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 THE 2002 PROJECTED FINANCIAL STATEMENT DATA WITH INDUSTRY AVERAGE 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. SMALL PROFIT BY DECEMBER. FINAL MONTHLY DATA. AND MONTHLY SALES WERE RISING, COSTS WERE FALLING, AND LARGE LOSSES IN THE EARLY MONTHS HAD TURNED TO A THUS, THE ANNUAL DATA LOOKED SOMEWHAT WORSE THAN IT APPEARS TO BE TAKING LONGER TO FOR THE ALSO, FOR THE

ADVERTISING PROGRAM TO GET THE MESSAGE ACROSS, FOR THE NEW SALES OFFICES TO GENERATE SALES, NEW MANUFACTURING FACILITIES OPERATE EFFICIENTLY. IN OTHER WORDS, THE LAGS BETWEEN SPENDING MONEY AND DERIVING FOR THESE

BENEFITS WERE LONGER THAN COMPUTRONS MANAGERS HAD ANTICIPATED. IN THE SHORT RUN.

REASONS, JAMISON AND CAMPO SEE HOPE FOR THE COMPANY--PROVIDED IT CAN SURVIVE 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. EXPLANATIONS, NOT YES OR NO ANSWERS. YOUR PROVIDE CLEAR

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 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: E INDICATES ESTIMATED. $ 14,000 71,632 878,000 1,716,480 $2,680,112 1,197,160 380,120 $ 817,040 $3,497,152 $ 436,800 600,000 408,000 $1,444,800 500,000 1,680,936 (128,584) $1,552,352 $3,497,152 $ 2001 7,282 0 632,160 1,287,360 $1,926,802 1,202,950 263,160 $ 939,790 $2,866,592 $ 524,160 720,000 489,600 $1,733,760 1,000,000 460,000 (327,168) $ 132,832 $2,866,592 $ 2000___ 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
SALES COST OF GOODS SOLD OTHER EXPENSES DEPRECIATION TOTAL OPERATING COSTS EBIT INTEREST EXPENSE EBT TAXES (40%) NET INCOME EPS DPS BOOK VALUE PER SHARE STOCK PRICE SHARES OUTSTANDING TAX RATE LEASE PAYMENTS SINKING FUND PAYMENTS NOTE: E INDICATES ESTIMATED. Mini Case: 3 - 2 2002E $7,035,600 6,100,000 312,960 120,000 $6,532,960 $ 502,640 80,000 $ 422,640 169,056 $ 253,584 $1.014 $0.220 $6.209 $12.17 250,000 40.00% 40,000 0 2001 $5,834,400 5,728,000 680,000 116,960 $6,524,960 ($ 690,560) 176,000 ($ 866,560) (346,624) ($ 519,936) ($5.199) $0.110 $1.328 $2.25 100,000 40.00% 40,000 0 2000___ $3,432,000 2,864,000 340,000 18,900 $3,222,900 $ 209,100 62,500 $ 146,600 58,640 $ 87,960 $0.880 $0.220 $6.638 $8.50 100,000 40.00% 40,000 0

THE 2002 DATA ARE FORECASTS.

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. HOWEVER. BOTH RATIOS ARE WELL BELOW THE INDUSTRY AVERAGE,

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)

Mini Case: 3 - 4

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

= $878,000/($7,035,600/360) = 44.9 DAYS.

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 WHILE ITS THE DAYS FIRMS SALES FIXED OUTSTANDING ASSETS HAS BEEN STEADILY IS INCREASING. ITS 2000 TURNOVER RATIO BELOW

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 INDUSTRY AVERAGE THE FIRMS DAYS SALES OUTSTANDING IS ABOVE (WHICH IS BAD); HOWEVER, THE FIRMS FIXED (THIS MIGHT BE DUE

ASSETS TURNOVER IS ABOVE THE INDUSTRY AVERAGE.

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.) CAPITAL REQUIREMENT THAT RATIO IS HIGHER THAN MORE INDICATING COMPUTRON REQUIRES THE FIRMS OPERATING THE INDUSTRY OF AVERAGE, TO CAPITAL

DOLLARS

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? WHAT CAN YOU CONCLUDE FROM THESE RATIOS?

