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a)

ABC Technology Co. (ABC company hereafter), is an IT firm with mostly cooperate
customers.
Companys assets are divided into current assets and fixed assets. The market recession
did not have any negative effect on the companys fixed assets. This is because the
company has already made the investments in the fixed assets and the depreciation policy
is predetermined, therefore fixed assets do not change in the short-term. But the
companys current assets are affected by the recession. Although the companys current
ratio increased from 2007 to 2008 the companys acid test ratio decreased in the same
period. This is due to increase in inventory. The companys accounts receivable has
decreased meanwhile the inventory has increased. This shows that there was a slow down
in sales towards the end of the year and the company is not able to sell the products it
produced during 2008. But it is important to note that the overall sales of 2008 increased
compared to 2007. Although companys collection period and inventory turnover can be
calculated for 2008, due to lack of information it cannot be compared with the past years
or the industry.

On the liabilities side the companys current liabilities mainly accounts payable have
decreased from 2007 to 2008. This shows that the company is a good liquidity position as
the company is able to increase its cash at the meantime reduce the accounts receivable
and payable. However companys total debt to equity ratio has increased from 2007 to
2008. This increase is due to increase in liabilities. Both the long-term debt and the notes
payable have increased significantly. This may be due to increasing cost of borrowing on
fluctuating borrowing arrangements with the banks. The companys debt to equity ratio
also increased suggesting that the company is using more debt in 2008 compared with
2007. This increase in debt has increased companys financing cost and therefore reduced
the time interest earned. This suggests that the company is now in a weaker position in
terms of covering the interest payments.

Companys sales have also increased from 2007 to 2008. This may be due to the fact that
orders for IT equipment is placed in advance and the delivery takes some time, thereby
delivering orders of 2007 in 2008. If this has happened the company will account these as
2008 sales although the orders are placed in 2007. Also it is important to note that the
recession was hit later in 2008. This may have been the reason why the companys
inventory increased as the company was not able to make sales to the forecasted level.
The companys assets are not significantly affected although inventory increased from
2007 to 2008. However the companys liabilities have increased leading to higher
financing costs which have reduced net profit significantly. But the company is not in any
solvency crisis as the company can cover the interest costs. But the company needs to be
careful about the debt in the future.
b)
ABC Companys EBIT decreased significantly (84%) from 2007 to 2008.
This decrease in EBIT was mainly due to increase in operating costs
and other expenses. The administrative and selling expenses are
increased from 2007 to 2008. This may not be directly related with the
recession although company may have increased its spending on
advertising in order to increase the sales. But being a supplier for
cooperate customers the company is likely to increase sales based on
long-term relationships instead of advertising. But due to lack of
information on companys other expenses and operating expenses it is
not possible to conclusively determine the reason for the increase in
these costs. W e do not see increase in cost of sales as a reason for the
decrease in EBIT because cost of sales naturally will increase with an
increase in sales. Because those two items have a linear relationship in
the income statement.
c)
ABC Companys total assets is comprised of current assets and fixed
assets. The companys fixed assets increased slightly and depreciation
also increased in proportion. But the main increase in assets is due to
increase in inventory. The inventory increased even though the sales
increased in 2008. This suggests that the sales growth of the company
declined in last quarter of the 2008 leaving the inventory produced at

the end of 2008 idle. However because of lack of information regarding


industry and past years for the company it is not possible to
conclusively say anything about the effects of inventory on the liquidity
position. However it is safe to safe that the companys total increase in
cash coupled with a very slight reduction in acid test ratio will keep the
company healthy in terms of paying for short-term liabilities.
d)
The company used mostly external financing to finance the increase in
assets. But it is important to note that the companys retained earnings
have also increased which may provide the company to use internal
source of financing in the future. But in 2008 company has increased
notes payable by 53% suggesting that the company depends on shortterm financial instruments to finance the assets. This may be due to
the fact that the major component increase in assets is the inventory,
which is current asset. Companies usually use current liabilities to
finance current assets. The company has also increased long-term debt
by 10%. The increase in long term debts may have been used to
finance the increase in fixed assets which amounted to a 36% increase.
This suggests that short-term notes may have financed part of the
increase in fixed assets as well. But it is important to note that using
short-term financing for fixed asset acquisitions is not healthy as
higher interest have to be paid for short-term financing instruments.
e)
ABC Companys current assets accounted for around 87% of total
assets in 2008. This suggests that the company uses large amount of
current assets. Based on the common size analysis of the company in
2008 it shows that the company finances around 50% of total assets
using short-term financing. Only 20% of total assets are financed by
using long-term debt. As mentioned earlier this may have been due to
high current assets of the company. Use of short-term financing may
increase cost of financing more than use of long-term financing. But
use of short term financing gives the company flexibility to refinance
when favorable financial terms become available.
f)
Although companys total liabilities are more than the companys
equity, companys long-term liabilities are less than companys total
equity in 2007 as well as 2008. However a high amount of long-term
liabilities will increase cost of debt (financing cost) for the company.
This will reduce companys net profit available for shareholders. The
companys times interest earned (in other words how many times the
net profit can pay the interest) is reduced significantly from 2007 to
2008. But because of the companys good liquidity position the
company is not in an immediate threat of solvency problem. This
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situation is likely to correct as the financial system recovers after the


2008 recession. I high debt to equity ratio will limit companys options
for future financing. Some banks may be reluctant to lend to a
company with a very high financial leverage.