LIABILITIES AND EQUITIES

50,000

Short-term bank loans $150,000 $145,000 $140,000 $148,000 $148,000 Accounts payable 10,000 10,506 19,998 15,995 16,795 Accruals 5,000 5,100 7,331 9,301 11,626

Current liabilities $65,000 $160,606 $167,329 $173,296 $176,421

63,366 Long-term bank loans $100,000 $98,000 $196,000 $190,000 $183,000 Mortgage 175,000 173,000 271,000 268,000 264,000

Long-term debt $238,366 $271,000 $467,000 $458,000 $447,000

Total liabilities $303,366 $431,606 $634,329 $631,296 $623,421

Common stock (100,000 shares) $320,000 $320,000 $320,000 $320,000 $320,000 Retained earnings 16,634 39,493 41,619 25,184 25,082

Total equity $336,634 $359,493 $361,619 $345,184 $345,082

Total liabilities and equity $640,000 $791,099 $995,948 $976,480 $968,503

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Table II

Quickfix Autoparts

Income Statement

1997 1998 1999 2000 2001

Net sales $600,000 $655,000 $780,000 $873,600 $1,013,376 Cost of goods sold 480,000 537,100 655,200 742,560 861,370

Gross profit $120,000 $117,900 $124,800 $131,040 $152,006

Admin and selling exp $30,000 $15,345 $16,881 $43,680 $40,535 Depreciation 25,000 25,000 50,000 50,000 50,000 Miscellaneous expenses 2,027 3,557 5,725 17,472 15,201

Total operating exp $57,027 $43,902 $72,606 $111,152 $105,736

EBIT $62,973 $73,998 $52,194 $19,888 $46,271

Interest on ST loans $15,000 $15,950 $14,000 $13,320 $13,320 Interest on LT loans 8,000 7,840 15,680 15,200 14,640 Interest on mortgage 12,250 12,110 18,970 18,760 18,480

Total interest $35,250 $35,900 $48,650 $47,280 $46,440

Before-tax earnings $27,723 $38,098 $3,544 ($27,392) ($169)Taxes 11,089 15,239 1,418 (10,957) (68)

Net income $16,634 $22,859 $2,126 ($16,435) ($102)

Dividends on stock 0 0 0 0 0

Additions to retained earnings $16,634 $22,859 $2,126 ($16,435) ($102)

EPS (100,000 shares) $0.17 $0.23 $0.02 ($0.16) ($0.00)

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1. How does Quickfix’s average compound growth rate in sales compare with its earnings growth rate over the past five years?

Quickfix’s sales have increased by an average compound rate of 14% per year over the period, 1997-2001. In comparison, its net income has declined from over $16,600 million to a loss of $102 in 2001.

2. Which statements should Juan refer to and which one’s should he construct so as to develop a fair assessment of the firm’s financial condition? Explain why?

Juan should refer to the income statement and the balance sheet over the past 3-5 year period. In addition, he should prepare a cash flow statement, common size income statement and common size balance sheet. The accounting statements provide the raw data from which the other statements can be prepared. The cash flow statement helps determine where the cash came from and where it was spent during a year. The common size statements provide useful information regarding the relative trends of the various assets, liabilities, revenue sources, and expense items. They also help the analyst make meaningful comparisons between firms of varying sizes.

3. What calculations should Juan do in order to get a good grasp of what is going on

with Quickfix’s performance? Juan should calculate the various liquidity, leverage, profitability, activity, and coverage ratios for at least a three-year period. In addition, a Du Pont analysis of the return on equity will help determine what has affected the profitability of the company.

4. Juan knows that he should compare Quickfix’s condition with an appropriate benchmark. How should he go about obtaining the necessary comparison data? Based on Quickfix’s industry classification code, Juan should collect industry averages of the key financial ratios. Some useful sources for industry ratios include: Value Line, Moody’s, Standard & Poor, And Dun & Bradstreet. In addition to the industry average, the industry leader’s (within the size category) ratios could also be collected from the Internet (e.g. Marketguide.com) and used for comparison.

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5. Besides comparison with the benchmark what other types of analyses could Juan

perform to comprehensively analyze the firm’s condition? Perform the suggested analyses and comment on your findings. Besides comparison with the benchmark, Juan could perform common size analyses of the financial statements and a DuPont analysis of the return on assets and the return on equity.

