Analysis of Financial Statements: MINI CASE STUDY

addison karev WAS BROUGHT IN AS ASSISTANT TO FRED CAMPO, COMPUTRON S CHAIR MAN, WHO HAD THE TASK OF GETTING THE COMPANY BACK INTO A SOUND FINANCIAL POSITIO N. COMPUTRON S 2000 AND 2001 BALANCE SHEETS AND INCOME STATEMENTS, TOGETHER WITH P ROJECTIONS FOR 2002, ARE SHOWN IN THE FOLLOWING TABLES. ALSO, THE TABLES SHOW T HE 2000 AND 2001 FINANCIAL RATIOS, ALONG WITH INDUSTRY AVERAGE DATA. THE 2002 P ROJECTED FINANCIAL STATEMENT DATA REPRESENT JAMISON S AND CAMPO S BEST GUESS FOR 200 2 RESULTS, ASSUMING THAT SOME NEW FINANCING IS ARRANGED TO GET THE COMPANY OVER T HE HUMP. JAMISON EXAMINED MONTHLY DATA FOR 2001 (NOT GIVEN IN THE CASE), AND SHE DETECTED AN IMPROVING PATTERN DURING THE YEAR. MONTHLY SALES WERE RISING, COSTS WERE FALLING, AND LARGE LOSSES IN THE EARLY MONTHS HAD TURNED TO A SMALL PROFIT BY DECEMBER. THUS, THE ANNUAL DATA LOOKED SOMEWHAT WORSE THAN FINAL MONTHLY DA TA. ALSO, IT APPEARS TO BE TAKING LONGER FOR THE ADVERTISING PROGRAM TO GET THE MESSAGE ACROSS, FOR THE NEW SALES OFFICES TO GENERATE SALES, AND FOR THE NEW MA NUFACTURING FACILITIES TO OPERATE EFFICIENTLY. IN OTHER WORDS, THE LAGS BETWEEN SPENDING MONEY AND DERIVING BENEFITS WERE LONGER THAN COMPUTRON S MANAGERS HAD AN TICIPATED. FOR THESE REASONS, JAMISON AND CAMPO SEE HOPE FOR THE COMPANY--PROVI DED IT CAN SURVIVE IN THE SHORT RUN. JAMISON MUST PREPARE AN ANALYSIS OF WHERE THE COMPANY IS NOW, WHAT IT MU ST DO TO REGAIN ITS FINANCIAL HEALTH, AND WHAT ACTIONS SHOULD BE TAKEN. YOUR AS SIGNMENT IS TO HELP HER ANSWER THE FOLLOWING QUESTIONS. PROVIDE CLEAR EXPLANATI ONS, NOT YES OR NO ANSWERS. BALANCE SHEETS 2002E ASSETS CASH SHORT-TERM INVESTMENTS ACCOUNTS RECEIVABLE INVENTORIES TOTAL CURRENT ASSETS GROSS FIXED ASSETS LESS ACCUMULATED DEPRECIATION NET FIXED ASSETS TOTAL ASSETS LIABILITIES AND EQUITY ACCOUNTS PAYABLE NOTES PAYABLE ACCRUALS TOTAL CURRENT LIABILITIES LONG-TERM DEBT COMMON STOCK RETAINED EARNINGS TOTAL EQUITY TOTAL LIABILITIES AND EQUITY NOTE: $ 14,000 71,632 878,000 1,716,480 $2,680,112 1,197,160 380,120 $ 817,040 $3,497,152 $ 436,800 600,000 408,000 $1,444,800 500,000 1,680,936 (128,584) $1,552,352 $3,497,152 $ 2001 7,282 0 632,160 1,287,360 $1,926,802 1,202,950 263,160 $ 939,790 $2,866,592 $ 524,160 720,000 489,600 $1,733,760 1,000,000 460,000 (327,168) $ 132,832 $2,866,592 $ 2000___ 9,000 48,600 351,200 715,200 $1,124,000 491,000 146,200 $ 344,800 $1,468,800 $ 145,600 200,000 136,000 $ 481,600 323,432 460,000 203,768 $ 663,768 $1,468,800

E INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS.

