CHAPTER 4 Analysis of Financial Statements:

MINI CASE ( Corresponds to PPTs & Class) (10-3)

THE FIRST PART OF THE CASE, PRESENTED IN CHAPTER 3, DISCUSSED THE SITUATION
THAT COMPUTRON INDUSTRIES WAS IN AFTER AN EXPANSION PROGRAM.

THUS FAR, SALES

HAVE NOT BEEN UP TO THE FORECASTED LEVEL, COSTS HAVE BEEN HIGHER THAN WERE
PROJECTED, AND A LARGE LOSS OCCURRED IN 2001, RATHER THAN THE EXPECTED PROFIT.
AS A RESULT, ITS MANAGERS, DIRECTORS, AND INVESTORS ARE CONCERNED ABOUT THE
FIRMS SURVIVAL.
DONNA

JAMISON

WAS

BROUGHT

IN

AS

ASSISTANT

TO

FRED

CAMPO,

COMPUTRONS

CHAIRMAN, WHO HAD THE TASK OF GETTING THE COMPANY BACK INTO A SOUND FINANCIAL
POSITION. COMPUTRONS 2000 AND 2001 BALANCE SHEETS AND INCOME STATEMENTS,
TOGETHER WITH PROJECTIONS FOR 2002, ARE SHOWN IN THE FOLLOWING TABLES.

ALSO,

THE TABLES SHOW THE 2000 AND 2001 FINANCIAL RATIOS, ALONG WITH INDUSTRY
AVERAGE DATA.

THE 2002 PROJECTED FINANCIAL STATEMENT DATA REPRESENT JAMISONS

AND CAMPOS BEST GUESS FOR 2002 RESULTS, ASSUMING THAT SOME NEW FINANCING IS
ARRANGED TO GET THE COMPANY OVER THE HUMP.
JAMISON EXAMINED MONTHLY DATA FOR 2001 (NOT GIVEN IN THE CASE), AND SHE
DETECTED AN IMPROVING PATTERN DURING THE YEAR.

MONTHLY SALES WERE RISING,

COSTS WERE FALLING, AND LARGE LOSSES IN THE EARLY MONTHS HAD TURNED TO A SMALL
PROFIT BY DECEMBER.
MONTHLY DATA.

THUS, THE ANNUAL DATA LOOKED SOMEWHAT WORSE THAN FINAL

ALSO, IT APPEARS TO BE TAKING LONGER FOR THE ADVERTISING

PROGRAM TO GET THE MESSAGE ACROSS, FOR THE NEW SALES OFFICES TO GENERATE
SALES, AND FOR THE NEW MANUFACTURING FACILITIES TO OPERATE EFFICIENTLY.

IN

OTHER WORDS, THE LAGS BETWEEN SPENDING MONEY AND DERIVING BENEFITS WERE LONGER
THAN COMPUTRONS MANAGERS HAD ANTICIPATED.

FOR THESE REASONS, JAMISON AND

CAMPO SEE HOPE FOR THE COMPANY--PROVIDED IT CAN SURVIVE IN THE SHORT RUN.
JAMISON MUST PREPARE AN ANALYSIS OF WHERE THE COMPANY IS NOW, WHAT IT MUST
DO TO REGAIN ITS FINANCIAL HEALTH, AND WHAT ACTIONS SHOULD BE TAKEN.
ASSIGNMENT IS TO HELP HER ANSWER THE FOLLOWING QUESTIONS.

