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A large loss occurred in 2017 at Transpire Inc in Canterbury, rather than the expected profit. As a result, its stakeholders are concerned about the firm’s performance.
You are hired as the new Chief Financial Officer and are given the task of getting the company back into a sound financial position. Transpire’s 2016 and 2017 balance sheets and income statements, together with projections for 2018, are shown in the following tables. The tables also show the 2016 and 2017 financial ratios, along with industry average data. The 2018 projected financial statement data represent the best projection for 2018 results, assuming that some new financing is arranged to get the company “over the hump” and back on track.
You 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.
Table 1. Transpire Inc. Balance Sheets
| Assets | 2016 | 2017 | 2018e | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ($‘000) | ($‘000) | ($‘000) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cash | 8,000 | 7,482 | 15,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Short-Term Investments | 48,600 | 20,000 | 71,632 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Accounts Receivable | 351,200 | 652,160 | 878,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Inventories | 715,200 | 1,287,360 | 1,816,480 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Current Assets | 1,123,000 | 1,967,002 | 2,781,112 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Gross Fixed Assets | 491,000 | 1,202,950 | 1,220,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Less: Accumulated Depreciation | 146,200 | 263,160 | 383,160 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net Fixed Assets | 344,800 | 939,790 | 836,840 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total Assets | 1,467,800 | 2,906,792 | 3,617,952 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Table 2. Transpire Inc. Income Statements
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Table 3 Transpire Inc. other data
| Stock Price ($) | 85.00 | 60.00 | 78.00 | |
| Shares (units) | 100,000 | 100,000 | 250,000 | |
| Earnings per Share ($) | 6.88 | – | 1.59 | 3.41 |
| Dividend per Share ($) | 0.22 | – | 0.22 | |
| Tax Rate (%) | 40.00 | 40.00 | 40.00 | |
| Book Value per Share ($) | 6.638 | 5.960 | 7.909 | |
| Lease Payments ($) | 40,000 | 40,000 | 40,000 |
Table 4 Transpire Inc. Ratio Analysis
| 2016 | 2017 | 2018e | Industry | ||
| Average | |||||
| Current Ratio (X) | 2.34 | 1.50 | 2.67 | 2.00 | |
| Quick Ratio (X) | 0.85 | 0.52 | 0.93 | 1.00 | |
| Inventory Turnover (X) | 4.00 | 3.87 | 3.19 | 5.00 | |
| Average Age of Inventory (days) | 91.15 | 94.35 | 114.31 | 45.00 | |
| Average Collection Period (days) | 28.92 | 40.80 | 39.88 | 30.00 | |
| Average Payment Period (days) | 18.56 | 23.75 | 22.64 | 60.00 | |
| Fixed Asset Turnover (X) | 12.85 | 6.21 | 9.60 | 8.00 | |
| Total Asset Turnover (X) | 3.02 | 2.01 | 2.22 | 2.50 | |
| Debt Ratio (X) | 0.55 | 0.79 | 0.45 | 0.35 | |
| Debt to Equity Ratio (X) | 1.21 | 3.88 | 0.83 | 0.80 | |
| Times Interest Earned (X) | 19.35 | 0.10 | 18.78 | 25.00 | |
| Gross Profit Margin (%) | 35.38 | 14.64 | 27.82 | 28.00 | |
| Operating Profit Margin (%) | 27.28 | 0.30 | 18.70 | 17.00 | |
| Net Profit Margin (%) | 15.52 | – | 2.72 | 10.62 | 12.00 |
| Return on Total Assets (%) | 46.87 | – | 5.45 | 23.59 | 30.00 |
| Return on Equity (%) | 103.64 | – | 26.60 | 43.17 | 35.00 |
| Price/Earnings (P/E) Ratio (X) | 12.36 | – | 37.84 | 22.84 | 10.00 |
| Market/Book Value Ratio (X) | 12.81 | 10.07 | 9.86 | 7.00 |
1.Discuss the major strengths and weaknesses of the firm using the results of Du Pont analysis as projected for 2018.
2.Perform a common size analysis and percent change analysis. What do these analyses tell you about Transpire? What actions should be taken to improve its overall financial position?
