Ace Company Loan Request Evaluation
Margie Alexander
Accounting Methods for Leaders
Assessment 3-1
August 17, 2020
Ace Company Loan Evaluation
Introduction
The Ace Company is requesting a 3 dollar loan with a paid back over ten years. Ace Company is
growing and will use the loan for production equipment and software development. Analysis of
Ace Company's 2016 and 2017 financial data will determine loan approval. Financial
documents and calculations are in the Appendix.
Executive Summary
Balance Sheet
A company's balance sheet looks into their financial health. A critical part of a balance sheet is
the accounts receivable. The accounts receivable is the money owed to the customer for their
services or products. Accounts payable is the money that the company owes to others for
products and services (Investopedia Staff, 2020). The size of the company can affect the number
of accounts receivable. Smaller companies may perform as well as larger companies but with
different volumes. To determine if Ace Company's receivables are in-line with the industry
average, the account receivables turnover ratio is used. Accounts receivable turnover is the
number of times per year that a business collects its average accounts receivable. The ratio is
used to evaluate a company's ability to issue a credit to its customers efficiently and receive
funds from them on time (Murphy, 2020). The ratio is calculated as:
Net Credit Sales ÷ ((Beginning Accounts Receivable + Ending Accounts Receivable) / 2)
A high turnover ratio indicates a combination of conservative credit policy and an active
collections department (Accounting Tools, 2019). For ACE company, their account
receivables ratio for 2016 was 4.67, and 2017 was 5.06, a 10.8% increase year over year,
indicating an upward trend. To convert to the number of days it took to turn over their
receivables, we used the following calculation: 365 days/Average Receivable Turnover
Ratio. In 2016 it took 78 days to turn over receivables, and in 2017 it took 72 days, which
was a 10.8% decrease in the number of days to turn over receivables.
Inventory Turnover Ratio
Inventory turnover measures the number of times inventory is sold and replaced during a
set time, usually a year. This ratio is important because it tells us if there is an excessive
inventory compared to their sales and is calculated by dividing the cost of goods sold by the
average inventory. The average inventory is calculated by adding the beginning inventory
and ending inventory and dividing the sum by 2. This ratio provides information on how
well management manages inventory, allowing better decisions on pricing, producing,
marketing, and purchasing new inventory. ACE’s average inventory turnover is 1.82 for 2017
and 1.94 for 2016 (cost of goods sold/average inventory), which is low compared to the industry
average of 10 times/year. A low inventory turnover ratio could indicate weak sales or too much
inventory, while a high number can be the result of robust sales or not enough inventory. When
comparing the turnover ratio's look at that industry average. The inventory turnover ratio for a
car dealership is lower than the inventory of a store targeted at fickle teenagers (Fuhrmann,
2020).
Another way to look at inventory turnover is to calculate the number of days it takes to
turn inventory into sales (DSI). The lower the number, the better in this case because it indicates
how quickly a company is turning over its inventory. DSI is calculated by (Average inventory ÷
cost of goods sold) x 365. The industry average for ACE is 37. In 2017 ACE had a DSI of 201
days and, in 2016, a DSI of 188 days. Both methods of calculations show that ACE is trending
in the wrong direction and is underperforming. Management should evaluate how inventory is
purchased and make adjustments to bring the company more in line with the industry average
(Fuhrmann, 2020).
ACE Company creditworthiness
Financial statement analysis is a judgmental process. One of the primary objectives
is identifying significant changes in trends and relationships and investigating the reasons
underlying those changes. Determining the company's financial health is more than just
looking at the balance sheet, and financial analysis is a judgmental process. While many
ratios can be used to assess creditworthiness, analysts tend to use the ratios they are most
comfortable with and understand or are company driven (Credit Research Foundation,
1999). Two ratios are used here to evaluate ACE's short-term and long-term
creditworthiness, the current ratio, or ratio of assets to liabilities for short term worthiness
and debt to equity for more long-term worthiness. These ratios are compared to similar
businesses in the same industry and the potential borrowers' financial patterns (Credit
Research Foundation, 1999).
Ace’s short-term worthiness is calculated by the current ratio, which indicates the
business's liquidity by comparing the number of current assets to current liabilities
(Johnston, n.d.). The formula is current assets/current liabilities. For 2017 ACEs' current
ratio is 1.79, and for 2016 is 1.53. The increase in the current ratio from 2016 to 2017
shows that ACE does have the cash to pay off short term debt (Credit Research Foundation,
1999).
ACE's long term debt creditworthiness is determined by debt to equity, which can
indicate how ACE is handling their credit. A lower number shows that they are not taking on too
much debt and means creditors are more protected in case of the company's insolvency (Credit
Research Foundation, 1999). The formula is total debt/total equity. For 2017 ACE had a debt
to equity of 2.49 and in 2016 3.78, showing a decrease in the amount of debt owed by the
company.
Finally, reviewing the income statement shows that ACE increased sales year over year from
2016 to 2017 indicating an upward trend in net sales.
Recommendations
All the factors and ratios reviewed were positive and trending in the right direction.
The only anomaly to this is the inventory turnover ratio. Their financials indicate they can
collect their accounts receivables, they have the funds to cover their short-term debts, and
upward sales provide them with the cash to cover obligations. The inventory turnover can
be reviewed, and changes made to improve that number quickly. The recommendation is to
approve the loan. The ability to grow and increase sales will provide greater cash flow to
meet obligations, including the terms of our loan.
References
Accounting Tools. (2019, March 29). Accounts receivable turnover
ratio. https://www.accountingtools.com/articles/2017/5/5/accounts-receivable-turnover-ratio
Credit Research Foundation. (1999). Ratios and Formulas in Customer Financial
Analysis. Credit Research Foundation. https://www.crfonline.org/orc/cro/cro-16.html
Fuhrmann, R. (2020, July 21). How to Calculate the Inventory Turnover
Ratio. Investopedia. https://www.investopedia.com/ask/answers/070914/how-do-i-calculateinventory-turnover-ratio.asp
Investopedia Staff. (2020, March 20). Reading the Balance
Sheet. Investopedia. https://www.investopedia.com/articles/04/031004.asp
Johnston, K. (n.d.). How to Evaluate a Firm's Credit
Worthiness. *Chron. https://smallbusiness.chron.com/evaluate-firms-credit-worthiness25925.html
Murphy, C. (2020, July 26). Receivables Turnover
Ratio. Investopedia. https://www.investopedia.com/terms/r/receivableturnoverratio.asp
Appendix