Solution to Case 2

Financial Ratio Analysis

Bigger Isnt Always Better!*

*Note to Instructor: Please note that the Balance sheet figures for 1997 have a few errors.
These are highlighted below.

Table I
Quickfix Autoparts
Balance Sheet
1997
ASSETS
Cash and marketable
securities
Accounts receivable
Inventory
Current assets
Land, buildings, plant,
and equipment
Accumulated depreciation

1998

1999

2000

2001

$155,000
10,000
250,000

$309,099
12,000
270,000

$75,948
20,000
500,000

$28,826
77,653
520,000

$18,425
90,078
560,000

$415,000

$591,099

$595,948

$626,480

$668,503

$250,000
(25,000)

$250,000
(50,000)

$500,000
(100,000)

$500,000
(150,00

$500,000

50,000
LIABILITIES AND EQUITIES
Short-term bank loans
Accounts payable
Accruals

$150,000
10,000
5,000

$145,000
10,506
5,100

$140,000
19,998
7,331

$148,000
15,995
9,301

$148,000
16,795
11,626

$65,000
63,366
$100,000
175,000

$160,606

$167,329

$173,296

$176,421

$98,000
173,000

$196,000
271,000

$190,000
268,000

$183,000
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

$320,000
16,634

$320,000
39,493

$320,000
41,619

$320,000
25,184

$320,000
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

Current liabilities
Long-term bank loans
Mortgage

Common stock (100,000 shares)

Retained earnings

Table II
Quickfix Autoparts
Income Statement
1997

1998

1999

2000

$600,000
480,000

$655,000
537,100

$780,000
655,200

$873,600
742,560

$1,013,376
861,370

$120,000

$117,900

$124,800

$131,040

$152,006

$30,000
25,000
2,027

$15,345
25,000
3,557

$16,881
50,000
5,725

$43,680
50,000
17,472

$40,535
50,000
15,201

$57,027

$43,902

$72,606

$111,152

$105,736

$62,973

$73,998

$52,194

$19,888

$46,271

$15,000
8,000
12,250

$15,950
7,840
12,110

$14,000
15,680
18,970

$13,320
15,200
18,760

$13,320
14,640
18,480

$35,250

$35,900

$48,650

$47,280

$46,440

Before-tax earnings
Taxes

$27,723
11,089

$38,098
15,239

$3,544
1,418

($27,392)
(10,957)

($169)
(68)

Net income

$16,634

$22,859

$2,126

($16,435)

($102)

$16,634

$22,859

$2,126

($16,435)

($102)

$0.17

$0.23

$0.02

($0.16)

($0.00)

Net sales
Cost of goods sold
Gross profit
Admin and selling exp
Depreciation
Miscellaneous expenses
Total operating exp
EBIT
Interest on ST loans
Interest on LT loans
Interest on mortgage
Total interest

Dividends on stock
Additions to
retained earnings
EPS (100,000 shares)

2001

1.

How does Quickfixs average compound growth rate in sales compare with its
earnings growth rate over the past five years?
Quickfixs 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 ones should he construct so as to
develop a fair assessment of the firms 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 Quickfixs 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 Quickfixs condition with an appropriate

benchmark. How should he go about obtaining the necessary comparison data?
Based on Quickfixs industry classification code, Juan should collect industry averages of
the key financial ratios. Some useful sources for industry ratios include: Value Line,
Moodys, Standard & Poor, And Dun & Bradstreet. In addition to the industry average,
the industry leaders (within the size category) ratios could also be collected from the
Internet (e.g. Marketguide.com) and used for comparison.

5.

Besides comparison with the benchmark what other types of analyses could Juan
perform to comprehensively analyze the firms 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

Net sales
Cost of goods
sold

2001%

$600,000 100.0% $655,000 100.0% $780,000 100.0% $873,600 100.0% $1,013,376 100.0%
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

Admin and
selling exp
Depreciation

$30,000

5.0% $15,345

2.3% $16,881

2.2% $43,680

5.0%

$40,535

4.0%

25,000

4.2%

25,000

3.8%

50,000

6.4%

50,000

5.7%

50,000

4.9%

2,027

0.3%

3,557

0.5%

5,725

0.7%

17,472

2.0%

15,201

1.5%

12.7% $105,736

10.4%

Miscellaneous
expenses
Total
operating exp

15.0% $152,006

15.0%

$57,027

9.5% $43,902

6.7% $72,606

9.3% $111,152

$62,973

10.5% $73,998

11.3% $52,194

6.7% $19,888

2.3%

$46,271

4.6%

Interest on ST
loans
Interest on LT
loans
Interest on
mortgage

$15,000

2.5% $15,950

2.4% $14,000

1.8% $13,320

1.5%

$13,320

1.3%

8,000

1.3%

7,840

1.2%

15,680

2.0%

15,200

1.7%

14,640

1.4%

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
Taxes

$27,723

4.6% $38,098

5.8%

$3,544

0.5% ($27,392)