3. What are some potential problems and limitations of financial ratio analysis?
Expert Answer
| 1. Du-Pont Ananlysis for 2018 |
| ROE=Profit Margin*Total Asset Turnover*Financial Leverage |
| ie. ROE=(Net Income/Net Sales)*(Net Sales/Av total Assets)*(Total Assets/Total Equity) |
| 43.17=10.62*2.22*1.83 |
| ROE=Net Income/Total Equity– $ income generated per $ of total equity employed more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average |
| N/P Margin Is almost comparable but for yrs. 2017 & 2018 |
| ATO=Sales/Total assets–Generated more $ sales per $ of fixed assets than in the year 2017 |
| Financial leverage suggest that assets are funded by debt (almost 83%) in addition to equity financing |
| Table 4 Transpire Inc. Ratio Analysis | |||||
| 2016 | 2017 | 2018e | Ind. | Intrepretation | |
| Av. | |||||
| Current Ratio (X) | 2.34 | 1.5 | 2.67 | 2 | Current asset/Current Liabilities–ratio is above normal but for 2017 when it falls below normal due to increase in all components of current liabilities esp. notes payable |
| Quick Ratio (X) | 0.85 | 0.52 | 0.93 | 1 | Quick assets/Current liabilities—Below normal in all 3 yrs. –reason being increase in current liabilities |
| Inventory Turnover (X) | 4 | 3.87 | 3.19 | 5 | COGS/Av.Inventory–Below industry average in all 3 yrs.—indicating slow conversion of inventory into sales/receivables |
| Average Age of Inventory (days) | 91.15 | 94.35 | 114.31 | 45 | 365/Inv.T.O.—Very high compared to industry average.Inventory management needs appraisal. |
| Average Collection Period (days) | 28.92 | 40.8 | 39.88 | 30 | 365/Receivables T.O.—Receivables take more to convert to cash in 2017 & 2018.Cash inflows will be affected |
| Average Payment Period (days) | 18.56 | 23.75 | 22.64 | 60 | 365/Payables T.O.—Indicates quicker payment to creditors than prevalent in the industry –non/under -utilistion of credit period,again cash circulation within the business will be adversely affected |
| Fixed Asset Turnover (X) | 12.85 | 6.21 | 9.6 | 8 | Sales/Fixed assets–Generated more $ sales per $ of fixed assets but for the year 2017 |
| Total Asset Turnover (X) | 3.02 | 2.01 | 2.22 | 2.5 | Sales/Total assets–Generated more $ sales per $ of fixed assets than in the year 2017 |
| Debt Ratio (X) | 0.55 | 0.79 | 0.45 | 0.35 | Total liabilities/Total assets—Compared to Industry average denotes more liabilities per $ of total assets esp. in 2017 |
| Debt to Equity Ratio (X) | 1.21 | 3.88 | 0.83 | 0.8 | Total liabilities/Total Equity—Compared to Industry average denotes more liabilities per $ of total equity esp. in 2017. A higher ratio is risky for investors & creditors |
| Times Interest Earned (X) | 19.35 | 0.1 | 18.78 | 25 | EBIT/Interest expense– Times interest expense covered by EBIT is no where near the industry average esp. in 2017 |
| Gross Profit Margin (%) | 35.38 | 14.64 | 27.82 | 28 | Is almost comparable but for 2017 |
| Operating Profit Margin (%) | 27.28 | 0.3 | 18.7 | 17 | Is almost comparable but for 2017 |
| Net Profit Margin (%) | 15.52 | 2.72 | 10.62 | 12 | Is almost comparable but for yrs. 2017 & 2018 |
| Return on Total Assets (%) | 46.87 | 5.45 | 23.59 | 30 | Net Income/Total assets– $ income generated per $ of total asset more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average |
| Return on Equity (%) | 103.6 | 26.6 | 43.17 | 35 | Net Income/Total Equity– $ income generated per $ of total equity employed more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average |
| Price/Earnings (P/E) Ratio (X) | 12.36 | 37.84 | 22.84 | 10 | MPS/EPS- Ratio is more in 2017 as the denominator EPS is the least in that year,even though the stock price is also at a low |
| Market/Book Value Ratio (X) | 12.81 | 10.07 | 9.86 | 7 | MV/BV – Ratio is declining but still more than the industry average. |
| 2. Transpire Inc. Income Statements | |||||||||
| 2016 | % of sales | 2017 | % of sales | (2017-2016 ) | 2018 | % of sales | 2018-2017 | Analysis of the change | |
| % change | % change | ||||||||
| Sales | 4432000 | 100.00% | 5834400 | 100.00% | 0.00% | 8035600 | 100.00% | 0.00% | |
| COGS excluding depreciation | 2864000 | 64.62% | 4980000 | 85.36% | 20.73% | 5800000 | 72.18% | -13.18% | Major increase in 2017 -projected to decrease in 2018 |
| Depreciation | 18900 | 0.43% | 116960 | 2.00% | 1.58% | 120000 | 1.49% | -0.51% | Decrease projected |
