Chapter 6
Case Studies

Learning objective

• Recall measures that are useful in the analysis of financial statements and data.

The following four case studies provide examples of financial information upon which liquidity, leverage, profitability, and casual calculations may be performed. The first two case studies also contain example ratio summary and analysis. Considering this information, what problem areas regarding each company’s financial health exist?

Two discussion cases are also provided, followed by questions related to the financial condition of the subject company.

Case study 1: Paper products company

Paper products company
	20X0	20X1	20X2	20X3
Cash	$550,000	$450,000	$150,000	$ 50,000
Receivables	800,000	750,000	750,000	700,000
Inventory	900,000	850,000	850,000	800,000
All other	250,000	250,000	250,000	250,000
Total current	2,500,000	2,300,000	2,000,000	1,800,000
Fixed	1,500,000	1,450,000	1,400,000	1,300,000
All other	500,000	500,000	400,000	300,000
Total assets	$4,500,000	$4,250,000	$3,800,000	$3,400,000
Due banks	$400,000	$400,000	$400,000	$400,000
Due trade	400,000	500,000	700,000	1,050,000
Taxes	100,000	-0-	-0-	-0-
All other	-0-	-0-	-0-	-0-
Total current	900,000	900,000	1,100,000	1,450,000
Long-term liabilities	600,000	550,000	500,000	450,000
Total liabilities	1,500,000	1,450,000	1,600,000	1,900,000
Net worth	3,000,000	2,800,000	2,200,000	1,500,000
Total	$4,500,000	$4,250,000	$3,800,000	$3,400,000
Net sales	$9,000,000	$8,500,000	$8,000,000	$7,500,000
Net profit	300,000	(200,000)	(600,000)	(700,000)
Working capital	1,600,000	1,400,000	900,000	350,000
	20X0	20X1	20X2	20X3	Industry average
Liquidity measures
Current ratio	2.8×	2.6×	1.8×	1.2×	2.5×
Inventory to working capital	56%	61%	94%	229%	68%
Receivables to working capital	50%	54%	83%	200%	39%
Net sales to working capital	5.6×	6.1×	8.9×	21.4×	5.9×
Leverage and profitability measures
Current liabilities to net worth	30.0	32.1%	50.0%	96.7%	29.6%
Total liabilities to net worth	50.0%	51.8%	72.7%	126.7%	60.3%
Net profit to net worth	10.0%	(7.1%)	(27.3%)	(46.7%)	8.6%
Causal ratios
Fixed assets to net worth	50.0%	51.8%	63.6%	86.7%	55.9%
Net sales to net worth	3.0×	3.0×	3.6×	5.0×	2.5×
Net profit to net sales	3.3%	(2.4%)	(7.5%)	(9.3%)	3.5%
Net sales to inventory	10.0×	10.0×	9.4×	9.4×	9.2×
Collection period	32 days	32 days	34 days	34 days	33 days
Miscellaneous assets to net worth	25%	27%	29%	37%	16%

Case study 1: Causal ratio summary

• Fixed assets to net worth – With 86.7 percent against an industry average of 55.9 percent, the company appears to have excess investment in fixed assets relative to capital. This ratio is “bad” or at best “doubtful.”
• Net profit to net sales – Loss of 9.3 percent on each dollar of sales, in contrast with the industry average profit of 3.5 percent, certainly reflects an alarming situation and immediately places their performance in the “bad” category.
• Net sales to net worth – With a trading ratio of 5 times per year in contrast to the industry average of 2.5, this measure points to an overtrading situation and should prompt the analyst to mark this ratio, too, as “bad.”
• Miscellaneous assets to net worth – The present investment of 37 percent in this area is more than twice as large as the industry average of 16 percent. Any such major variance requires investigation; thus, a preliminary assessment of this ratio shows it as “bad.”