Quickfix Autoparts

Common Size Income Statement 1997 1997% 1998 1998% 1999 1999% 2000 2000% 2001 2001%

Net sales $600,000 100.0% $655,000 100.0% $780,000 100.0% $873,600 100.0% $1,013,376 100.0%Cost of goods sold

480,000 80.0% 537,100 82.0% 655,200 84.0% 742,560 85.0% 861,370 85.0%

Gross profit $120,000 20.0% $117,900 18.0% $124,800 16.0% $131,040 15.0% $152,006 15.0%

Admin and selling exp

$30,000 5.0% $15,345 2.3% $16,881 2.2% $43,680 5.0% $40,535 4.0%

Depreciation 25,000 4.2% 25,000 3.8% 50,000 6.4% 50,000 5.7% 50,000 4.9%

Miscellaneous expenses

2,027 0.3% 3,557 0.5% 5,725 0.7% 17,472 2.0% 15,201 1.5%

Total operating exp

$57,027 9.5% $43,902 6.7% $72,606 9.3% $111,152 12.7% $105,736 10.4%

EBIT $62,973 10.5% $73,998 11.3% $52,194 6.7% $19,888 2.3% $46,271 4.6%

Interest on ST loans

$15,000 2.5% $15,950 2.4% $14,000 1.8% $13,320 1.5% $13,320 1.3%

Interest on LT loans

8,000 1.3% 7,840 1.2% 15,680 2.0% 15,200 1.7% 14,640 1.4%

Interest on mortgage

12,250 2.0% 12,110 1.8% 18,970 2.4% 18,760 2.1% 18,480 1.8%

Total interest $35,250 5.9% $35,900 5.5% $48,650 6.2% $47,280 5.4% $46,440 4.6%

Before-tax earnings

$27,723 4.6% $38,098 5.8% $3,544 0.5% ($27,392) -3.1% ($169) -0.02%

Taxes 11,089 1.8% 15,239 2.3% 1,418 0.2% -10,957 -1.3% -68 -0.01%

Net income $16,634 2.8% $22,859 3.5% $2,126 0.3% ($16,435) -1.9% ($102) -0.01%

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The common size income statement indicates that the firm’s cost of goods sold has increased quite a bit since 1997. Miscellaneous expenses have also increased from .3% of sales to 1.5% of sales. On the other hand, selling and administrative expenses and interest charges have come down a bit. The firm needs to look into its cost structure and try and reduce the overall costs of doing business. The common size balance sheet (shown below) shows that the firm’s inventory and accounts receivables levels have gone up sharply, while its cash balance has significantly declined. Fixed assets have increased over the past 5 years. The firm has taken on significantly larger amounts of short and long-term debt relative to its total assets. Equity has not increased proportionately with debt. As a result its capital structure has become more leveraged.

Quickfix Autoparts

Balance Sheet 1997 2000% 1998 1998% 1999 1999% 2000 2000% 2001 2001%

ASSETS Cash and marketable

securities $155,000 24.22% $309,099 39.07% $75,948 7.63% $28,826 2.95% $18,425 1.90%Accounts receivable 10,000 1.56% 12,000 1.52% 20,000 2.01% 77,653 7.95% 90,078 9.30%Inventory 250,000 39.06% 270,000 34.13% 500,000 50.20% 520,000 53.25% 560,000 57.82%

Current assets $415,000 64.84% $591,099 74.72% $595,948 59.84% $626,480 64.16% $668,503 69.02%

Land, buildings, plant, and equipment $250,000 39.06% $250,000 31.60% $500,000 50.20% $500,000 51.20% $500,000 51.63%Accumulated depreciation -25,000 -3.91% -50,000 -6.32% -100,000 -10.04% -150,000 -15.36% -200,000 -20.65%

Net fixed assets $225,000 35.16% $200,000 25.28% $400,000 40.16% $350,000 35.84% $300,000 30.98%

Total assets $640,000 100.00% $791,099 100.00% $995,948 100.00% $976,480 100.00% $968,503 100.00%

LIABILITIES AND EQUITIES

Short-term bank loans $50,000 7.81% $145,000 18.33% $140,000 14.06% $148,000 15.16% $148,000 15.28%

Accounts payable 10,000 1.56% 10,506 1.33% 19,998 2.01% 15,995 1.64% 16,795 1.73%Accruals 5,000 0.78% 5,100 0.64% 7,331 0.74% 9,301 0.95% 11,626 1.20%

Current liabilities $65,000 10.16% $160,606 20.30% $167,329 16.80% $173,296 17.75% $176,421 18.22%

Long-term bank loans $63,366 9.90% $98,000 12.39% $196,000 19.68% $190,000 19.46% $183,000 18.90%

Mortgage 175,000 27.34% 173,000 21.87% 271,000 27.21% 268,000 27.45% 264,000 27.26%

Long-term debt $238,366 37.24% $271,000 34.26% $467,000 46.89% $458,000 46.90% $447,000 46.15%

Total liabilities $303,366 47.40% $431,606 54.56% $634,329 63.69% $631,296 64.65% $623,421 64.37%

Common stock (100,000 shares)

