3. Compose a financial analysis based on your evaluation of the ratios. For EACH of the five (5)
classifications of ratios, write a two-paragraph analysis, which answers the following (one
paragraph for 3A and one paragraph for 3B) (40 points in total):
3A. Comparison between 2020E and 2019 ratios - (1) What happened? Did each of the ratios
increase, decrease, or not change?
(2) What had caused the movement or non-movement for each ratio? and (3) Is this a good
thing or a bad thing for the company?
3B. Comparison between 2020E ratios and industry averages - (1) Are the 2020E ratios
above, below, or equal to the industry
averages? (2) Is this a good thing or a bad thing for the company? and (3) What can be done
to improve the weak ratios or to maintain
the strong ones?
Answers to 3A.2 may vary. Students' answers are graded based on how they explained it.
For answers to 3A.1 and 3A.3, refer to "Comparison" tab.
Answers to 3B.3 may vary. Students' answers are graded based on how they explained it.
For answers to 3B.1 and 3B.2, refer to "Comparison" tab.
A. Liquidity Ratios
3.A All liquidity ratios which are the current, quick, and cash ratio increased in
comparison to the 2019 ratios. Based on the financial statements of ABC corporation,
there was an increase in cash and other current assets and a decrease in the total
current liabilities in 2020 compared to the 2019 financial statement thus increasing the
liquidity ratio of the 2020 financial statement. An increased liquidity ratio indicates that a
company’s liquid assets which can be quickly converted to cash is increasing and the
company is able to pay its maturing obligation which is a good thing for the company.
3.B All liquidity ratios are below the industry average which is a bad indicator for the
company. Liquidity ratios can be improved by paying off liabilities, cutting back on costs
and getting rid of useless assets, using long-term financing, and managing receivables
and payables.
B. Solvency
3.A
- For the solvency ratios, the debt, debt to equity, and the equity multiplier ratios
decreased and the equity, times interest earned and dividend payout ratio increased in
comparison to the 2019 ratios. The debt ratio decreased because the current liabilities
and long-term bonds for 2020 also decreased. The debt to equity also decreased
significantly from 481.94% to 79.13% because there is a significant increase on the total
common equity. The equity multiplier also decreased from 374.92% to 260.28% because
of the significant increase in the total common equity which is from 492,592 to 1,952,352
thus affecting the average of the total common equity. On the other hand, the equity ratio
increased because of the increase in the total common equity. The times interest earned
(TIE) also increased from -0.96 to 7.04 because the EBIT increased in 2020 and the
interest expense decreases. Lastly, the dividend payout ratio also increased because the
dividends paid by the company increased from 11,000 to 55,000 and also the net income
in 2020 also increased. All solvency ratios have a good effect on the company except for
the equity multiplier which is a bad thing for the company.
-
3.B
The debt ratio, debt to equity ratio, and dividend payout ratio are all below the industry
average and the equity, equity multiplier and TIE are above the industry average.
Although the debt ratio and debt to equity ratio are below the industry average it is still a
good thing for the company together with the equity and TIE ratio. The dividend payout
ratio which is below the industry average is a bad thing for ABC corporation. In order to
improve the dividend payout ratio the company can increase the dividends paid and
decrease the earnings per share. To maintain the debt ratio, debt to equity ratio, equity
multiplier, equity ratio and TIE is to balance the current liabilities, equity and net income.
C. Asset Utilization
3A
- The inventory turnover, A/R turnover, A/P turnover, fixed asset turnover, and total asset
turnover decreased in comparison to the 2019 ratios while the day sales in inventory,
day sales outstanding, days payable outstanding, operating cycle, and cash conversion
cycle increased in comparison to the 2019 ratios. The inventory turnover decreased can
be due to the fact that there’s an extra production of inventories thus we can see from
the 2020 financial statement that there is an increase in inventories. This decrease in
inventory turnover can also be a result from holding inventories for a longer period of
time. The accounts receivable turnover decreased can be due to the fact that the
collection of receivables are taking longer thus we can also see that there was an
increase in accounts receivable for the year 2020. The accounts payable turnover
decreased can be due to the fact that ABC corporation is slow in paying its purchases on
credit. Although there is a decrease in accounts payable, there is an increase for net
purchases for the year 2020. The fixed asset turnover and total asset turnover also
decreased can be due to the fact that the company does not use its assets effectively.
Days sales in inventory increased because it is inverse to the inventory turnover. If there
is a low inventory turnover there will be an increase for days sales in inventory. This
scenario is also applicable for days sales outstanding and accounts receivable turnover,
days payable outstanding and accounts payable turnover. The operating cycle increased
because the days sales in inventory and days payable outstanding also increased. The
cash conversion cycle also increased because ABC corporation has increased the
length of time for inventories to convert into cash. Only the accounts payable turnover
and days payable outstanding has a good effect on ABC corporation and the rest of the
asset utilization ratios has a bad effect on the company.
