Answered Essay: A large loss occurred in 2017 at Transpire Inc in Canterbury, rather than the expected profit. As a result, its sta

A large loss occurred in 2017 at Transpire Inc in Canterbury, rather than the expected profit. As a result, its stakeholders are concerned about the firm’s performance.

You are hired as the new Chief Financial Officer and are given the task of getting the company back into a sound financial position. Transpire’s 2016 and 2017 balance sheets and income statements, together with projections for 2018, are shown in the following tables. The tables also show the 2016 and 2017 financial ratios, along with industry average data. The 2018 projected financial statement data represent the best projection for 2018 results, assuming that some new financing is arranged to get the company “over the hump” and back on track.

You must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken.

Table 1. Transpire Inc. Balance Sheets

Assets 2016 2017 2018e
($‘000) ($‘000) ($‘000)
Cash 8,000 7,482 15,000
Short-Term Investments 48,600 20,000 71,632
Accounts Receivable 351,200 652,160 878,000
Inventories 715,200 1,287,360 1,816,480
Total Current Assets 1,123,000 1,967,002 2,781,112
Gross Fixed Assets 491,000 1,202,950 1,220,000
Less: Accumulated Depreciation 146,200 263,160 383,160
Net Fixed Assets 344,800 939,790 836,840
Total Assets 1,467,800 2,906,792 3,617,952
Liabilities And Equity 2016 2017 2018e
($‘000) ($‘000) ($‘000)
Accounts Payable 145,600 324,000 359,800
Notes Payable 200,000 701,800 301,000
Accruals 135,000 284,960 380,000
Total Current Liabilities 480,600 1,310,760 1,040,800
Long-Term Debt 323,432 1,000,000 600,000
Common Stock 460,000 536,800 1,680,936
Retained Earnings 203,768 59,232 296,216
Total Equity 663,768 596,032 1,977,152
Total Liabilities And Equity 1,467,800 2,906,792 3,617,952

Table 2. Transpire Inc. Income Statements

2016 2017 2018e
($‘000) ($‘000) ($‘000)
Sales 4,432,000 5,834,400 8,035,600
COGS excluding depreciation 2,864,000 4,980,000 5,800,000
Depreciation 18,900 116,960 120,000
Other Expenses 340,000 720,000 612,960
Total Operating Costs 3,222,900 5,816,960 6,532,960
EBIT 1,209,100 17,440 1,502,640
Interest Expense 62,500 176,000 80,000
EBT 1,146,600 158,560 1,422,640
Taxes (40%) 458,640 569,056
Net Income 687,960 158,560 853,584

Table 3 Transpire Inc. other data

Stock Price ($) 85.00 60.00 78.00
Shares (units) 100,000 100,000 250,000
Earnings per Share ($) 6.88 1.59 3.41
Dividend per Share ($) 0.22 0.22
Tax Rate (%) 40.00 40.00 40.00
Book Value per Share ($) 6.638 5.960 7.909
Lease Payments ($) 40,000 40,000 40,000

Table 4 Transpire Inc. Ratio Analysis

2016 2017 2018e Industry
Average
Current Ratio (X) 2.34 1.50 2.67 2.00
Quick Ratio (X) 0.85 0.52 0.93 1.00
Inventory Turnover (X) 4.00 3.87 3.19 5.00
Average Age of Inventory (days) 91.15 94.35 114.31 45.00
Average Collection Period (days) 28.92 40.80 39.88 30.00
Average Payment Period (days) 18.56 23.75 22.64 60.00
Fixed Asset Turnover (X) 12.85 6.21 9.60 8.00
Total Asset Turnover (X) 3.02 2.01 2.22 2.50
Debt Ratio (X) 0.55 0.79 0.45 0.35
Debt to Equity Ratio (X) 1.21 3.88 0.83 0.80
Times Interest Earned (X) 19.35 0.10 18.78 25.00
Gross Profit Margin (%) 35.38 14.64 27.82 28.00
Operating Profit Margin (%) 27.28 0.30 18.70 17.00
Net Profit Margin (%) 15.52 2.72 10.62 12.00
Return on Total Assets (%) 46.87 5.45 23.59 30.00
Return on Equity (%) 103.64 26.60 43.17 35.00
Price/Earnings (P/E) Ratio (X) 12.36 37.84 22.84 10.00
Market/Book Value Ratio (X) 12.81 10.07 9.86 7.00

1.Discuss the major strengths and weaknesses of the firm using the results of Du Pont analysis as projected for 2018.