Case study 2: National west airline

National west airline
	20Y5	20Y6	20Y7	20Y8	20Y9
Assets
Cash	$76,600	$26,049	$63,490	$66,780	$90,997
Marketable securities	0	0	4,958	12,877	19,705
Accounts receivable (net)	22,060	66,352	44,904	66,360	70,294
Parts and supplies	6,114	14,755	17,857	22,467	30,782
Prepaid expenses	9,933	15,047	15,063	26,940	39,360
Total current assets	114,707	122,203	146,272	195,424	251,138
Net property and equipment	206,583	401,751	470,389	613,789	867,968
Restricted cash	49,018	33,974	7,300	6,640	30,076
Other assets	15,098	14,327	15,516	20,032	16,074
Total assets	$385,406	$572,255	$639,477	$835,885	$1,165,256
Liabilities and equity
Accounts payable	$17,420	$41,104	$37,422	$64,363	$111,974
Accrued wages	3,378	3,661	9,078	11,232	13,119
Accrued interest	4,551	6,798	7,269	12,298	18,346
Accrued taxes	4,867	9,199	12,167	14,718	16,760
Current portion of long-term debt	12,158	19,816	20,717	28,864	50,827
Other	22,156	40,042	67,225	82,833	134,783
Total current liability	64,530	120,620	153,878	214,308	345,809
Long-term debt	263,034	405,856	427,707	534,465	798,397
Net worth	57,842	45,779	57,892	87,112	21,050
Total liabilities and equity	$385,406	$572,255	$639,477	$835,885	$1,165,256
Operating revenues*	$328,926	$575,447	$775,675	$993,409	$1,315,804
Net income	3,027	(45,675)	13,111	29,324	(74,671)
	20Y5	20Y6	20Y7	20Y8	20Y9	Ind.**
Liquidity
Current ratio	1.78	1.01	0.95	0.91	0.73	1.36
Receivables/current assets*	19.2%	54.3%	30.7%	33.9%	28.0%	40.7%
Inventory/current assets*	5.3%	12.1%	12.2%	11.5%	12.3%	1.8%
Sales/current assets*	286.8%	470.9%	530.3%	508.3%	523.9%	235.6%
Debt
Debt to net worth	566.3%	1,150.0%	1,004.6%	859.6%	5,435.7%	172.3%
Current debt/net worth	111.6%	263.5%	265.8%	246.0%	1,642.7%	91.9%
Profits
ROE	5.2%	(99.8%)	22.6%	33.7%	(354.7%)	9.1%
Causal
Fixed assets/net worth	357.2%	877.6%	812.5%	704.6%	4,123.4%	92.9%
Collection period	24.1 days	41.5 days	20.8 days	24.0 days	19.2 days	62.2 days
Inventory turnover	53.8x	39.0x	43.4x	44.2x	42.7x	26.3x
Net sales/net worth	5.68x	12.57x	13.4x	11.4x	62.5x	2.95x
Profit margin	0.9%	(7.9%)	1.7%	3.0%	(5.7%)	3.1%
Misc. assets/net worth	43.3%	64.2%	52.8%	53.9%	263.3%	N/A

* In 20Y6 revenues were $575,447 (not shown above). By 20Y9, revenues had grown to $1,315,804, which is a 3-year annual compound growth rate of 31.7 percent.

* For these three ratios, receivables, inventory, and sales are generally divided by the working capital. However, working capital is negative, so we use current assets in the denominator. The interpretation is very similar.

** Per Dun and Bradstreet.

National west airline

Analysis

• Liquidity – The company’s quantity of liquidity, as measured by the current ratio, has declined over this three-year period and is well below the industry average of 1.36. This pattern can also be seen in the sales to the current asset ratio, which is considerably above the industry average.
• Debt – The company’s debt ratios each year are very large and considerably above average.
• Profits – The return on equity is very high in 20Y7 and 20Y8. However, a recession hits in 20Y9, and the company loses a lot of money.
• Causes – This is a classic case of a company that has grown too quickly. The fixed assets to net worth ratio and the trading ratio are considerably larger than the industry averages.

