balance sheets of the company. the decrease in the net profit margin is caused by increasing selling.7 on 2007.5 by 2008 and even decreased to 1. Cross-sectional: the company’s net profit margin is lower than the industry median of 1. it turns down to 1. Clearly.1 by the year 2009. the company’s net profit margin is declining.  Return on Total Asset Time-series: the ROA of the company is decreasing.

6% by 2009.  Return on Common Equity Time-series: The ROE of the company decreases from 3. its earning power is less than the industry since it needs more assets for generating earnings/profit from its operations. Cross-sectional: the company’s ROE is lower than the industry average of 3. The firm became less efficient in utilizing stockholders’ wealth to generate profit. the firm’s acceptance of investment opportunities and expense management is becoming lower.1% is unfavourable as compared to the industry average of 2. It was due to a decrease in the net profit since the same for of the the the company stockholders’ stayed investment consecutive years 2008 and 2009. It is using more asset than the industry to generate profit. It means that the company employs more asset to generate profit than a typical firm in the industry. It is because of the fact that it has a low total asset turnover and low net profit margin.3% by 2008 to 2. This means that it has a large amount of assets that generate low profit for the company. the change was due to poor sales and/or big administrative and selling expenses.2%. Recommendation: Although the gross profit margin of the company is higher than the industry average. it is still better if it can be increased.4%. its ROE became lower than the industry. . Cross-sectional: The company’s ROA of 1. and therefore. There is not much change in the assets of the company for the past two years (2008 and 2009). The strategies to increase the ratio include increasing the marginal profit by either increasing the price or selling more than the company used to sell. In addition. In addition. As a result.in assets. It can also increase it by having efficient production/operations.

it would be better off if it can maintain only a reasonable sales force and office workers.It will help the company if it can assess its selling and administrative expenditures.5 for 2007. This means that for the year 2009.7 by 2008 and 34. MARKET RATIOS  Price/Earnings Ratio Time-series: The P/E ratio of the company for the past three years is fluctuating. It has a 33. And since the company is still selling the same amount of products for the past three years (based on gross profit margin). it can be concluded that investors is paying far less on the earnings of the company than a typical firm in the industry. investors were paying $34. Based on the 2009 income statement.4.  Market/Book Ratio Time-series: an increasing book value means that investors are becoming more favourable with the company by paying more and more each year for each $1 book value of the company’s .5 for each $1 of the company’s earnings. 38.5 by 2009. a large portion of its expenditures come from those factors. Cross-sectional: Comparing the ratio to the industry average of 43.

In addition. Also. investors view the company favourably since they are paying more than the market value of a typical firm in the industry.stock. It is a good indication that the investors becoming devoted with the business. . Cross-sectional: The company has a favourable M/B ratio with the industry since I has a higher value. This means that the company may have increased their market share in the industry. it also means that the stocks of the firm are performing well in the market.

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