Assessing a Company’s Future Financial
Health Case Analysis Executive Summary
A firm’s ability to analyze its long-term financial health can become a key asset for management as it formulates new, and/or revises old, strategies, and goals. The key goal of management is to anticipate future imbalances in its financial systems before a negative result occurs within its financials. As the HBR case describes, “Management must ensure the continuity of the flow of funds to all of its strategically important programs, even in periods of adversity. This is true in business but also in everyone’s personal life. There will always be ups and downs in life, but everyone as an individual must prepare for these obstacles and continue to strive forward.
Does high growth always require external financing? No, the high growth of a firm does not always require external financing. The need for a firm to rely on external financing depends on the industry of the firm. As explained in the case, a restaurant does not require external financing to result in high growth. With a low level of total assets found in a restaurant, it will not need financing during a period where it experiences rapid growth because the financial gap will be offset by the increase in accrued expenses. On the other hand, in a different industry where the level of total assets is quite large, this gap can’t be sufficed by an increase in the liabilities side of the balance sheet. This gap can only be bridged by obtaining loans or issuing debt against the firm.
Fill in the blanks on pages 6 through 10.
During the four-year period ended December 31, 2008, SciTronics’ sales grew at a 65. 9% compound rate. There were no acquisitions or divestitures.
Sitronics’ profit as a percentage of sales in 2008 was 5. 74%. (Return on Sales = Net Income/Net Sales = $14 mil/$244 mil)
This represented an increase from 3. 40% in 2005. (Return on Sales = $5 mil/ $147 mil)
Sitronics had a total of $111 mil of capital at year-end 2008 and earned, before interest but after taxes (EBIT), $15. 158 mil in 2008. Its return on capital was 13. 66% in 2008, which represented an increase from the 7. 72% earned in 2005.
SciTronics had $75 mil of owner’s equity and earned $14 mil after taxes in 2008. Its return on equity was 18. 67%, which represented an improvement from the 8. 20% earned in 2005. (ROE2008 = 14 mil/75 mil and ROE2005 =5 mil/61 mil)
Total asset turnover for SciTronics in 2008 can be calculated by dividing $159 mil into $244 mil. The turnover deteriorated from 1. 58 times in 2005 to 1. 53 times in 2008.
SciTronics had $66 mil invested in accounts receivable at year-end 2008. Its average sales per day were $668,493. 15 during 2008 and its average collection period was 98. 73 days. This represented an improvement from the average collection period of 104. 9 days in 2005.
SciTronics apparently needed $29 mil of inventory at year-end 2008 to support its operations during 2008. Its activity during 2008 as measured by the cost of goods sold was $74 mil. It, therefore, had an inventory turnover of 2. 55 times. This represented an improvement from 2. 05 times in 2005. (Inv. Turnover2008 = 74 mil/29 mil and Inv. Turnover2005 = 43 mil/21 mil).
SciTronics had net fixed assets of $18 mil and sales of $244 mil in 2008. Its fixed asset turnover ratio is 2008 was 13. 56 times, a deterioration from 16. 33 times in 2005. (FA Turnover2008 = 244 mil/18 mil and FA Turnover2005 = 147 mil/9 mil)
SciTronics’ ratio of total assets divided by owner’s equity increased from 1. 52 at year-end 2005 to 2. 12 at year-end 2008.
At year-end 2008, SciTronics total liabilities were 52. 83% of its total assets, which compares with 34. 41% in 2005.
The market value of SciTronics equity was $175,000,000 on December 31, 2008. The total debt ratio at the market was 32. 43%. (TD @ market = 84 mil/259 mil).
SciTronics’ earnings before interest and taxes (operating income) were $24 mil in 2008 and its interest charges were $2 mil. Its time interest earned was 12 times. This represented an improvement from the 2005 level of 9 times.
SciTronics owed its suppliers $6 mil at year-end 2008. This represented 8. 11% of the cost of goods sold and was a decrease from 11. 63% at year-end 2005. The company appears to be more prompt in paying its suppliers in 2008 than it was in 2005.
The financial riskiness of SciTronics decrease between 2005 and 2008.
SciTronics held $133 mil of current assets at year-end 2008 and owed $48 mil to creditors, due to be paid within one year. SciTronics’ current ratio was 2. 77, a decrease from the ratio of 3. 90 at year-end 2005. The quick ratio for SciTronics at year-end 2008 was 2. 17, and increase/decrease from the ratio of 2. 90 at year-end 2005. (Quick2008 = (133 mil-29 mil)/48 mil and Quick2005 = (82 mil-21 mil)/21 mil)
The improvement in SciTronics’ return on equity from 8. 2% in 2005 to 18. 7% in 2008 resulted from an increase (RoS2008 = 14 mil/244 mil and RoS2005 = 5 mil/147 mil) in its return on sales, and from a decrease (ATO2008=244 mil/159 mil and ATO2005=147 mil/93 mil) in its asset turnover, and a decrease (Lev2008=159 mil/75 mil and Lev2005=147 mil/61 mil) in its financial leverage. Assign the five unidentified industries to A, B, C, D, and Eon.
A. Electric Utility – low inventory, large fixed assets
B. Discount General Merchandise Retailer – large fixed assets
C. Japanese automobile manufacturer – large fixed assets, longest inventory turnover time
D. Automated Test Equipment – low inventory, high accounts payable
E. Upscale Apparel Retailer – small margin of profitability, medium-sized inventory
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