Bagang Charmaine G.- Machine Problem 1- July 16 2011

8/2/2019 Bagang Charmaine G.- Machine Problem 1- July 16 2011

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Bagang, Charmaine G. July 15, 2011

Machine Problem No. 1

REPORT:

FINANCIAL RATIO

ANALYSIS


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Summary of Martin Manufacturing Company Ratios (2007-2009, Including 2009 Industry

Average)

Actual Actual Actual Industry Average

Ratio 2007 2008 2009 2009

Current Ratio 1.7 1.8 2.5 1.5

Quick Ratio 1 0.9 1.3 1.2

Inventory turnover 5.2 5 5.3 10.2

Average collection period

(days)

50.7 55.8 57.9 46

Total Asset turnover 1.5 1.5 1.6 2

Debt Ratio 45.8% 54.3% 57.0% 24.5%

Times interest earned ratio 2.2 1.9 1.6 2.5

Gross profit margin 27.5% 28.0% 27.0% 26.0%

Net profit margin 1.1% 1.0% 0.7% 1.2%

Return on total assets 1.7% 1.5% 1.1% 2.4%

Return on common equity 3.1% 3.3% 2.5% 3.2%

Price/earnings ratio 33.5 38.7 34.5 43.4Market/book ratio 1.0 1.1 2.8 1.2

1. LIQUIDITYYear Current Ratio

2007 1.7

2008 1.8

2009(actual) 2.5

2009(industry

ave)

1.5


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High current ratio at 2009 is an indication that the firm is liquid and has the ability to

pay its current obligations in time and when they become due. But, having a current ratio

higher than the industry average is also not good for the firm. Actual current ratio at 2009 is

very high compared to the industry average of 1.5 at 2009. This big gap suggests that the firm

may not be using its' current funds efficiently. The firm hoards its assets instead of using themto grow the business. In the balance sheet, you can see that most of the forms current assets

are on accounts receivable and inventories.

Current ratio of 2007 slightly increased by 10% at 2008. At 2009, a big increase in

current ratio happened. Increasing value of current ratio every year is a good sign for the firm

because it represents improvement in the liquidity position of the firm.

Year Quick

Ratio

2007 1

0 0.5 1 1.5 2 2.5

2007

2008

2009(actual)

2009(industry ave)

Current Ratio

Year

Current Ratio Graph


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2008 0.9

2009(actual) 1.3

2009(industry

ave)

1.2

Actual quick ratio at 2009 is higher than the industry average at 2009. This indicates that

the firm can meet its current financial obligations with the available quick funds on hand. But a

higher quick ratio also means that a firm is either keeping too much cash or is having a problem

collecting its accounts receivable. In 2008, quick ratio decreased, but at 2009, the firms quick

ratio had a big increase. In the case of Martin Manufacturing Company, the firm has a difficulty

in collecting its accounts receivable and this can be seen on the firms balance sheet. The firms

accounts receivable amounted to $805,556.

A quick ratio of 1.0 or greater is occasionally recommended. For Martin Manufacturing

Company, it is recommended that they must be strict regarding their credit policies. The

company must also evaluate its credit terms and credit policies because they seem to be

ineffective. The firm could also adjust also its credit terms.

0 0.2 0.4 0.6 0.8 1 1.2 1.4

2007

2008

2009(actual)

2009(industry ave)

Quick Ratio

Year

Quick Ratio


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2. ActivityYear Inventory turnover

2007 5.2

2008 5

2009(actual) 5.3

2009(industry ave) 10.2

Inventory turnover is consistent for the past three years. At 2008, inventory turnover

decreased slightly. At 2009, inventory turnover improved. These ratios for the past three years

indicate that the firm has a slow turnover in its operating cycle in a given year. The firm has a

difficulty in managing and selling its inventory efficiently.

Compared to the industry average, it is too low. This implies poor sales of the firm and,

therefore, excess inventory. Amount of inventories on the firms balance sheet at 2009

amounted at $700,625. The low inventory turnover of the firm indicates that there is a risk they

0 2 4 6 8 10 12

2007

2008

2009(actual)

2009(industry ave)

Inv. turnover

Year

Inventory turnover


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are holding obsolete inventory which is difficult to sell. Holding obsolete inventory may eat.

However, the company may be holding a lot of inventory for legitimate reasons.