INCOME STATEMENTS SALES COST OF GOODS SOLD OTHER EXPENSES DEPRECIATION TOTAL OPERATING COSTS EBIT INTEREST EXPENSE EBT TAXES (40%) NET INCOME EPS DPS BOOK VALUE PER SHARE STOCK PRICE SHARES OUTSTANDING TAX RATE LEASE PAYMENTS SINKING FUND PAYMENTS NOTE: E 2002E $7,035,600 6,100,000 312,960 120,000 $6,532,960 $ 502,640 80,000 $ 422,640 169,056 $ 253,584 $1.014 $0.220 $6.209 $12.17 250,000 40.00% 40,000 0 2001 $5,834,400 5,728,000 680,000 116,960 $6,524,960 ($ 690,560) 176,000 ($ 866,560) (346,624) ($ 519,936) ($5.199) $0.110 $1.328 $2.25 100,000 40.00% 40,000 0 2000___ $3,432,000 2,864,000 340,000 18,900 $3,222,900 $ 209,100 62,500 $ 146,600 58,640 $ 87,960 $0.880 $0.220 $6.638 $8.50 100,000 40.00% 40,000 0

INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS. RATIO ANALYSIS 2002E 2001 1.1 0.4 4.5 39.0 6.2 2.0 95.4% -3.9 -2.5 -8.9% -24.1% -18.1% -391.4% -0.4 -0.6 1.7 $1.33 2000 2.3 0.8 4.8 36.8 10.0 2.3 54.8% 3.3 2.6 2.6% 14.2% 6.0% 13.3% 9.7 8.0 1.3 $6.64 INDUSTRY AVERAGE 2.7 1.0 6.1 32.0 7.0 2.5 50.0% 6.2 8.0 3.6% 17.8% 9.0% 18.0% 14.2 7.6 2.9 N.A.

CURRENT QUICK INVENTORY TURNOVER DAYS SALES OUTSTANDING (DSO) FIXED ASSETS TURNOVER TOTAL ASSETS TURNOVER DEBT RATIO TIE EBITDA COVERAGE PROFIT MARGIN BASIC EARNING POWER ROA ROE PRICE/EARNINGS PRICE/CASH FLOW MARKET/BOOK BOOK VALUE PER SHARE NOTE: E

INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS.

A. TIOS?

WHY ARE RATIOS USEFUL? WHAT ARE THE FIVE MAJOR CATEGORIES OF RA

ANSWER: RATIOS ARE USED BY MANAGERS TO HELP IMPROVE THE FIRM S PERFORMANCE, BY LEN DERS TO HELP EVALUATE THE FIRM S LIKELIHOOD OF REPAYING DEBTS, AND BY STOCKHOLDERS TO HELP FORECAST FUTURE EARNINGS AND DIVIDENDS. THE FIVE MAJOR CATEGORIES OF R ATIOS ARE: LIQUIDITY, ASSET MANAGEMENT, DEBT MANAGEMENT, PROFITABILITY, AND MAR KET VALUE.

B. CALCULATE THE 2002 CURRENT AND QUICK RATIOS BASED ON THE PROJECT ED BALANCE SHEET AND INCOME STATEMENT DATA. WHAT CAN YOU SAY ABOUT THE COMPANY S LIQUIDITY POSITION IN 2000, 2001, AND AS PROJECTED FOR 2002? WE OFTEN THINK OF R ATIOS AS BEING USEFUL (1) TO MANAGERS TO HELP RUN THE BUSINESS, (2) TO BANKERS F OR CREDIT ANALYSIS, AND (3) TO STOCKHOLDERS FOR STOCK VALUATION. WOULD THESE DI FFERENT TYPES OF ANALYSTS HAVE AN EQUAL INTEREST IN THE LIQUIDITY RATIOS? ANSWER: CURRENT RATIO02 = CURRENT ASSETS/CURRENT LIABILITIES = $2,680,112/$1,444,800 = 1.86. QUICK RATIO02 = (CURRENT ASSETS INVENTORY)/CURRENT LIABILITIES = ($2,680,112 - $1,716,480)/$1,444,800 = 0.667. THE COMPANY S CURRENT AND QUICK RATIOS ARE LOW RELATIVE TO ITS 2000 CURRENT AND QU ICK RATIOS; HOWEVER, THEY HAVE IMPROVED FROM THEIR 2001 LEVELS. BOTH RATIOS ARE WELL BELOW THE INDUSTRY AVERAGE, HOWEVER. C. CALCULATE THE 2002 INVENTORY TURNOVER, DAYS SALES OUTSTANDING (D SO), FIXED ASSETS TURNOVER, AND TOTAL ASSETS TURNOVER. HOW DOES COMPUTRON S UTILI ZATION OF ASSETS STACK UP AGAINST OTHER FIRMS IN ITS INDUSTRY? ANSWER: INVENTORY TURNOVER02 = = $7,035,600/$1,716,480 = 4.10. DSO02 SALES/INVENTORY

= RECEIVABLES/(SALES/360) = $878,000/($7,035,600/360) = 44.9 DAYS.

