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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