Year Average collection period

2007 50.7

2008 55.8

2009(actual) 57.9

2009(industry

ave)

46

Average collection period for the past three years is increasing. But if you will compare

these three periods with its industry average, all of them are high. Increasing average collection

every year means that Martin Manufacturings accounts receivable are not as liquid or are not

converted quickly to cash. The firm has a difficulty in implementing its credit policies.

Compared to the industry average, average collection periods for the past three years are

all high. These mean that Martin Manufacturing Company has a long collection period

compared to the average collection period in the industry. This implies too liberal and

0

10

20

30

40

50

60

70

2007 2008 2009(actual) 2009(industry

ave)Aver

ageco

llectionperio

din

days

Year

Average collection period


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inefficient credit collection performance. It is difficult to provide a standard collection period of

debtors.

It is recommended that the firm may change its credit term that will be useful in lessening

their accounts receivable. The firm must also put an effort in managing its credit collection

performance. It seems that the firm is not strict in terms of collecting accounts receivable. It is

also recommended that the firm must be strict regarding their credit policies to improve credit

collection performance.

Year Total Asset

turnover

2007 1.5

2008 1.5

2009(actual) 1.6

2009(industry

ave)

2

0 0.5 1 1.5 2

2007

2008

2009(actual)

2009(industry ave)

Total Asset turnover

Year

Total Asset turnover


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For 2007 and 2008, total asset turnover remained the same. At 2009, total asset

turnover slightly increased. Turnovers for 2007, 2008, and 2009 are still low for the industry

average. Low total asset turnover means that the firms sales are slow. This may indicate a

problem with one or more of the asset categories composing total assets - inventory,

receivables, or fixed assets. The small business owner should analyze the various asset classes

to determine where the problem lies. In this case, the problem would be on inventories and

accounts receivable. The firm is holding a large value of accounts receivable and inventory.

Problem in inventory arises because Martin Manufacturing Company may be holding

obsolete inventory and not selling inventory fast enough. Another problem also arises with the

firms accounts receivable; the firm's collection period is too long compared to the industry

average. There is also a possibility that a problem also arises at the firms fixed assets, such as

plant and equipment, could be sitting idle instead of being used to their full capacity. All of

these problems point at the low total asset turnover ratio of the firm.

It is recommended that the firm must resolve its issues on accounts receivable and

inventory problems to improve total asset turnover. The firm could focus first in resolving its

accounts receivable problem because its amount is larger than the amount of inventory for

2009. The firm could improve its credit collection by improving its credit policies and credit

terms. The firm should study carefully which credit term would best suit their need to increase

total asset turnover. Second problem that the firm must consider is regarding its inventory. The

firm must not be holding too large amount of inventory.

3. DebtYear Debt

Ratio

2007 45.8%

2008 54.3%

2009(actual) 57.0%


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2009(industry ave) 24.5%

Martin Manufacturing Companys indebtedness increased over 2007-2009 periods and

is currently above the industry average. However, ratios are not consistent with the average of

the industry. Compared to the average on the industry, these ratios are all high. Ratios at 2008

and 2009 are greater than 0.5. This indicates that most of Martin Manufacturing Companys

assets are financed through debt. In this case, Martin Manufacturing Company is said to be

"highly leveraged," not highly liquid. Thus, the firm with a high debt ratio (highly leveraged)

could be in danger if creditors start to demand repayment of debt. Also, this indicates that the

firms degree of indebtedness.

High debt ratio brings greater risk for the companys operation. This means that the firm

has a low borrowing capacity, which in turn will lower the firm's financial flexibility. Also, this

shows that the company has been aggressive in financing its growth with debt. This can result

in volatile earnings as a result of the additional interest expense. If a lot of debt is used to

finance increased operations (high debt to equity), the company could generate more

earnings than it would have without this outside financing. If this were to increase earnings by a

greater amount than the debt cost (interest), then the shareholders benefit as more earnings

are being spread among the same amount of shareholders. However, the cost of this debt

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2007 2008 2009(actual) 2009(industry

ave)

De

btRatio

(Percentage

)

Year

Debt Ratio


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financing may outweigh the return that the company generates on the debt through

investment and business activities and become too much for the company to handle. This can

lead to bankruptcy, which would leave shareholders with nothing.

