1.
Blake International 1999 2000 2001 2002 2003
Current ratio 3.11 2.83 2.54 2.22 1.99
Acid-test ratio 1.64 1.78 1.56 1.35 1.33
Average collection period 53.16 62.00 56.29 58.63 52.48 Accounts receivable turnover 6.87 5.89 6.48 6.23 6.95
Inventory turnover 3.28 3.87 4.00 3.73 4.21
Operating income return on investment
0.22 0.15 0.16 0.08 0.09 Gross profit margin 0.40 0.39 0.38 0.38 0.40 Operating profit margin 0.10 0.08 0.08 0.04 0.05 Total asset turnover 2.10 1.95 2.07 1.85 1.85 Fixed asset turnover 18.13 18.81 23.21 18.64 16.29
Debt ratio 0.43 0.79 0.71 0.69 0.66
Times interest earned 14.00 6.31 4.31 2.30 2.78
Return on equity 0.18 0.36 0.27 0.04 0.02
Note: Above ratio calculations may be subject to rounding errors.
Question #1
It is apparent that Blake’s liquidity is decreasing over time, as the current and acid-test ratios indicate. However, the receivable turnover and average collection period stayed relatively constant while the inventory turnover actually increased. When we review the balance sheet, we note that the cash balance has actually increased while the receivable and inventory balances decreased, creating more liquidity within the total current assets, even though the net current asset balance decreased in total. The real problem lies with the increase in current liabilities over time in combination with the decrease in current assets.
Question #2
Also of great concern is the decrease in operating profitability that is shown in the OIROI ratios over time. The problem does not seem to be in the cost of goods sold as
indicated by the gross profit margin ratio. The problem appears in the operating profit margin having also decreased over time. Upon review of the income statement, we will see that while sales have decreased, the operating expenses have stayed the same. The total asset turnover and fixed asset turnover have also decreased, although not to the same degree. Blake has lowered the asset balances as sales have lowered, but still needs to work further to lower fixed assets, decrease expenses, and increase sales. Question #3
While sales and assets have decreased over time, the level of debt to equity has increased. As of 2003, 66% of Blake’s assets are being financed through the use of debt. The company is quickly becoming over-leveraged and soon will lose its ability to pay interest as the times interest earned ratio shows.
Question #4
Return on common equity has declined, especially in the last two years. This can be the result of two factors, a lower rate of return or financing through less debt. As noted above, Blake has increased debt greatly over the last five years. As we have also noted, Blake’s operating profitability has also decreased over the last few years as a result of decreasing sales and higher interest costs. We can safely assume that the decreasing return is the result of decreasing profits.
Scott Corp. 1999 2000 2001 2002 2003
Current ratio 1.85 1.86 2.05 2.07 2.26
Acid-test ratio 1.28 1.22 1.33 1.25 1.43
Average collection period 80.75 75.92 69.69 63.96 64.71 Accounts receivable turnover 4.52 4.81 5.24 5.71 5.64
Inventory turnover 4.45 4.11 4.01 4.21 4.42
Operating income return on
investment 0.21 0.24 0.25 0.16 0.16
Gross profit margin 0.41 0.41 0.42 0.38 0.40 Operating profit margin 0.14 0.14 0.15 0.09 0.10 Total asset turnover 1.51 1.64 1.71 1.77 1.67 Fixed asset turnover 8.58 10.06 9.96 8.28 6.93
Debt ratio 0.37 0.38 0.41 0.40 0.36
trend of the current ratio. Despite inventory growth of 90%, the acid-test ratio and inventory turnover both increased positively over time due to strong growth in other areas such as receivables and sales (which in turn impacted cost of goods sold on which the inventory turnover ratio is based). The receivable turnover ratio and average collection period also trended positively due to a slight increase in receivables as compared to an 84% increase in sales.
Question #2
Operating profitability seems to have decreased slightly over the last five years. Upon review of the ratios in combination with the financial statements, this seems to be the result of two factors. One, operating expenses have grown disproportionately to sales over the years. Depreciation has grown due to the fixed asset growth, which is the second factor. The total asset turnover has increased as a result of the positive use of receivables and inventories. However, fixed assets have grown considerably, affecting both the OIROI and the fixed asset turnover.
Question #3
Upon initial review of the debt ratio, Scott seems to be successively financing its growth with the same proportion of debt over the last five years. However, Scott does need to be aware that the times interest earned is trending down due to the fact that the operating expenses have grown disproportionately. This will impact its ability to service debt over future years.
Question #4
Scott has decreased its return on common equity especially in the last two years. Since Scott has not decreased its debt ratio, we must review the income statement for the explanation. Even though Scott has almost doubled its sales, net income has remained the same. This is the result of decreased operating profit margin and increased interest. The increased interest is either the result of increased debt or a higher cost of debt. 2. The differences in Scott’s and Blake’s financial performance are easy to find. Scott
continues to be a thriving company while Blake seems to have many financial problems. Scott’s sales have grown 84% while Blake’s sales have decreased by 17%. However, they also have many similarities. Let’s look at the differences and similarities by question.
Liquidity – Both Blake and Scott have done a good job of controlling their inventories and receivables. Both had positive trends in these areas. The difference is that Scott has considerable liquidity while Blake is losing this ability due to its increasing current liabilities.
Profitability – Both Scott and Blake are having problems with operating profitability. Their OIROI’s have trended downward over time due to increasing operating expenses and increasing fixed assets as compared to sales.
Financing – The true differences appear in how Blake and Scott are financing their assets. While Scott’s debt ratio has stayed the same, Blake has increased its debt ratio to 66%. This has significantly increased the risk to the financial health of Blake. While both Scott’s and Blake’s times interest earned have decreased due to increasing operating expenses, Blake is dangerously close to losing its ability to service its debt. Return on Investment – Once again, Scott and Blake are more similar than different, except as to the severity of the amount. Scott and Blake have decreased their return on investment. Blake has increased its debt while Scott’s stayed the same. Both have decreased their net income as compared to sales. This is the result of increased operating and interest costs, as gross profit margins have stayed the same.