YOUR

PROVIDE CLEAR

EXPLANATIONS, NOT YES OR NO ANSWERS.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Mini Case: 3 - 1

BALANCE SHEETS
2002E
ASSETS
CASH
SHORT-TERM INVESTMENTS
ACCOUNTS RECEIVABLE
INVENTORIES
TOTAL CURRENT ASSETS
GROSS FIXED ASSETS
LESS ACCUMULATED DEPRECIATION
NET FIXED ASSETS
TOTAL ASSETS

2000___

14,000
71,632
878,000
1,716,480
$2,680,112
1,197,160
380,120
$ 817,040
$3,497,152

7,282
0
632,160
1,287,360
$1,926,802
1,202,950
263,160
$ 939,790
$2,866,592

LIABILITIES AND EQUITY

ACCOUNTS PAYABLE
NOTES PAYABLE
ACCRUALS
TOTAL CURRENT LIABILITIES
LONG-TERM DEBT
COMMON STOCK
RETAINED EARNINGS
TOTAL EQUITY
TOTAL LIABILITIES AND EQUITY
NOTE:

2001

436,800
600,000
408,000
$1,444,800
500,000
1,680,936
(128,584)
$1,552,352
$3,497,152

E INDICATES ESTIMATED.

524,160
720,000
489,600
$1,733,760
1,000,000
460,000
(327,168)
$ 132,832
$2,866,592

9,000
48,600
351,200
715,200
$1,124,000
491,000
146,200
$ 344,800
$1,468,800
145,600
200,000
136,000
$ 481,600
323,432
460,000
203,768
$ 663,768
$1,468,800

THE 2002 DATA ARE FORECASTS.

INCOME STATEMENTS
2002E
$7,035,600
6,100,000
312,960
120,000
$6,532,960
$ 502,640
80,000
$ 422,640
169,056
$ 253,584

2001
$5,834,400
5,728,000
680,000
116,960
$6,524,960
($ 690,560)
176,000
($ 866,560)
(346,624)
($ 519,936)

2000___
$3,432,000
2,864,000
340,000
18,900
$3,222,900
$ 209,100
62,500
$ 146,600
58,640
$
87,960

EPS
DPS
BOOK VALUE PER SHARE
STOCK PRICE
SHARES OUTSTANDING
TAX RATE
LEASE PAYMENTS
SINKING FUND PAYMENTS

$1.014
$0.220
$6.209
$12.17
250,000
40.00%
40,000
0

($5.199)
$0.110
$1.328
$2.25
100,000
40.00%
40,000
0

$0.880
$0.220
$6.638
$8.50
100,000
40.00%
40,000
0

NOTE: E INDICATES ESTIMATED.

THE 2002 DATA ARE FORECASTS.

SALES
COST OF GOODS SOLD
OTHER EXPENSES
DEPRECIATION
TOTAL OPERATING COSTS
EBIT
INTEREST EXPENSE
EBT
TAXES (40%)
NET INCOME

Mini Case: 3 - 2

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

RATIO ANALYSIS
2002E
CURRENT
QUICK
INVENTORY TURNOVER
DAYS SALES OUTSTANDING (DSO)
FIXED ASSETS TURNOVER
TOTAL ASSETS TURNOVER
DEBT RATIO
TIE
EBITDA COVERAGE
PROFIT MARGIN
BASIC EARNING POWER
ROA
ROE
PRICE/EARNINGS
PRICE/CASH FLOW
MARKET/BOOK
BOOK VALUE PER SHARE
NOTE: E INDICATES ESTIMATED.

2001
1.1
0.4
4.5
39.0
6.2
2.0
95.4%
-3.9
-2.5
-8.9%
-24.1%
-18.1%
-391.4%
-0.4
-0.6
1.7
$1.33

2000
2.3
0.8
4.8
36.8
10.0
2.3
54.8%
3.3
2.6
2.6%
14.2%
6.0%
13.3%
9.7
8.0
1.3
$6.64

INDUSTRY
AVERAGE
2.7
1.0
6.1
32.0
7.0
2.5
50.0%
6.2
8.0
3.6%
17.8%
9.0%
18.0%
14.2
7.6
2.9
N.A.

THE 2002 DATA ARE FORECASTS.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Mini Case: 3 - 3

A.

WHY ARE RATIOS USEFUL?

WHAT ARE THE FIVE MAJOR CATEGORIES OF RATIOS?