Case study 3: Firm A

Firm A (in 000s) – Selected figures
	200V	200W	200X	200Y	200Z
Cash	$27,256	$25,205	$137,106	$185,561	$40,691
Trade receivables (net)	682,641	895,542	768,756	555,394	305,467
Inventory	1,892,830	2,342,941	2,331,676	1,634,425	646,842
Current assets	2,648,711	3,265,769	3,427,419	2,672,003	1,656,178
Fixed assets (net)	889,723	1,039,147	1,277,239	1,360,792	965,638
Other assets	68,000	124,400	231,400	146,062	131,673
Current liabilities	1,438,891	1,873,371	2,480,230	1,846,039	1,135,247
Long-term liabilities	932,541	948,170	1,327,068	1,984,981	2,015,346
Total liabilities	2,439,957	3,098,402	4,147,003	3,842,348	3,666,155
Net worth	1,876,148	2,149,073	1,696,455	1,501,880	32,629
Net sales	6,664,347	8,392,042	6,311,804	6,297,915	4,292,304
Net profit	186,680	369,562	397,328	(393,128)	(1,638,193)
Working capital (CA-CL)	1,209,820	1,392,398	947,189	825,964	520,931
Causal ratios
Fixed assets to net worth	.47x	.48x	.75x	.91x	29.6x
Collection period	37 days	38 days	44 days	32 days	26 days
Net sales to inventory	3.52x	3.58x	2.7x	3.85x	6.6x
Net sales to net worth	3.55x	3.90x	3.72x	4.19x	131.5x
Net profits to net sales	2.8%	4.4%	6.3%	(6.24%)	(38.2%)
Misc. assets to net worth	3.6%	5.8%	13.6%	9.7%	403.5%
Effect ratios
Current assets to current liabilities	1.84x	1.74x	1.38x	1.45x	1.46x
Current liability to net worth	76.7%	87.2%	146.2%	122.9%	3,479.3%
Total liability to net worth	130.1%	144.2%	244.5%	255.8%	11,235.9%
Inventory to working capital	156.5%	168.3%	246.2%	197.9%	124.2%
Trade receivables to working capital	56.4%	64.3%	81.16%	67.2%	58.6%
Long-term liabilities to working capital	77.1%	68.1%	140.1%	240.3%	386.9%
Net profit to net worth	9.9%	17.2%	23.4%	(26.2%)	(5,020.6%)
Net sales to fixed assets	7.49x	8.08x	4.94x	4.63x	4.45x
Net sales to working capital	5.51x	6.03x	6.66x	7.62x	8.24x

Case study 4: Store container corporation

Store container corporation balance sheet (millions of dollars)
December 31,	200X	200Y	200Z
Assets
Cash and equivalent	$8,290	$3,880	$15,400
Receivables	123,860	127,950	243,140
Inventories	152,660	148,350	238,210
Other current	38,440	40,000	33,710
Total current	323,250	320,180	530,460
Net property, plant, and equipment	657,660	642,560	924,360
Other assets	25,750	47,580	68,780
Total assets	$1,006,660	$1,010,320	$1,523,600
Liabilities and stockholders’ equity
Notes payable	$62,200	$57,630	$7,330
Accounts payable	53,000	57,970	105,250
Income taxes payable	3,740	4,120	5,880
Other current	45,440	45,410	84,950
Total current	164,380	165,130	203,410
Long-term debt	491,330	501,250	768,490
Deferred taxes	55,800	49,210	69,900
Total long-term debt	547,130	550,460	838,390
Total liabilities	711,510	715,590	1,041,800
Common stock	147,390	152,170	222,360
Retained earnings	147,760	142,560	163,250
Total common equity	295,150	294,730	385,610
Preferred stock	–	–	96,190
Total liabilities & equity	$1,006,660	$1,010,320	$1,523,600
Net sales	$1,244,390	$1,229,150	$2,032,320
Other income	7,110	4,600	10,850
Total	1,251,500	1,233,750	2,043,170
Costs and expenses
Cost of sales	925,870	944,150	1,564,610
Selling and administrative expenses	147,640	156,990	241,180
Depreciation and amortization	63,380	67,810	92,310
Interest expense	59,280	63,310	85,340
Total	1,196,170	1,232,260	1,983,440
Income (loss) before taxes	55,330	1,490	59,730
Provision (credit) for income taxes	21,670	(2,290)	24,320
Net income	$33,660	$3,780	$35,410