$320,000 50.00% $320,000 40.45% $320,000 32.13% $320,000 32.77% $320,000 33.04%

Retained earnings 16,634 2.60% 39,493 4.99% 41,619 4.18% 25,184 2.58% 25,082 2.59%

Total equity $336,634 52.60% $359,493 45.44% $361,619 36.31% $345,184 35.35% $345,082 35.63%

Total liabilities and equity $640,000 100.00% $791,099 100.00% $995,948 100.00% $976,480 100.00% $968,503 100.00%

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Du Pont Analysis

Net Profit Margin 2.77% 3.49% 0.27% -1.88% -0.01%Total Asset Turnover 0.9375 0.827962 0.7831734 0.894642 1.046332329Equity Multiplier 1.901175 2.200596 2.7541363 2.828868 2.806587999 Return on Assets 2.60% 2.89% 0.21% -1.68% -0.01% Return on Equity 4.94% 6.36% 0.59% -4.76% -0.03%

Quickfix Auto’s ROA has is currently negative but has improved since 2000. Most of the decrease has come from the deteriorating profit situation. The firm’s total asset turnover has improved since 1999. The firm’s ROE has suffered significantly since 1997. This has occurred largely due to the steep drop in net profit margin. Had the firm not had such a high equity multiplier (from its high level of debt), the ROE situation would have looked considerably worse. 6. Comment on Quickfix’s liquidity, asset utilization, long-term solvency, and

profitability ratios. What arguments would have to be made to convince the bank that they should grant Quickfix the loan?

1997 1998 1999 2000 2001

Current Ratio 6.38 3.68 3.56 3.62 3.79Quick Ratio 2.54 2.00 0.57 0.61 0.62Cash Ratio 2.38 1.92 0.45 0.17 0.10Total Debt Ratio 0.47 0.55 0.64 0.65 0.64Debt-Equity Ratio 0.90 1.20 1.75 1.83 1.81Equity Multiplier 1.90 2.20 2.75 2.83 2.81Times Interest Ratio 1.79 2.06 1.07 0.42 1.00Cash Coverage Ratio 2.50 2.76 2.10 1.48 2.07Inventory Turnover ratio 1.92 1.99 1.31 1.43 1.54Day's sales in Inventory 190.10 183.49 278.54 255.60 237.30Receivables Turnover 60.00 54.58 39.00 11.25 11.25ACP or Days' Sales in Receivables 6.08 6.69 9.36 32.44 32.44Total Asset Turnover 0.94 0.83 0.78 0.89 1.05Capital Intensity 1.07 1.21 1.28 1.12 0.96Profit Margin 2.77% 3.49% 0.27% -1.88% -0.01%ROA 2.60% 2.89% 0.21% -1.68% -0.01%ROE 4.94% 6.36% 0.59% -4.76% -0.03%

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Liquidity: The firm’s overall liquidity is quite good with a current ratio of 3.79 and it has improved quite a bit over the past three years. However, much of its current assets are tied in inventory, since its quick ratio is only 0.62. The ability of the firm to pay off its current liabilities from its cash reserves is not very good either and has deteriorated significantly over the past five years. Asset utilization: The firm’s inventory turnover has declined considerably since 1997. There was some improvement in 2001, but there is still a lot of room for further improvement. The receivables turnover ratio has declined as well. An average collection period of 32 days is pretty high for a retail business. The total asset turnover although not very high is at its highest level in five years. Long-term solvency: Quickfix Auto’s debt ratio is 64% of total assets. It’s debt level has gone up by almost 37% since 1997. Since the firm’s coverage ratios are fairly low, the firm’s financial structure can be considered to be fairly risky. Profitability: The firm’s profitability ratios have declined significantly in the past three years. The firm is currently making losses.

Arguments that can be made to get the loan: Improving liquidity (current ratio) and total asset turnover. Improving cash coverage and interest coverage ratios. Proof of better inventory management system (if possible) 7. If you were the commercial loan officer and were approached by Andre for a short

term loan of $25,000, what would your decision be?

Given the firm’s poor profitability and cash flow situation, I would not grant the loan. However, I would tell him that if he can demonstrate improvement in inventory management and better profitability over the next 2 quarters, we would reconsider.

8. What recommendations should Juan make for improvement, if any?

The firm needs to improve its inventory management, and credit collection policies. Further, the cost of sales and miscellaneous costs should be looked into and brought down more in line with its level in 1997. This will improve the liquidity and profitability of the company.

9. What kinds of problems do you think Juan would have to cope with when doing a comprehensive financial statement analysis of Quickfix Parts? What are the limitations of financial statement analysis in general?

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General Problems Selection of comparison benchmark Accounting procedures differ. Different fiscal year end Seasonal businesses Extraordinary gains/losses

Specific Problems Selection of appropriate benchmark/ industry averages

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