ANSWER:

RATIOS ARE USED BY MANAGERS TO HELP IMPROVE THE FIRMS PERFORMANCE,

BY LENDERS TO HELP EVALUATE THE FIRMS LIKELIHOOD OF REPAYING DEBTS,
AND BY STOCKHOLDERS TO HELP FORECAST FUTURE EARNINGS AND DIVIDENDS.
THE

FIVE

MAJOR

CATEGORIES

OF

RATIOS

ARE:

LIQUIDITY,

ASSET

MANAGEMENT, DEBT MANAGEMENT, PROFITABILITY, AND MARKET VALUE.

B.

CALCULATE THE 2002 CURRENT AND QUICK RATIOS BASED ON THE PROJECTED
BALANCE SHEET AND INCOME STATEMENT DATA.

WHAT CAN YOU SAY ABOUT THE

COMPANYS LIQUIDITY POSITION IN 2000, 2001, AND AS PROJECTED FOR

2002? WE OFTEN THINK OF RATIOS AS BEING USEFUL (1) TO MANAGERS TO
HELP RUN THE BUSINESS, (2) TO BANKERS FOR CREDIT ANALYSIS, AND (3) TO
STOCKHOLDERS FOR STOCK VALUATION.

WOULD THESE DIFFERENT TYPES OF

ANALYSTS HAVE AN EQUAL INTEREST IN THE LIQUIDITY RATIOS?

ANSWER:

CURRENT RATIO02 = CURRENT ASSETS/CURRENT LIABILITIES

= $2,680,112/$1,444,800 = 1.86.
QUICK RATIO02 = (CURRENT ASSETS INVENTORY)/CURRENT LIABILITIES
= ($2,680,112 - $1,716,480)/$1,444,800 = 0.667.
THE COMPANYS CURRENT AND QUICK RATIOS ARE LOW RELATIVE TO ITS
2000 CURRENT AND QUICK RATIOS; HOWEVER, THEY HAVE IMPROVED FROM THEIR
2001

LEVELS.

BOTH

RATIOS

ARE

WELL

BELOW

THE

INDUSTRY

AVERAGE,

HOWEVER.

C.

CALCULATE THE 2002 INVENTORY TURNOVER, DAYS SALES OUTSTANDING (DSO),

FIXED

ASSETS

TURNOVER,

AND

TOTAL

ASSETS

TURNOVER.

HOW

DOES

COMPUTRONS UTILIZATION OF ASSETS STACK UP AGAINST OTHER FIRMS IN ITS

INDUSTRY?
ANSWER:

INVENTORY TURNOVER02 = SALES/INVENTORY

= $7,035,600/$1,716,480 = 4.10.
DSO02 = RECEIVABLES/(SALES/360)
= $878,000/($7,035,600/360) = 44.9 DAYS.

Mini Case: 3 - 4

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Mini Case: 3 - 5

FIXED ASSETS TURNOVER02 = SALES/NET FIXED ASSETS

= $7,035,600/$817,040 = 8.61.
TOTAL ASSETS TURNOVER99 = SALES/TOTAL ASSETS
= $7,035,600/$3,497,152 = 2.01.
THE FIRMS INVENTORY TURNOVER RATIO HAS BEEN STEADILY DECLINING,
WHILE ITS DAYS SALES OUTSTANDING HAS BEEN STEADILY INCREASING.

WHILE

THE FIRMS FIXED ASSETS TURNOVER RATIO IS BELOW ITS 2000 LEVEL, IT IS
ABOVE THE 2001 LEVEL.

THE FIRMS TOTAL ASSETS TURNOVER RATIO IS

BELOW ITS 2000 LEVEL AND JUST SLIGHTLY BELOW ITS 2001 LEVEL.
THE FIRMS INVENTORY TURNOVER AND TOTAL ASSETS TURNOVER ARE BELOW
THE INDUSTRY AVERAGE.