2.Perform a common size analysis and percent change analysis. What do these analyses tell you about Transpire? What actions should be taken to improve its overall financial position?

3. What are some potential problems and limitations of financial ratio analysis?

Expert Answer

 

1. Du-Pont Ananlysis for 2018
ROE=Profit Margin*Total Asset Turnover*Financial Leverage
ie. ROE=(Net Income/Net Sales)*(Net Sales/Av total Assets)*(Total Assets/Total Equity)
43.17=10.62*2.22*1.83
ROE=Net Income/Total Equity– $ income generated per $ of total equity employed more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average
N/P Margin Is almost comparable but for yrs. 2017 & 2018
ATO=Sales/Total assets–Generated more $ sales per $ of fixed assets than in the year 2017
Financial leverage suggest that assets are funded by debt (almost 83%) in addition to equity financing
Table 4 Transpire Inc. Ratio Analysis
2016 2017 2018e Ind. Intrepretation
Av.
Current Ratio (X) 2.34 1.5 2.67 2 Current asset/Current Liabilities–ratio is above normal but for 2017 when it falls below normal due to increase in all components of current liabilities esp. notes payable
Quick Ratio (X) 0.85 0.52 0.93 1 Quick assets/Current liabilities—Below normal in all 3 yrs. –reason being increase in current liabilities
Inventory Turnover (X) 4 3.87 3.19 5 COGS/Av.Inventory–Below industry average in all 3 yrs.—indicating slow conversion of inventory into sales/receivables
Average Age of Inventory (days) 91.15 94.35 114.31 45 365/Inv.T.O.—Very high compared to industry average.Inventory management needs appraisal.
Average Collection Period (days) 28.92 40.8 39.88 30 365/Receivables T.O.—Receivables take more to convert to cash in 2017 & 2018.Cash inflows will be affected
Average Payment Period (days) 18.56 23.75 22.64 60 365/Payables T.O.—Indicates quicker payment to creditors than prevalent in the industry –non/under -utilistion of credit period,again cash circulation within the business will be adversely affected
Fixed Asset Turnover (X) 12.85 6.21 9.6 8 Sales/Fixed assets–Generated more $ sales per $ of fixed assets but for the year 2017
Total Asset Turnover (X) 3.02 2.01 2.22 2.5 Sales/Total assets–Generated more $ sales per $ of fixed assets than in the year 2017
Debt Ratio (X) 0.55 0.79 0.45 0.35 Total liabilities/Total assets—Compared to Industry average denotes more liabilities per $ of total assets esp. in 2017
Debt to Equity Ratio (X) 1.21 3.88 0.83 0.8 Total liabilities/Total Equity—Compared to Industry average denotes more liabilities per $ of total equity esp. in 2017. A higher ratio is risky for investors & creditors
Times Interest Earned (X) 19.35 0.1 18.78 25 EBIT/Interest expense– Times interest expense covered by EBIT is no where near the industry average esp. in 2017
Gross Profit Margin (%) 35.38 14.64 27.82 28 Is almost comparable but for 2017
Operating Profit Margin (%) 27.28 0.3 18.7 17 Is almost comparable but for 2017
Net Profit Margin (%) 15.52 2.72 10.62 12 Is almost comparable but for yrs. 2017 & 2018
Return on Total Assets (%) 46.87 5.45 23.59 30 Net Income/Total assets– $ income generated per $ of total asset more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average
Return on Equity (%) 103.6 26.6 43.17 35 Net Income/Total Equity– $ income generated per $ of total equity employed more in 2016 .After a deep slump in 2017 , recovered in 2018 but still trailing the industry average
Price/Earnings (P/E) Ratio (X) 12.36 37.84 22.84 10 MPS/EPS- Ratio is more in 2017 as the denominator EPS is the least in that year,even though the stock price is also at a low
Market/Book Value Ratio (X) 12.81 10.07 9.86 7 MV/BV – Ratio is declining but still more than the industry average.
2. Transpire Inc. Income Statements
2016 % of sales 2017 % of sales (2017-2016 ) 2018 % of sales 2018-2017 Analysis of the change
% change % change
Sales 4432000 100.00% 5834400 100.00% 0.00% 8035600 100.00% 0.00%
