AAA Tutorial 7 Question 1 Liquidity: The current and quick ratios show a weaker position relative to the industry

average. (the net working capital figure should not be used in this cross-sectional analysis. It would be better applied for comparison against a trend in a time-series analysis.) Activity: All activity ratios indicate a faster turnover of assets compared to the industry. Further analysis is necessary to determine whether the firm is in a weaker or stronger position than the industry. A higher inventory turnover ratio may indicate low inventory, resulting in stock outs and lost sales. A shorter average collection period may indicate extremely efficient receivables management, an overly zealous credit department, or credit terms which prohibit growth in sales. Debt: The firm uses more debt than the average firm, resulting in higher interest obligations which could reduce its ability to meet other financial obligations. Profitability: The firm has a higher gross profit margin than the industry, indicating either a higher sales price or a lower cost of goods sold. The net profit margin is lower than industry, an indication that expenses other than cost of goods sold are higher than the industry. Most likely, the damaging factor is high interest expenses due to a greater than average amount of debt. The increased leverage, however, magnifies the return the owners receive, as evidenced by the superior ROE. b) Fox Manufacturing Company needs improvement in its liquidity ratios and possibly a reduction in its total liabilities. The firm is more highly leveraged than the average firm in its industry and, therefore, has more financial risk. The profitability of the firm is lower than average but is enhanced by the use of debt in the capital structure, resulting in a superior ROE.

Question 2 (i) Liquidity Liquidity as measured by the current ratio which has increased slightly from 2007 to 2008. However, the quick ratio has decreased over the same period and this is more acute in measuring liquidity. The liquidity levels over the two years were below the industry averages but were above the recommended levels of 2 for current ratio and 1 for quick ratio. The company was slightly more able to meet its current obligations but actions should be taken to improve the liquidity position further. (ii) Activity or Efficiency Although the company had improved slightly on its collection policy 2008 compared to 2007, it still took a longer time to collect from debtors, as compared to other companies in the same industry. More relaxed collection policy might have accounted for increased sales in 2008 but Excel Limited must realize the adverse consequences of slow collection with its greater probability of bad and doubtful debts. Excel Limited s inventory turnover was at a slower rate over the two years compared to other firms in the same industry as could be seen from a much lower than average inventory turnover figure. Excel Limited increased its stock holding by 61.22% in 2008 when its sales only increased by 14.87% during the same period. Large accumulation of inventory balance would contribute to high storage and insurance costs, contributing to lower profitability. (iii) Debt The debt position of the company has improved slightly as evidenced from debt ratio that had decreased slightly over the two years. However, for both years, the debt ratio of Excel Limited was higher than the industry average figure. The times interest earned ratio had also declined over the two years and they were lower than the industry average figure, showing that the earnings of Excel Limited could not cover interest expenses by as much times as the industry s. Excel Limited is increasingly more dependent on outside borrowings to finance its operations, resulting in greater risk from the higher financial leverage.