THE FIRMS DAYS SALES OUTSTANDING IS ABOVE THE

INDUSTRY AVERAGE (WHICH IS BAD); HOWEVER, THE FIRMS FIXED ASSETS

TURNOVER IS ABOVE THE INDUSTRY AVERAGE.

(THIS MIGHT BE DUE TO THE

FACT THAT COMPUTRON IS AN OLDER FIRM THAN MOST OTHER FIRMS IN THE
INDUSTRY, IN WHICH CASE, ITS FIXED ASSETS ARE OLDER AND THUS HAVE
BEEN DEPRECIATED MORE, OR THAT COMPUTRONS COST OF FIXED ASSETS WERE
LOWER THAN MOST FIRMS IN THE INDUSTRY.)

THE FIRMS OPERATING CAPITAL

REQUIREMENT RATIO IS HIGHER THAN THE INDUSTRY AVERAGE, INDICATING

THAT COMPUTRON REQUIRES MORE DOLLARS OF CAPITAL TO GENERATE A DOLLAR
OF SALES THAN THE AVERAGE FIRM IN THE INDUSTRY.

D.

CALCULATE THE 2002 DEBT, TIMES-INTEREST-EARNED, AND EBITDA COVERAGE

RATIOS. HOW DOES COMPUTRON COMPARE WITH THE INDUSTRY WITH RESPECT TO
FINANCIAL LEVERAGE?

ANSWER:

WHAT CAN YOU CONCLUDE FROM THESE RATIOS?

DEBT RATIO02 = TOTAL DEBT/TOTAL ASSETS

= ($1,444,800 + $500,000)/$3,497,152 = 55.61%.
TIE02 = EBIT/INTEREST = $502,640/$80,000 = 6.3.

EBITDA COVERAGE01

EBITDA LEASE /

PAYMENTS

LOAN
LEASE
INTEREST
PAYMENTS

REPAYMENTS

= ($502,640 + $120,000 + $40,000)/($80,000 + $40,000) = 5.5.

THE FIRMS DEBT RATIO IS MUCH IMPROVED FROM 2001, BUT IT IS STILL
Mini Case: 3 - 6

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

ABOVE ITS 2000 LEVEL AND THE INDUSTRY AVERAGE.

THE FIRMS TIE AND

EBITDA COVERAGE RATIOS ARE MUCH IMPROVED FROM THEIR 2000 AND 2001
LEVELS, BUT THEY ARE STILL BELOW THE INDUSTRY AVERAGE.

E.

CALCULATE THE 2002 PROFIT MARGIN, BASIC EARNING POWER (BEP), RETURN
ON ASSETS (ROA), AND RETURN ON EQUITY (ROE).

WHAT CAN YOU SAY ABOUT

THESE RATIOS?
ANSWER:

PROFIT MARGIN02 = NET INCOME/SALES = $253,584/$7,035,600 = 3.6%.

BASIC EARNING POWER02 = EBIT/TOTAL ASSETS = $502,640/$3,497,152 =

14.4%.
ROA02 = NET INCOME/TOTAL ASSETS = $253,584/$3,497,152 = 7.25%.
ROE02 = NET INCOME/COMMON EQUITY = $253,584/$1,552,352 = 16.34%.
THE FIRMS PROFIT MARGIN IS ABOVE 2000 AND 2001 LEVELS AND IS AT
THE INDUSTRY AVERAGE.

THE BASIC EARNING POWER, ROA, AND ROE RATIOS

ARE ABOVE BOTH 2000 AND 2001 LEVELS, BUT BELOW THE INDUSTRY AVERAGE
DUE TO POOR ASSET UTILIZATION.

F.

CALCULATE THE 2002 PRICE/EARNINGS RATIO, PRICE/CASH FLOW RATIOS, AND

MARKET/BOOK RATIO.

DO THESE RATIOS INDICATE THAT INVESTORS ARE

EXPECTED TO HAVE A HIGH OR LOW OPINION OF THE COMPANY?