COGS excluding depreciation 2864000 64.62% 4980000 85.36% 20.73% 5800000 72.18% -13.18% Major increase in 2017 -projected to decrease in 2018
Depreciation 18900 0.43% 116960 2.00% 1.58% 120000 1.49% -0.51% Decrease projected
Other Expenses 340000 7.67% 720000 12.34% 4.67% 612960 7.63% -4.71% Decrease projected
Total Operating Costs 3222900 72.72% 5816960 99.70% 26.98% 6532960 81.30% -18.40% Decrease projected
EBIT 1209100 27.28% 17440 0.30% -26.98% 1502640 18.70% 18.40% Increase projected due to decrease in COGS
Interest Expense 62500 1.41% 176000 3.02% 1.61% 80000 1.00% -2.02% show a decline in interest expenses
EBT 1146600 25.87% -158560 -2.72% -28.59% 1422640 17.70% 20.42% Increase projected due to decrease in COGS& int.exp.
Taxes (40%) 458640 10.35% 0 0.00% -10.35% 569056 7.08% 7.08% Change due to profits projected
Net Income 687960 15.52% -158560 -2.72% -18.24% 853584 10.62% 13.34% Increase projected due to decrease in COGS& int.exp.
Transpire Inc. Balance Sheets
Assets 2016 % 2017 % % 2018e % %
($‘000) to Tot. ($‘000) to Tot. Change ($‘000) to Tot. Change
Cash 8,000 0.55% 7,482 0.26% -0.29% 15,000 0.41% 0.16%
Short-Term Investments 48,600 3.31% 20,000 0.69% -2.62% 71,632 1.98% 1.29%
Accounts Receivable 351,200 23.93% 652,160 22.44% -1.49% 878,000 24.27% 1.83%
Inventories 715,200 48.73% 1,287,360 44.29% -4.44% 1,816,480 50.21% 5.92% Major change in acquisition of inventory
Total Current Assets 1,123,000 76.51% 1,967,002 67.67% -8.84% 2,781,112 76.87% 9.20%
Gross Fixed Assets 491,000 33.45% 1,202,950 41.38% 7.93% 1,220,000 33.72% -7.66%
Less: Accumulated Depn. 146,200 9.96% 263,160 9.05% -0.91% 383,160 10.59% 1.54%
Net Fixed Assets 344,800 23.49% 939,790 32.33% 8.84% 836,840 23.13% -9.20%
Total Assets 1,467,800 100.00% 2,906,792 100.00% 0.00% 3,617,952 100.00% 0.00%
Liabilities And Equity 2016 2017 2018e
Accounts Payable 145,600 9.92% 324,000 11.15% 1.23% 359,800 9.94% -1.20%
Notes Payable 200,000 13.63% 701,800 24.14% 10.52% 301,000 8.32% -15.82% Major change in repayments
Accruals 135,000 9.20% 284,960 9.80% 0.61% 380,000 10.50% 0.70%
Total Current Liabilities 480,600 32.74% 1,310,760 45.09% 12.35% 1,040,800 28.77% -16.33%
Long-Term Debt 323,432 22.04% 1,000,000 34.40% 12.37% 600,000 16.58% -17.82% Major change in repayments
Common Stock 460,000 31.34% 536,800 18.47% -12.87% 1,680,936 46.46% 27.99% New Issue
Retained Earnings 203,768 13.88% 59,232 2.04% -11.84% 296,216 8.19% 6.15%
Total Equity 663,768 45.22% 596,032 20.50% -24.72% 1,977,152 54.65% 34.14%
Total Liabilities And Equity 1,467,800 100.00% 2,906,792 100.00% 0.00% 3,617,952 100.00% 0.00%
Summary:
As of 2017, COGS constitutes maximum % (85.36%) of sales eating into profits.
that has been cut down to 72.18% in 2018
2017 is marked with acquisition of current liabilities like account payables, Notes payables(reason for lesser current ratio) & also long-term debt.
In 2018,these have been reduced& repaid
Recommendations:
1.To improve the liquidity ratios like current & quick ratios, current liabilities have to be kept at the optimum level
2. Collection of Accounts Receivables must be within the industry average which will improve the cash position.
3.Maximum advantage should be taken with payment to creditors ,keeping in line with the industry norm.
Limitations of ratio analysis:
1.They are only numbers & cannot be used as a stand-alone metric for any useful & meaningful analysis
2.Many reasons behind a particular value for any item on the financials,need to be analysed before & cannot be assumed as such.
3.The accounting figures ,from which the ratios are calculated,are themselves sometimes subject to many approximations or even manipulation. Therefore, ratios may not be very helpful in drawing reliable conclusions
4. Inflation is bound to limit the utility of accounting ratios.
5. Different method of aggregating the sub-headings of accounts in different years,may complicate grouping of figures for purposes of
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