1. How does Quickfix’s average compound growth rate in sales compare with its earnings growth rate over the past five years?
Quickfix’s sales have increased by an average compound rate of 14% per year over the past five years. In comparison, its net income has declined from over $16,600 in 2000, to a loss of $102 in 2004.
2. Which statements should Juan refer to and which should he construct so as to develop a fair assessment of the firm’s 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 Quickfix’s 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 Quickfix’s condition with an appropriate benchmark. How should he go about obtaining the necessary comparison data?
Based on Quickfix’s industry classification code, Juan should collect industry averages of the key financial ratios. Some useful sources for
industry ratios include: Value Line, Moody’s, 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 firm’s 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.
Common Size Income Statement
The firm’s 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.
The firm’s inventory turnover has declined considerably since 2000. There was some improvement in 2004, 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.
Quickfix Auto’s debt ratio is 64% of total assets. Its debt level has gone up by almost 37% since 2000. Since the firm’s coverage ratios are fairly low, the firm’s financial structure can be considered to be fairly risky.
The firm’s 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 firm’s 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 2000. 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?
Selection of comparison benchmark
Accounting procedures differ.
Different fiscal year end
Selection of appropriate benchmark/ industry averages