ANSWER:

EPS = NET INCOME/SHARES OUTSTANDING = $253,584/250,000 = $1.0143.

PRICE/EARNINGS99 = PRICE PER SHARE/EARNINGS PER SHARE
= $12.17/$1.0143 = 12.0.
CHECK:

PRICE = EPS P/E = $1.0143(12) = $12.17.

CASH FLOW/SHARE02 = (NI + DEP)/SHARES = ($253,584 + $120,000)/250,000

= $1.49.
PRICE/CASH FLOW = $12.17/$1.49 = 8.2.

BVPS = COMMON EQUITY/SHARES OUTSTANDING = $1,552,352/250,000 = $6.21.

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Mini Case: 3 - 7

MARKET/BOOK = MARKET PRICE PER SHARE/BOOK VALUE PER SHARE

= $12.17/$6.21 = 1.96X.
BOTH THE P/E RATIO AND BVPS ARE ABOVE THE 2000 AND 2001 LEVELS BUT
BELOW THE INDUSTRY AVERAGE.

F.

PERFORM A COMMON SIZE ANALYSIS AND PERCENT CHANGE ANALYSIS.

THESE ANALYSES TELL YOU ABOUT COMPUTRON?

ANSWER:

FOR THE COMMON SIZE BALANCE SHEETS, DIVIDE ALL ITEMS IN A YEAR BY THE
TOTAL ASSETS FOR THAT YEAR. FOR THE COMMON SIZE INCOME STATEMENTS,
DIVIDE ALL ITEMS IN A YEAR BY THE SALES IN THAT YEAR.

Common Size Balance Sheets

Assets
2000
Cash
0.6%
ST Invest.
3.3%
AR
23.9%
Invent.
48.7%
Total CA
76.5%
Net FA
23.5%
TA
100.0%
Liabilities and
Equity
2000
AP
9.9%
Notes pay.
13.6%
Accruals
9.3%
Total CL
32.8%
LT Debt
22.0%
Com. Stock
31.3%
Ret. Earnings
13.9%
Total equity
45.2%
Total L&E
100.0%

WHAT DO

2001
0.3%
0.0%
22.1%
44.9%
67.2%
32.8%
100.0%

2002E
0.4%
2.0%
25.1%
49.1%
76.6%
23.4%
100.0%

Ind.
0.3%
0.3%
22.4%
41.2%
64.1%
35.9%
100.0%

2001
18.3%
25.1%
17.1%
60.5%
34.9%
16.0%
-11.4%
4.6%
100.0%

2002E
12.5%
17.2%
11.7%
41.3%
14.3%
48.1%
-3.7%
44.4%
100.0%

Ind.
11.9%
2.4%
9.5%
23.7%
26.3%
20.0%
30.0%
50.0%
100.0%

2001
100.0%
98.2%
11.7%
2.0%
-11.8%

2002E
100.0%
86.7%
4.4%
1.7%
7.1%

Ind.
100.0%
84.5%
4.4%
4.0%
7.1%

Common Size Income

statement
Sales
COGS
Other exp.
Depr.
EBIT
Mini Case: 3 - 8

2000
100.0%
83.4%
9.9%
0.6%
6.1%

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Int. Exp.
EBT
Taxes
NI

1.8%
4.3%
1.7%
2.6%

3.0%
-14.9%
-5.9%
-8.9%

1.1%
6.0%
2.4%
3.6%

1.1%
5.9%
2.4%
3.6%

COMPUTRON HAS HIGHER PROPORTION OF CURRENT ASSETS (49.1%) THAN

INDUSTRY (41.2%).

COMPUTRON HAS SLIGHTLY LESS EQUITY (WHICH MEANS

MORE DEBT) THAN INDUSTRY.

COMPUTRON HAS MORE SHORT-TERM DEBT THAN

INDUSTRY, BUT LESS LONG-TERM DEBT THAN INDUSTRY.