3B
The inventory turnover, accounts receivable turnover, accounts payable turnover and total asset
turnover ratios are below the industry average while the days sales in inventory, days sales
outstanding, days payable outstanding, operating cycle, cash conversion cycle, and fixed asset
turnover ratios are all above the industry average. Only the accounts payable turnover, days
payable outstanding and fixed asset turnover have a good effect on ABC corporation while the
rest of the asset utilization ratios have a bad effect for the company. In order to improve the
inventory turnover ratio, the company can improve its forecasting, improve sales, reduce the
price, better inventory price, encourage sale of old stock and many more. In order for the days
sales in inventory to have a good effect on the company it should decrease by increasing the
inventory turnover. In order to improve the accounts receivable turnover ratio, the company can
improve billing efficiency, include payment terms, build strong client relationships, use cloud
based software, follow up regularly and reconcile frequently. The days sales outstanding should
also decrease by increasing the accounts receivable turnover so that it will also be a good thing
for the company. In order to further improve or maintain the accounts payable turnover ratio, the
company can improve by paying suppliers on time, take advantage of early payment discounts,
consider outsourcing,and be proactive with supplier relationship management. The operating
cycle of ABC corporation can be further improved by decreasing the length of time required in
converting inventories to cash which can be done by decreasing the days sales in inventory and
days sales outstanding. ABC corporation can improve their cash conversion cycle by asking the
customers or clients to pay sooner, analyze cash flow and operations on a daily basis, time the
invoices to coincide with customer’s payment cycles, and speed up the sales and delivery
cycles. Lastly, to improve the total asset turnover ratio, the company can increase in revenue,
liquidate assets, leasing, improve the efficiency of assets, accelerate accounts receivables and
better inventory management.
D. Profitabilitiy
3.A All profitability ratios which are the gross margin, operating margin, profit margin,
ROA, ROE, BEP, and EPS increased in 2020 in comparison to the 2019 ratios. Both
gross margin and profit margin increased because the sales for 2020 also increased.
The operating margin also increased because there is an increase in the sales and the
EBIT in the 2020 financial statement. The ROA increased from -7.39% to 7.97%
because there is also a significant increase on the net income and total assets of 2020.
ROE also increased from -27.70% to 20.74% because there is a significant increase on
the net income and total common equity of 2020. The BEP also increased because the
EBIT increased from (130,948) in 2019 to 492,648 in 2020 and the average of total
assets. The EPS also increased significantly from -1.60 to 1.01 due to the fact that the
net income and shares outstanding increased in comparison to the 2019 net income and
shares outstanding. Increased profitability ratios indicate a good effect on ABC
corporation.
3.B
The profit margin and return on equity (ROE) are the only profitability ratios which are
above the industry average. The gross margin, operating margin, ROA, BEP, and EPS
are all below the industry average. The profitability ratios which are above the industry
average have a good effect on ABC corporation and those ratios which are below the
industry average have a bad effect on the corporation. In order to improve the gross
margin ratio, the company can increase their prices, reduce the cost of goods and also
reduce inventory waste. The company can improve their operating margin through better
management controls, efficient use of resources and they can also improve their pricing.
In order to improve ROA, the company can increase their net income by increasing their
total sales, decrease total assets, and improve the efficiency of current assets and fixed
assets. For BEP to improve, ABC corporation can increase EBIT by increasing revenue
and non-operating income and decreasing their operating expenses. Lastly, EPS can be
improved by expanding the margin by lowering the costs. The company can also utilized
share buybacks which means that the company can lower the amount of share that can
be bought without making changes on the profit.
E. Market Performance
3.A All the market performance ratios increased except for the dividend yield that
decreased in comparison to the 2019 ratios. The price to earnings ratio increased
because the stock price increased from 2.25 to 12.17 in 2020. The book value per share
also increased because there was an increase in the total common equity and the
number of shares outstanding in 2020 compared to the 2019 total common equity and
shares outstanding. The market/book (M/B) ratio increased in comparison to the 2019
ratio because the stock price and book value per share also increased in 2020. Lastly,
the dividend yield decreased in the 2020 financial statement because there was an
increase in the dividends paid by ABC corporation. This decrease can be a bad thing for
the company since it may indicate that the company is struggling and neither profitable
nor has a positive effect on the future. The increase of the price to earnings ratio,
market/book, and book value per share is a good thing for the company.
3.B
All the market performance ratios are below the industry average except for the book
value per share because there is no indicated industry average. Although there is no
basis for the industry average of book value per share it is also a bad thing for the
company together with the price to earnings ratio, dividend yield, and market/book ratio.
In order to improve the price to earnings ratio of the company it can increase the
payment of dividends. Although paying dividends does not increase the company’s
earnings, the investors are willing to pay higher prices for stocks to receive regular
dividend payments. For the dividend yield to improve, the company should improve their
cash flows in order for more room to pay shareholders higher dividends. Higher dividend
is a positive indicator of a company’s performance. For the market/book ratio to improve
there should be an increase in the market price per share. Lastly, for the book value per
share to improve ABC corporation can either repurchase common stocks or increase
assets and reduce liabilities.