-3.1%

($169) -0.02%

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%

EBIT

11,089

The common size income statement indicates that the firms 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 firms 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
Accounts receivable
Inventory
Current assets
Land, buildings, plant,
and equipment
Accumulated depreciation
Net fixed assets
Total assets

$155,000

24.22%

$309,099

39.07%

$75,948

7.63%

$28,826

2.95%

$18,425

10,000

1.56%

12,000

1.52%

20,000

2.01%

77,653

7.95%

90,078

9.30%

250,000

39.06%

270,000

34.13%

500,000

50.20%

520,000

53.25%

560,000

57.82%

$415,000

64.84%

$591,099

74.72%

$595,948

59.84%

$626,480

64.16%

$668,503

69.02%

$250,000

39.06%

$250,000

31.60%

$500,000

50.20%

$500,000

51.20%

$500,000

51.63%

-25,000

-3.91%

-50,000

-6.32%

-100,000

-10.04%

-150,000

-15.36%

-200,000

-20.65%

$225,000

35.16%

$200,000

25.28%

$400,000

40.16%

$350,000

35.84%

$300,000

30.98%

$791,099 100.00%

$995,948 100.00%

$976,480 100.00%

$968,503

100.00%

7.81%

$145,000

18.33%

$140,000

14.06%

$148,000

15.16%

$148,000

15.28%

10,000

1.56%

10,506

1.33%

19,998

2.01%

15,995

1.64%

16,795

1.73%

5,000

0.78%

5,100

0.64%

7,331

0.74%

9,301

0.95%

11,626

1.20%

$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%

$238,366

37.24%

$271,000

34.26%

$467,000

46.89%

$458,000

46.90%

$447,000

46.15%

$303,366

47.40%

$431,606

54.56%

$634,329

63.69%

$631,296

64.65%

$623,421

64.37%

$320,000

50.00%

$320,000

40.45%

$320,000

32.13%

$320,000

32.77%

$320,000

33.04%

16,634

2.60%

39,493

4.99%

41,619

4.18%

25,184

2.58%

25,082

2.59%

$336,634

52.60%

$359,493

45.44%

$361,619

36.31%

$345,184

35.35%

$345,082

35.63%

$976,480 100.00%

$968,503

100.00%

LIABILITIES AND
EQUITIES
Short-term bank loans
Accounts payable
Accruals
Current liabilities

Long-term debt
Total liabilities
Common stock (100,000
shares)
Retained earnings
Total equity
Total liabilities
and equity

$640,000 100.00%

1.90%

$50,000

$640,000 100.00%

$791,099 100.00%

$995,948 100.00%

Du Pont Analysis
Net Profit Margin
Total Asset
Turnover
Equity Multiplier

2.77%

3.49%

0.27%

-1.88%

-0.01%

0.9375 0.827962 0.7831734 0.894642 1.046332329

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 Autos ROA has is currently negative but has improved since 2000. Most of the decrease has
come from the deteriorating profit situation. The firms total asset turnover has improved since 1999.
The firms 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 Quickfixs 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

6.38
2.54
2.38
0.47
0.90
1.90
1.79
2.50
1.92
190.10
60.00
6.08
0.94
1.07
2.77%
2.60%
4.94%

3.68
2.00
1.92
0.55
1.20
2.20
2.06
2.76
1.99
183.49
54.58
6.69
0.83
1.21
3.49%
2.89%
6.36%

3.56
0.57
0.45
0.64
1.75
2.75
1.07
2.10
1.31
278.54
39.00
9.36
0.78
1.28
0.27%
0.21%
0.59%

3.62
0.61
0.17
0.65
1.83
2.83
0.42
1.48
1.43
255.60
11.25
32.44
0.89
1.12
-1.88%
-1.68%
-4.76%

3.79
0.62
0.10
0.64
1.81
2.81
1.00
2.07
1.54
237.30
11.25
32.44
1.05
0.96
-0.01%
-0.01%
-0.03%

Current Ratio
Quick Ratio
Cash Ratio
Total Debt Ratio
Debt-Equity Ratio
Equity Multiplier
Times Interest Ratio
Cash Coverage Ratio
Inventory Turnover ratio
Day's sales in Inventory
Receivables Turnover
ACP or Days' Sales in Receivables
Total Asset Turnover
Capital Intensity
Profit Margin
ROA
ROE
7

Liquidity:
The firms 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 firms 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 Autos debt ratio is 64% of total assets. Its debt level has gone up by almost
37% since 1997. Since the firms coverage ratios are fairly low, the firms financial
structure can be considered to be fairly risky.
Profitability:
The firms 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 firms 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?
8

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