COMPUTRON HAS

HIGHER COGS (86.7) THAN INDUSTRY (84.5), BUT LOWER DEPRECIATION.

RESULT IS THAT COMPUTRON HAS SIMILAR EBIT (7.1) AS INDUSTRY.
FOR THE PERCENT CHANGE ANALYSIS, DIVIDE ALL ITEMS IN A ROW BY THE
VALUE IN THE FIRST YEAR OF THE ANALYSIS.

Percent Change Balance

Sheets
Assets
Cash
ST Invest.
AR
Invent.
Total CA
Net FA
TA
Liabilities and
Equity
AP
Notes pay.
Accruals
Total CL
LT Debt
Com. Stock
Ret. Earnings
Total equity
Total L&E

2000
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%

2001
-19.1%
-100.0%
80.0%
80.0%
71.4%
172.6%
95.2%

2002E
55.6%
47.4%
150.0%
140.0%
138.4%
137.0%
138.1%

2000
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%

2001
260.0%
260.0%
260.0%
260.0%
209.2%
0.0%
-260.6%
-80.0%
95.2%

2002E
200.0%
200.0%
200.0%
200.0%
54.6%
265.4%
-163.1%
133.9%
138.1%

Harcourt, Inc. items and derived items copyright 2002 by Harcourt, Inc.

Mini Case: 3 - 9

Percent Change Income

statement
2000
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%

Sales
COGS
Other exp.
Depr.
EBIT
Int. Exp.
EBT
Taxes
NI

2001
70.0%
100.0%
100.0%
518.8%
-430.3%
181.6%
-691.1%
-691.1%
-691.1%

2002E
105.0%
113.0%
-8.0%
534.9%
140.4%
28.0%
188.3%
188.3%
188.3%

WE SEE THAT 2002 SALES GROW 105% FROM 2000, AND THAT NI GROWS 188%
FROM 2000. SO COMPUTRON HAS BECOME MORE PROFITABLE. WE SEE THAT
TOTAL ASSETS GROW AT A RATE OF 138%, WHILE SALES GROW AT A RATE OF
ONLY 105%. SO ASSET UTILIZATION REMAINS A PROBLEM.

H.

USE THE EXTENDED DU PONT EQUATION TO PROVIDE A SUMMARY AND OVERVIEW

OF COMPUTRONS FINANCIAL CONDITION AS PROJECTED FOR 2002.

WHAT ARE

THE FIRMS MAJOR STRENGTHS AND WEAKNESSES?

ANSWER:

DU PONT EQUATION =

PROFIT
TOTAL ASSETS
EQUITY

MARGIN
TURNOVER
MULTIPLIER

= 3.6% 2.01 1/(1 - 0.5561) = 16.3%.

STRENGTHS:
AVERAGE.

THE FIRMS FIXED ASSETS TURNOVER WAS ABOVE THE INDUSTRY

HOWEVER, IF THE FIRMS ASSETS WERE OLDER THAN OTHER FIRMS

IN ITS INDUSTRY THIS COULD POSSIBLY ACCOUNT FOR THE HIGHER RATIO.
(COMPUTRONS FIXED ASSETS WOULD HAVE A LOWER HISTORICAL COST AND
WOULD HAVE BEEN DEPRECIATED FOR LONGER PERIODS OF TIME.)

THE FIRMS

PROFIT MARGIN IS SLIGHTLY ABOVE THE INDUSTRY AVERAGE, DESPITE ITS

HIGHER DEBT RATIO.

THIS WOULD INDICATE THAT THE FIRM HAS KEPT COSTS

DOWN, BUT, AGAIN, THIS COULD BE RELATED TO LOWER DEPRECIATION COSTS.

WEAKNESSES:

THE FIRMS LIQUIDITY RATIOS ARE LOW; MOST OF ITS ASSET

MANAGEMENT RATIOS ARE POOR (EXCEPT FIXED ASSETS TURNOVER); ITS DEBT
MANAGEMENT RATIOS ARE POOR, MOST OF ITS PROFITABILITY RATIOS ARE LOW
(EXCEPT PROFIT MARGIN); AND ITS MARKET VALUE RATIOS ARE LOW.