Store container corporation key ratios 200X-200Z
Ratio	200X	200Y	200Z	Industry
Liquidity
CA/CL	1.97×	1.94×	2.61×	1.80×
Cash + receivables/CL	0.80×	0.80×	1.27×	0.90×
Receivables/working capital	78.00%	83.00%	74.00%	69.00%
Inventory/working capital	96.00%	96.00%	73.00%	72.00%
Debt
TL/equity	241.07%	242.80%	270.17%	129.10%
CL/equity	55.69%	56.03%	52.75%	50.90%
EBIT/interest	1.93×	1.02×	1.70×	5.76×
Profitability
Net income/sales	2.71%	0.31%	1.74%	2.50%
Sales/total assets	1.24×	1.22×	1.33×	1.68×
Total assets/equity	3.41×	3.43×	3.95×	3.26×
Net income/equity	11.400%	1.280%	9.180%	13.70%
Causal
Fixed assets/equity	222.82%	218.01%	239.71%	110.00%
Collection period	36.33 days	38.00 days	43.67 days	38.90 days
Sales/inventory	8.15×	8.29×	8.53×	12.30×
Sales/equity	4.22×	4.17×	5.27×	2.63×
Net income/sales	2.71%	0.30%	1.74%	5.20%
Miscellaneous assets/equity	8.72%	16.14%	17.83%	7.95%

Discussion case 1

Best Buy Company, Inc. Analyze this company’s financial condition
	Year 1	Year 2	Year 3	Year 4	Year 5
Assets
Cash	$23,830	$27,063	$112,789	$7,138	$59,872
Receivables	7,318	8,716	15,981	37,968	52,944
Inventory	92,991	95,684	135,838	249,991	637,950
Prepaid expenses	3,224	7,602	856	332	756
Other current assets	642	541	7,627	9,497	13,088
Total	128,005	139,606	273,091	304,926	764,610
Net plant and equipment	27,359	39,572	58,250	126,442	172,724
Other assets	1,423	6,350	5,877	7,774	15,160
Total assets	$156,787	$185,528	$337,218	$439,142	$952,494
Liabilities
Current portion of long-term debt	$2,598	$4,444	$38,096	$5,740	$8,899
Notes payable	0	0	4,174	8,571	11,156
Account payable	29,710	41,900	68,670	118,338	294,060
Taxes payable	3,223	2,178	1,496	6,545	11,694
Accruals	9,948	11,770	19,514	30,571	57,073
Other	4,128	14,691	14,324	16,240	19,146
Total current liabilities	49,607	74,983	146,274	186,005	402,028
Long-term debt	35,099	35,381	14,884	48,130	210,811
Other liabilities	5,931	18,423	18,492	22,724	28,211
Net worth	66,150	56,741	157,568	182,283	311,444
Total	$156,787	$185,528	$337,218	$439,142	$952,494
Revenues	$512,850	$664,823	$929,692	$1,619,978	$3,006,534
Net income	5,683	(9,457)	9,601	19,855	41,285
	Year 1	Year 2	Year 3	Year 4	Year 5	Industry average
Liquidity
Current ratio	2.58×	1.86×	1.87×	1.63×	1.90×	2.10×
Quick ratio	0.71×	0.58×	0.93×	0.30×	0.32×	0.60×
Receivables to working capital	9.30%	9.30%	13.50%	12.60%	14.60%	14.00%
Inventory to working capital	118.60%	122.10%	210.20%	197.10%	176.00%	124.00%
Debt
Debt to equity	137.00%	226.90%	114.00%	140.90%	205.80%	77.50
Current debt to equity	75.00%	132.10%	92.80%	102.00%	129.10%	55.70%
Times interest earned (given)	12.51×	2.40×	12.64×	26.75×	29.18×	N/A
Causal ratios
Fixed assets to net worth	41.40%	69.70%	36.90%	69.40%	55.50%	33.40%
Net sales to net worth	7.75×	11.72×	5.90×	8.89×	9.65×	4.56×
Profit margin	1.10%	(1.40%)	1.03	1.23	1.37	3.20
Net sales to inventory	5.52×	6.95×	6.84×	6.48×	4.71×	6.50×
Collection period (days)	5.14	4.72	6.19	8.44	6.34	11.00
Misc. assets to net worth	8.00%	25.50%	9.11%	9.66%	9.31%	N/A
DuPont analysis
Profit margin	1.10%	(1.40%)	1.03	1.23	1.37	3.20
Asset turnover	3.27	3.58	2.75	3.69	3.16	2.03
ROA	3.60%	(5.02%)	2.85	4.53	4.32	6.50
Equity multiplier	2.37	3.26	2.14	2.40	3.05	2.29
ROE	8.53%	(16.64%)	6.07	10.87	13.24	14.89