ANSWER:

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 + REPAYMENTS + PAYMENTS = ($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). ABOUT THESE RATIOS? WHAT CAN YOU SAY

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?

WHAT DO

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% Common Size Income statement Sales COGS Other exp. Depr. EBIT
Mini Case: 3 - 8

2001 0.3% 0.0% 22.1% 44.9% 67.2% 32.8% 100.0% 2001 18.3% 25.1% 17.1% 60.5% 34.9% 16.0% -11.4% 4.6% 100.0%

2002E 0.4% 2.0% 25.1% 49.1% 76.6% 23.4% 100.0% 2002E 12.5% 17.2% 11.7% 41.3% 14.3% 48.1% -3.7% 44.4% 100.0%

Ind. 0.3% 0.3% 22.4% 41.2% 64.1% 35.9% 100.0% Ind. 11.9% 2.4% 9.5% 23.7% 26.3% 20.0% 30.0% 50.0% 100.0%

2000 100.0% 83.4% 9.9% 0.6% 6.1%

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%

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%). INDUSTRY, BUT LESS COMPUTRON HAS SLIGHTLY LESS EQUITY (WHICH MEANS COMPUTRON HAS MORE SHORT-TERM DEBT THAN DEBT THAN INDUSTRY. COMPUTRON HAS LONG-TERM MORE DEBT) THAN INDUSTRY.

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% 2000 0.0% 0.0% 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% 2001 260.0% 260.0% 260.0% 260.0% 209.2% 0.0% -260.6% -80.0% 95.2% 2002E 55.6% 47.4% 150.0% 140.0% 138.4% 137.0% 138.1% 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 Sales COGS Other exp. 2000 0.0% 0.0% 0.0% 2001 70.0% 100.0% 100.0% 2002E 105.0% 113.0% -8.0%

Depr. EBIT Int. Exp. EBT Taxes NI

0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

518.8% -430.3% 181.6% -691.1% -691.1% -691.1%

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. THE FIRMS MAJOR STRENGTHS AND WEAKNESSES? WHAT ARE

ANSWER:

PROFIT TOTAL ASSETS DU PONT EQUATION = MARGIN TURNOVER

EQUITY 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.) HIGHER DEBT RATIO. THE FIRMS PROFIT MARGIN IS SLIGHTLY ABOVE THE INDUSTRY AVERAGE, DESPITE ITS 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 $ 878 1,802 817 DEBT EQUITY LIABILITIES PLUS EQUITY $1,945 1,552 $3,497

$3,497

ANSWER:

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. IT COMES DUE IN 90 DAYS. THEREFORE, SUPPLIERS COULD CUT THE COMPANY OFF, AND ITS BANK COULD REFUSE TO RENEW THE LOAN WHEN ON THE BASIS OF DATA PROVIDED, WOULD YOU, (YOU AS A CREDIT MANAGER, CONTINUE TO SELL TO COMPUTRON ON CREDIT? THAT MIGHT CAUSE COMPUTRON TO STOP BUYING FROM YOUR

COULD DEMAND CASH ON DELIVERY, THAT IS, SELL ON TERMS OF COD, BUT COMPANY.) SIMILARLY, IF YOU WERE THE BANK LOAN OFFICER, WOULD YOU RECOMMEND RENEWING THE LOAN OR DEMAND ITS REPAYMENT? INFLUENCED IF, IN EARLY 2002, COMPUTRON WOULD YOUR ACTIONS BE 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, CURRENT CAPACITY. THE FIRMS LIQUIDITY PARTICULARLY RATIOS IF I ARE LOW. HAVE AS A CREDIT EXCESS MANAGER, I WOULD NOT CONTINUE TO EXTEND CREDIT TO THE FIRM UNDER ITS ARRANGEMENT, DIDNT ANY 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. ANSWER:

IN HINDSIGHT, WHAT SHOULD COMPUTRON HAVE DONE BACK IN 2000? 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. UNDERGOING THE EXPANSION. HAD THE RATIO ANALYSIS BEEN CONDUCTED, THE COMPANY WOULD HAVE GOTTEN ITS HOUSE IN ORDER BEFORE

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 QUALITATIVE FACTORS MUST BE

CONSIDERED WHEN EVALUATING A COMPANY. FOLLOWS:

THESE FACTORS, AS SUMMARIZED

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

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