I.

USE THE FOLLOWING SIMPLIFIED 2002 BALANCE SHEET TO SHOW, IN GENERAL

TERMS, HOW AN IMPROVEMENT IN THE DSO WOULD TEND TO AFFECT THE STOCK
PRICE.

FOR EXAMPLE, IF THE COMPANY COULD IMPROVE ITS COLLECTION

PROCEDURES AND THEREBY LOWER ITS DSO FROM 44.9 DAYS TO THE 32-DAY
INDUSTRY

AVERAGE

WITHOUT

AFFECTING

SALES,

HOW

WOULD

THAT

CHANGE

RIPPLE THROUGH THE FINANCIAL STATEMENTS (SHOWN IN THOUSANDS BELOW)

AND INFLUENCE THE STOCK PRICE?
ACCOUNTS RECEIVABLE
OTHER CURRENT ASSETS
NET FIXED ASSETS
TOTAL ASSETS

ANSWER:

878
1,802
817

DEBT

$3,497

EQUITY
LIABILITIES
PLUS EQUITY

$1,945
1,552
$3,497

SALES PER DAY = $7,035,600/360 = $19,543.

ACCOUNTS RECEIVABLE UNDER NEW POLICY = $19,543 32 DAYS
= $625,376.
FREED CASH = OLD A/R - NEW A/R = $878,000 - $625,376 = $252,624.

J.

DOES IT APPEAR THAT INVENTORIES COULD BE REDUCED, AND, IF SO, HOW

SHOULD THAT ADJUSTMENT AFFECT COMPUTRONS PROFITABILITY AND STOCK
PRICE.

ANSWER:

THE INVENTORY TURNOVER RATIO IS LOW.

IT APPEARS THAT THE FIRM EITHER

HAS EXCESSIVE INVENTORY OR SOME OF THE INVENTORY IS OBSOLETE.

IF

INVENTORY WERE REDUCED, THIS WOULD IMPROVE THE LIQUIDITY RATIOS, THE
INVENTORY AND TOTAL ASSETS TURNOVER, AND THE DEBT RATIO, WHICH SHOULD
IMPROVE THE FIRMS STOCK PRICE AND PROFITABILITY.

K.

IN 2001, THE COMPANY PAID ITS SUPPLIERS MUCH LATER THAN THE DUE
DATES, AND IT WAS NOT MAINTAINING FINANCIAL RATIOS AT LEVELS CALLED
FOR IN ITS BANK LOAN AGREEMENTS.

THEREFORE, SUPPLIERS COULD CUT THE

COMPANY OFF, AND ITS BANK COULD REFUSE TO RENEW THE LOAN WHEN IT
COMES DUE IN 90 DAYS.

ON THE BASIS OF DATA PROVIDED, WOULD YOU, AS A

CREDIT MANAGER, CONTINUE TO SELL TO COMPUTRON ON CREDIT?

(YOU COULD

DEMAND CASH ON DELIVERY, THAT IS, SELL ON TERMS OF COD, BUT THAT
MIGHT CAUSE COMPUTRON TO STOP BUYING FROM YOUR COMPANY.)

SIMILARLY,

IF YOU WERE THE BANK LOAN OFFICER, WOULD YOU RECOMMEND RENEWING THE
LOAN OR DEMAND ITS REPAYMENT?

WOULD YOUR ACTIONS BE INFLUENCED IF,

IN EARLY 2002, COMPUTRON SHOWED YOU ITS 2002 PROJECTIONS PLUS PROOF
THAT IT WAS GOING TO RAISE OVER $1.2 MILLION OF NEW EQUITY CAPITAL?
ANSWER:

WHILE THE FIRMS RATIOS BASED ON THE PROJECTED DATA APPEAR TO BE

IMPROVING, THE FIRMS LIQUIDITY RATIOS ARE LOW.