| Other Expenses | 340000 | 7.67% | 720000 | 12.34% | 4.67% | 612960 | 7.63% | -4.71% | Decrease projected |
| Total Operating Costs | 3222900 | 72.72% | 5816960 | 99.70% | 26.98% | 6532960 | 81.30% | -18.40% | Decrease projected |
| EBIT | 1209100 | 27.28% | 17440 | 0.30% | -26.98% | 1502640 | 18.70% | 18.40% | Increase projected due to decrease in COGS |
| Interest Expense | 62500 | 1.41% | 176000 | 3.02% | 1.61% | 80000 | 1.00% | -2.02% | show a decline in interest expenses |
| EBT | 1146600 | 25.87% | -158560 | -2.72% | -28.59% | 1422640 | 17.70% | 20.42% | Increase projected due to decrease in COGS& int.exp. |
| Taxes (40%) | 458640 | 10.35% | 0 | 0.00% | -10.35% | 569056 | 7.08% | 7.08% | Change due to profits projected |
| Net Income | 687960 | 15.52% | -158560 | -2.72% | -18.24% | 853584 | 10.62% | 13.34% | Increase projected due to decrease in COGS& int.exp. |
| Transpire Inc. Balance Sheets | |||||||||
| Assets | 2016 | % | 2017 | % | % | 2018e | % | % | |
| ($‘000) | to Tot. | ($‘000) | to Tot. | Change | ($‘000) | to Tot. | Change | ||
| Cash | 8,000 | 0.55% | 7,482 | 0.26% | -0.29% | 15,000 | 0.41% | 0.16% | |
| Short-Term Investments | 48,600 | 3.31% | 20,000 | 0.69% | -2.62% | 71,632 | 1.98% | 1.29% | |
| Accounts Receivable | 351,200 | 23.93% | 652,160 | 22.44% | -1.49% | 878,000 | 24.27% | 1.83% | |
| Inventories | 715,200 | 48.73% | 1,287,360 | 44.29% | -4.44% | 1,816,480 | 50.21% | 5.92% | Major change in acquisition of inventory |
| Total Current Assets | 1,123,000 | 76.51% | 1,967,002 | 67.67% | -8.84% | 2,781,112 | 76.87% | 9.20% | |
| Gross Fixed Assets | 491,000 | 33.45% | 1,202,950 | 41.38% | 7.93% | 1,220,000 | 33.72% | -7.66% | |
| Less: Accumulated Depn. | 146,200 | 9.96% | 263,160 | 9.05% | -0.91% | 383,160 | 10.59% | 1.54% | |
| Net Fixed Assets | 344,800 | 23.49% | 939,790 | 32.33% | 8.84% | 836,840 | 23.13% | -9.20% | |
| Total Assets | 1,467,800 | 100.00% | 2,906,792 | 100.00% | 0.00% | 3,617,952 | 100.00% | 0.00% | |
| Liabilities And Equity | 2016 | 2017 | 2018e | ||||||
| Accounts Payable | 145,600 | 9.92% | 324,000 | 11.15% | 1.23% | 359,800 | 9.94% | -1.20% | |
| Notes Payable | 200,000 | 13.63% | 701,800 | 24.14% | 10.52% | 301,000 | 8.32% | -15.82% | Major change in repayments |
| Accruals | 135,000 | 9.20% | 284,960 | 9.80% | 0.61% | 380,000 | 10.50% | 0.70% | |
| Total Current Liabilities | 480,600 | 32.74% | 1,310,760 | 45.09% | 12.35% | 1,040,800 | 28.77% | -16.33% | |
| Long-Term Debt | 323,432 | 22.04% | 1,000,000 | 34.40% | 12.37% | 600,000 | 16.58% | -17.82% | Major change in repayments |
| Common Stock | 460,000 | 31.34% | 536,800 | 18.47% | -12.87% | 1,680,936 | 46.46% | 27.99% | New Issue |
| Retained Earnings | 203,768 | 13.88% | 59,232 | 2.04% | -11.84% | 296,216 | 8.19% | 6.15% | |
| Total Equity | 663,768 | 45.22% | 596,032 | 20.50% | -24.72% | 1,977,152 | 54.65% | 34.14% | |
| Total Liabilities And Equity | 1,467,800 | 100.00% | 2,906,792 | 100.00% | 0.00% | 3,617,952 | 100.00% | 0.00% |
| Summary: |
| As of 2017, COGS constitutes maximum % (85.36%) of sales eating into profits. |
| that has been cut down to 72.18% in 2018 |
| 2017 is marked with acquisition of current liabilities like account payables, Notes payables(reason for lesser current ratio) & also long-term debt. |
| In 2018,these have been reduced& repaid |
| Recommendations: |
| 1.To improve the liquidity ratios like current & quick ratios, current liabilities have to be kept at the optimum level |
| 2. Collection of Accounts Receivables must be within the industry average which will improve the cash position. |
| 3.Maximum advantage should be taken with payment to creditors ,keeping in line with the industry norm. |
| Limitations of ratio analysis: |
| 1.They are only numbers & cannot be used as a stand-alone metric for any useful & meaningful analysis |
| 2.Many reasons behind a particular value for any item on the financials,need to be analysed before & cannot be assumed as such. |
| 3.The accounting figures ,from which the ratios are calculated,are themselves sometimes subject to many approximations or even manipulation. Therefore, ratios may not be very helpful in drawing reliable conclusions |
| 4. Inflation is bound to limit the utility of accounting ratios. |
| 5. Different method of aggregating the sub-headings of accounts in different years,may complicate grouping of figures for purposes of |