Knowledge check

1. Over the five-year period, the relative quantity of Best Buy’s liquidity has
   1. Increased.
   2. Decreased.
   3. Not changed materially.
   4. Cannot be determined.
2. The quality of Best Buy’s liquidity has ________ over the five-year period.
   1. Deteriorated.
   2. Improved slightly.
   3. Improved considerably.
   4. Not changed.
3. Best Buy can be considered
   1. An overtrader.
   2. An undertrader.
   3. A company with a collection period problem.
   4. All of the above.

Discussion case 2

Biscayne apparel balance sheet
	200X	200Y	200Z
Assets
Cash	$1,568	$4,178	$312
Receivables	14,401	21,009	18,271
Inventory	8,419	22,584	25,890
Other	337	1,573	3,941
Total current assets	24,725	49,344	48,414
Property, plant, and equipment	2,098	2,984	3,652
Other assets	7,968	8,250	9,676
Total assets	$34,791	$60,578	$61,742
Liabilities
Accounts payables	$2,343	$6,060	$3,841
Accruals	3,384	6,841	5,914
Notes payables	2,850	8,500	17,850
Current portion of long-term debt			1,250
Bridge note	–	4,776	–
Total current liabilities	8,577	26,177	28,855
Notes payable	6,444	7,944	6,444
Long-term debt	–	–	6,250
Other	210	576	358
Net worth	19,560	25,881	19,835
	$34,791	$60,578	$61,742
Revenue	$65,258	$72,350	$100,294
Net income	3,895	2,048	(6,127)
	200X	200Y	200Z	Industry average
Liquidity
Defensive interval	95.70	137.00	76.20	57.50
Current ratio	2.88	1.89	1.68	2.02
Quick ratio	1.90	1.02	0.78	1.18
Receivables to working capital	0.89	0.91	0.93	0.70
Inventory to working capital	0.52	0.97	1.32	0.83
Debt
Debt to equity	0.78	1.34	2.11	1.00
Current debt to equity	0.44	1.01	1.45	0.77
Times interest earned	5.74	3.19	(1.39)	N/A
DuPont
Profit margin	6.00%	3.00%	(6.00%)	4.00%
Asset turnover	1.88×	1.19×	1.62×	2.98×
ROA	11.28%	3.57%	(9.72%)	11.92%
Equity multiplex	1.78×	2.34×	3.11×	2.00×
ROE	20.08%	8.35%	(30.23%)	23.84%
Causal
Fixed assets to net worth	10.70%	11.50%	18.40%	34.00%
Collection period (days)	79.40	104.50	65.60	33.50
Net sales to inventory	7.75×	3.20×	3.87×	9.10×
Net sales to net worth	3.34×	2.80×	5.06×	5.94×
Net profit to net sales	6.00%	3.00%	(6.00%)	4.00%
Misc. assets to net worth	0.00%	6.00%	8.00%	10.00%

Knowledge check

4. Biscayne has _______ leverage.
   1. Excessive.
   2. Inadequate.
   3. The right amount of.
   4. The wrong kind of.
5. To improve Biscayne’s profit margin, what action would you suggest?
   1. Increase sales.
   2. Cut expenses.
   3. Downsize.
   4. None of the above would likely fix the problem.

Illustrative exercise

Describe causes of the Biscayne Company’s financial problems.