AS A CREDIT MANAGER,

I WOULD NOT CONTINUE TO EXTEND CREDIT TO THE FIRM UNDER ITS CURRENT
ARRANGEMENT,

PARTICULARLY

IF

DIDNT

HAVE

ANY

EXCESS

CAPACITY.

TERMS OF COD MIGHT BE A LITTLE HARSH AND MIGHT PUSH THE FIRM INTO
BANKRUPTCY. LIKEWISE, IF THE BANK DEMANDED REPAYMENT THIS COULD ALSO
FORCE THE FIRM INTO BANKRUPTCY.
CREDITORS ACTIONS WOULD DEFINITELY BE INFLUENCED BY AN INFUSION
OF EQUITY CAPITAL IN THE FIRM.

THIS WOULD LOWER THE FIRMS DEBT

RATIO AND CREDITORS RISK EXPOSURE.

L.

IN HINDSIGHT, WHAT SHOULD COMPUTRON HAVE DONE BACK IN 2000?

ANSWER:

BEFORE THE COMPANY TOOK ON ITS EXPANSION PLANS, IT SHOULD HAVE DONE
AN EXTENSIVE RATIO ANALYSIS TO DETERMINE THE EFFECTS OF ITS PROPOSED
EXPANSION ON THE FIRMS OPERATIONS.

HAD THE RATIO ANALYSIS BEEN

CONDUCTED, THE COMPANY WOULD HAVE GOTTEN ITS HOUSE IN ORDER BEFORE
UNDERGOING THE EXPANSION.

M.

WHAT ARE SOME POTENTIAL PROBLEMS AND LIMITATIONS OF FINANCIAL RATIO

ANALYSIS?

ANSWER:

SOME POTENTIAL PROBLEMS ARE LISTED BELOW:

1. COMPARISON

WITH

INDUSTRY

AVERAGES

IS

DIFFICULT

IF

THE

FIRM

OPERATES MANY DIFFERENT DIVISIONS.

2. DIFFERENT OPERATING AND ACCOUNTING PRACTICES DISTORT COMPARISONS.
3. SOMETIMES HARD TO TELL IF A RATIO IS GOOD OR BAD.
4. DIFFICULT TO TELL WHETHER COMPANY IS, ON BALANCE, IN A STRONG OR
WEAK POSITION.
5. AVERAGE PERFORMANCE IS NOT NECESSARILY GOOD.
6. SEASONAL FACTORS CAN DISTORT RATIOS.
7. WINDOW DRESSING TECHNIQUES CAN MAKE STATEMENTS AND RATIOS LOOK
BETTER.
N.

WHAT

ARE

SOME

QUALITATIVE

FACTORS

ANALYSTS

SHOULD

CONSIDER

WHEN

EVALUATING A COMPANYS LIKELY FUTURE FINANCIAL PERFORMANCE?

ANSWER:

TOP

ANALYSTS

RECOGNIZE

THAT

CERTAIN

CONSIDERED WHEN EVALUATING A COMPANY.

QUALITATIVE

FACTORS

MUST

BE

THESE FACTORS, AS SUMMARIZED

BY THE AMERICAN ASSOCIATION OF INDIVIDUAL INVESTORS (AAII), ARE AS

FOLLOWS:
1. ARE THE COMPANYS REVENUES TIED TO ONE KEY CUSTOMER?
2. TO WHAT EXTENT ARE THE COMPANYS REVENUES TIED TO ONE KEY PRODUCT?
3. TO WHAT EXTENT DOES THE COMPANY RELY ON A SINGLE SUPPLIER?
4. WHAT PERCENTAGE OF THE COMPANYS BUSINESS IS GENERATED OVERSEAS?
5. COMPETITION
6. FUTURE PROSPECTS
7. LEGAL AND REGULATORY ENVIRONMENT