FIXED ASSETS TURNOVER02 = SALES/NET FIXED ASSETS = $7,035,600/$817,040 = 8.61. TOTAL ASSETS TURNOVER99 = SALES/TOTAL ASSETS = $7,035,600/$3,497,152 = 2.01. THE FIRM S INVENTORY TURNOVER RATIO HAS BEEN STEADILY DECLINING, WHILE ITS DAYS SA LES OUTSTANDING HAS BEEN STEADILY INCREASING. WHILE THE FIRM S FIXED ASSETS TURNO VER RATIO IS BELOW ITS 2000 LEVEL, IT IS ABOVE THE 2001 LEVEL. THE FIRM S TOTAL A SSETS TURNOVER RATIO IS BELOW ITS 2000 LEVEL AND JUST SLIGHTLY BELOW ITS 2001 LE VEL. THE FIRM S INVENTORY TURNOVER AND TOTAL ASSETS TURNOVER ARE BELOW THE INDUSTRY AVE RAGE. THE FIRM S DAYS SALES OUTSTANDING IS ABOVE THE INDUSTRY AVERAGE (WHICH IS B AD); HOWEVER, THE FIRM S FIXED ASSETS TURNOVER IS ABOVE THE INDUSTRY AVERAGE. (TH IS MIGHT BE DUE TO THE FACT THAT COMPUTRON IS AN OLDER FIRM THAN MOST OTHER FIRM S IN THE INDUSTRY, IN WHICH CASE, ITS FIXED ASSETS ARE OLDER AND THUS HAVE BEEN DEPRECIATED MORE, OR THAT COMPUTRON S COST OF FIXED ASSETS WERE LOWER THAN MOST FI RMS IN THE INDUSTRY.) THE FIRM S OPERATING CAPITAL REQUIREMENT RATIO IS HIGHER TH AN THE INDUSTRY AVERAGE, INDICATING THAT COMPUTRON REQUIRES MORE DOLLARS OF CAPI TAL TO GENERATE A DOLLAR OF SALES THAN THE AVERAGE FIRM IN THE INDUSTRY. D. CALCULATE THE 2002 DEBT, TIMES-INTEREST-EARNED, AND EBITDA COVER AGE RATIOS. HOW DOES COMPUTRON COMPARE WITH THE INDUSTRY WITH RESPECT TO FINANCI AL LEVERAGE? WHAT CAN YOU CONCLUDE FROM THESE RATIOS? ANSWER: DEBT RATIO02 = TOTAL DEBT/TOTAL ASSETS

= ($1,444,800 + $500,000)/$3,497,152 = 55.61%. TIE02 = EBIT/INTEREST = $502,640/$80,000 = 6.3. EBITDA COVERAGE01 = / = ($502,640 + $120,000 + $40,000)/($80,000 + $40,000) = 5.5. THE FIRM S DEBT RATIO IS MUCH IMPROVED FROM 2001, BUT IT IS STILL ABOVE ITS 2000 L EVEL AND THE INDUSTRY AVERAGE. THE FIRM S TIE AND EBITDA COVERAGE RATIOS ARE MUCH IMPROVED FROM THEIR 2000 AND 2001 LEVELS, BUT THEY ARE STILL BELOW THE INDUSTRY AVERAGE. E. CALCULATE THE 2002 PROFIT MARGIN, BASIC EARNING POWER (BEP), RET URN ON ASSETS (ROA), AND RETURN ON EQUITY (ROE). WHAT CAN YOU SAY ABOUT THESE R ATIOS? ANSWER: PROFIT MARGIN02 = NET INCOME/SALES = $253,584/$7,035,600 = 3.6%. BASIC EARNING POWER02 = EBIT/TOTAL ASSETS = $502,640/$3,497,152 = 14.4%. ROA02 = NET INCOME/TOTAL ASSETS = $253,584/$3,497,152 = 7.25%. ROE02 = NET INCOME/COMMON EQUITY = $253,584/$1,552,352 = 16.34%. THE FIRM S PROFIT MARGIN IS ABOVE 2000 AND 2001 LEVELS AND IS AT THE INDUSTRY AVER AGE. THE BASIC EARNING POWER, ROA, AND ROE RATIOS ARE ABOVE BOTH 2000 AND 2001 LEVELS, BUT BELOW THE INDUSTRY AVERAGE DUE TO POOR ASSET UTILIZATION.