Year Times interest earned

ratio

2007 2.2

2008 1.9

2009(actual) 1.6

2009(industryave)

2.5

a

Martin Manufacturing Companys time interest earned ratio decreased over 2007-2009

periods and is currently below the industry average. This shows that the company has fewer

earnings available to meet its interest payments. Failing to meet these obligations could force a

company into bankruptcy. A low time interest earned ratio of the firm also suggests that the

business is more vulnerable to increases in interest rates.

0 0.5 1 1.5 2 2.5

2007

2008

2009(actual)

2009(industry ave)

Time interest earned ratio

Year

Times interest earned ratio


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4. ProfitabilityYear Gross Profit

Margin

2007 27.5%

2008 28.0%

2009(actual) 27.0%

2009(industry ave) 26.0%

Martin Manufacturing Companys gross profit margin indicates that the firms margin is

stable and is consistent with the industry average. Gross profit margin at 2009 is higher than

the industry average as presented in the graph. This means that Martin Manufacturing

Company is more liquid. Thus, it has more cash flow to spend on research & development

expenses, marketing or investing which will be good for the company.

25.0%

25.5%

26.0%

26.5%

27.0%

27.5%

28.0%

28.5%

2007 2008 2009(actual) 2009(industry

ave)GrossPro

fitMargin

(Percentage

)

Year

Gross Profit Margin


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Year Net Profit

Margin

2007 1.1%

2008 1.0%2009(actual) 0.7%

2009(industry

ave)

1.2%

At 2009, net profit margin is lower than the industry average. This low profit margin

indicates a low margin of safety. It also entails that the firm has a higher risk which means that

a decline in sales will erase profits and result in a net loss. This low profit margin is also

exhibited for 2007-2009 periods. These three ratios for the past three years are all below the

industry average.

Year Return on Total

Assets

2007 1.7%

2008 1.5%

0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2%

2007

2008

2009(actual)

2009(industry ave)

NetProfit Margin (Percentage)

Year

Net Profit Margin


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2009(actual) 1.1%

2009(industry

ave)

2.4%

Martin Manufacturing Companys ROA decreased for 2007-2009 periods. Compared to

the industry average, the firms ROA is low. The firms decreasing ROA indicates major upfront

investments in assets, including accounts receivables, inventories, production equipment and

facilities. It is possible that the company experienced a decline in demand which left the firm

high and dry. The firm overinvested in assets that it cannot sell to pay its bills anymore. Thus,

the result can be financial disaster.

Year Return on common

equity

2007 3.1%

2008 3.3%

2009(actual) 2.5%

2009(industry 3.2%

0.0% 0.5% 1.0% 1.5% 2.0% 2.5%

2007

2008

2009(actual)

2009(industry ave)

Return on Total Assets

Return on Total Assets


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ave)

There was a sudden decrease in the firms ROE from 2008 to 2009. This actual value at 2009

is also below the industry average. A decreasing Return on Equity indicates that Martin

Manufacturing Company has been less effective in using contributions from stockholders to

generate earnings for the company. Decreasing return on equity indicates weak earnings

growth for the company. It also means a decrease in business equity. Also, this means a

decrease in the intrinsic value of the company.

5. MarketYear P/E

Ratio

2007 33.5

2008 38.7

2009(actual) 34.5

2009(industry

ave)

43.4

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%

2007

2008

2009(actual)

2009(industry ave)

Axis Title

AxisTit

le

Return on common equity


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Martin Manufacturing Companys price-to earnings ratio increased at 2007-2008 but

also decreased at 2008-2009. These three ratios are all below the industry average. When this

ratio is lower than the industry average, this means that recent profit levels are no longer the

main factor in pricing. This might be because investors expect a worse performance next year -

or because sentiment is now the dominant factor.

Year M/B Ratio

2007 1.0

2008 1.1

2009(actual) 0.9

2009(industry

ave)

1.2

0.0 10.0 20.0 30.0 40.0 50.0

2007

2008

2009(actual)

2009(industry ave)

P/E Ratio

Year

P/E Ratio


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As presented in the graph below, there was a sudden decrease at 2008-2009 periods. At 2009,

M/B ratio reached 0.9. Because M/B ratio is less than 1, it is said to be that the ratio has an

overvalued stock.

References:

Gitman, L., 2003. Principles of Managerial Finance 10th

edition. Pearson Education, Inc.

Van Horne J., 2010. Fundamentals of Financial Management 13th

edition. Pearson Education,

Inc.

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

M/BRatio

M/B Ratio Graph

M/B Ratio

Documents

Bagang Charmaine G.- Machine Problem 1- July 16 2011