F. CALCULATE THE 2002 PRICE/EARNINGS RATIO, PRICE/CASH FLOW RATIOS, AND MARKET/BOOK RATIO. DO THESE RATIOS INDICATE THAT INVESTORS ARE EXPECTED TO HAVE A HIGH OR LOW OPINION OF THE COMPANY? ANSWER: EPS = NET INCOME/SHARES OUTSTANDING = $253,584/250,000 = $1.0143. PRICE/EARNINGS99 = PRICE PER SHARE/EARNINGS PER SHARE = $12.17/$1.0143 = 12.0. CHECK: PRICE = EPS P/E = $1.0143(12) = $12.17. CASH FLOW/SHARE02 000 = $1.49. PRICE/CASH FLOW = $12.17/$1.49 = 8.2. BVPS = COMMON EQUITY/SHARES OUTSTANDING = $1,552,352/250,000 = $6.21. MARKET/BOOK = MARKET PRICE PER SHARE/BOOK VALUE PER SHARE = $12.17/$6.21 = 1.96X. BOTH THE P/E RATIO AND BVPS ARE ABOVE THE 2000 AND 2001 LEVELS BUT BELOW THE IND USTRY AVERAGE. F. PERFORM A COMMON SIZE ANALYSIS AND PERCENT CHANGE ANALYSIS. WHA T DO THESE ANALYSES TELL YOU ABOUT COMPUTRON? ANSWER: FOR THE COMMON SIZE BALANCE SHEETS, DIVIDE ALL ITEMS IN A YEAR BY THE TO = (NI + DEP)/SHARES = ($253,584 + $120,000)/250,

TAL ASSETS FOR THAT YEAR. FOR THE COMMON SIZE INCOME STATEMENTS, DIVIDE ALL ITE MS IN A YEAR BY THE SALES IN THAT YEAR. Common Size Balance Sheets Assets 2000 2001 2002E Cash 0.6% 0.3% 0.4% ST Invest. 3.3% 0.0% AR 23.9% 22.1% 25.1% Invent. 48.7% 44.9% 49.1% Total CA 76.5% 67.2% Net FA 23.5% 32.8% 23.4% TA 100.0% 100.0% 100.0% Liabilities and Equity 2000 2001 2002E AP 9.9% 18.3% 12.5% Notes pay. 13.6% 25.1% Accruals 9.3% 17.1% Total CL 32.8% 60.5% LT Debt 22.0% 34.9% 14.3% Com. Stock 31.3% 16.0% Ret. Earnings 13.9% -11.4% Total equity 45.2% 4.6% Total L&E 100.0% 100.0% Common Size Income statement 2000 2001 2002E Sales 100.0% 100.0% 100.0% COGS 83.4% 98.2% 86.7% Other exp. 9.9% 11.7% Depr. 0.6% 2.0% 1.7% EBIT 6.1% -11.8% 7.1% Int. Exp. 1.8% 3.0% EBT 4.3% -14.9% 6.0% Taxes 1.7% -5.9% 2.4% NI 2.6% -8.9% 3.6%

Ind. 0.3% 2.0% 0.3% 22.4% 41.2% 76.6% 64.1% 35.9% 100.0% Ind. 11.9% 17.2% 11.7% 41.3% 26.3% 48.1% -3.7% 44.4% 100.0%

2.4% 9.5% 23.7% 20.0% 30.0% 50.0% 100.0%

Ind. 100.0% 84.5% 4.4% 4.4% 4.0% 7.1% 1.1% 1.1% 5.9% 2.4% 3.6%

COMPUTRON HAS HIGHER PROPORTION OF CURRENT ASSETS (49.1%) THAN INDUSTRY (41.2%). COMPUTRON HAS SLIGHTLY LESS EQUITY (WHICH MEANS MORE DEBT) THAN INDUST RY. COMPUTRON HAS MORE SHORT-TERM DEBT THAN INDUSTRY, BUT LESS LONG-TERM DEBT T HAN INDUSTRY. COMPUTRON HAS HIGHER COGS (86.7) THAN INDUSTRY (84.5), BUT LOWER DEPRECIATION. RESULT IS THAT COMPUTRON HAS SIMILAR EBIT (7.1) AS INDUSTRY. FOR THE PERCENT CHANGE ANALYSIS, DIVIDE ALL ITEMS IN A R OW BY THE VALUE IN THE FIRST YEAR OF THE ANALYSIS. Percent Change Balance Assets 2000 2001 Cash 0.0% -19.1% ST Invest. 0.0% AR 0.0% 80.0% Invent. 0.0% 80.0% Total CA 0.0% Net FA 0.0% 172.6% TA 0.0% 95.2% Liabilities and Equity Sheets 2002E 55.6% -100.0% 47.4% 150.0% 140.0% 71.4% 138.4% 137.0% 138.1%

2000 AP 0.0% Notes pay. Accruals Total CL LT Debt 0.0% Com. Stock Ret. Earnings Total equity Total L&E Percent Change 2000 Sales 0.0% COGS 0.0% Other exp. Depr. 0.0% EBIT 0.0% Int. Exp. EBT 0.0% Taxes 0.0% NI 0.0%

2001 260.0% 0.0% 0.0% 0.0% 209.2% 0.0% 0.0% 0.0% 0.0%

2002E 200.0% 260.0% 260.0% 260.0% 54.6% 0.0% -260.6% -80.0% 95.2%

200.0% 200.0% 200.0% 265.4% -163.1% 133.9% 138.1%

Income statement 2001 2002E 70.0% 105.0% 100.0% 113.0% 0.0% 100.0% -8.0% 518.8% 534.9% -430.3% 140.4% 0.0% 181.6% 28.0% -691.1% 188.3% -691.1% 188.3% -691.1% 188.3%

WE SEE THAT 2002 SALES GROW 105% FROM 2000, AND THAT NI GROWS 188% FROM 2000. S O COMPUTRON HAS BECOME MORE PROFITABLE. WE SEE THAT TOTAL ASSETS GROW AT A RATE OF 138%, WHILE SALES GROW AT A RATE OF ONLY 105%. SO ASSET UTILIZATION REMAINS A PROBLEM.

H. USE THE EXTENDED DU PONT EQUATION TO PROVIDE A SUMMARY AND OVERV IEW OF COMPUTRON S FINANCIAL CONDITION AS PROJECTED FOR 2002. WHAT ARE THE FIRM S M AJOR STRENGTHS AND WEAKNESSES? ANSWER: DU PONT EQUATION = = 3.6% 2.01 1/(1 - 0.5561) = 16.3%. STRENGTHS: THE FIRM S FIXED ASSETS TURNOVER WAS ABOVE THE INDUSTRY AVERAGE. HOWE VER, IF THE FIRM S ASSETS WERE OLDER THAN OTHER FIRMS IN ITS INDUSTRY THIS COULD P OSSIBLY ACCOUNT FOR THE HIGHER RATIO. (COMPUTRON S FIXED ASSETS WOULD HAVE A LOWE R HISTORICAL COST AND WOULD HAVE BEEN DEPRECIATED FOR LONGER PERIODS OF TIME.) THE FIRM S PROFIT MARGIN IS SLIGHTLY ABOVE THE INDUSTRY AVERAGE, DESPITE ITS HIGHE R DEBT RATIO. THIS WOULD INDICATE THAT THE FIRM HAS KEPT COSTS DOWN, BUT, AGAIN , THIS COULD BE RELATED TO LOWER DEPRECIATION COSTS. WEAKNESSES: THE FIRM S LIQUIDITY RATIOS ARE LOW; MOST OF ITS ASSET MANAGEMENT RAT IOS ARE POOR (EXCEPT FIXED ASSETS TURNOVER); ITS DEBT MANAGEMENT RATIOS ARE POOR , MOST OF ITS PROFITABILITY RATIOS ARE LOW (EXCEPT PROFIT MARGIN); AND ITS MARKE T VALUE RATIOS ARE LOW.

I. USE THE FOLLOWING SIMPLIFIED 2002 BALANCE SHEET TO SHOW, IN GENE RAL TERMS, HOW AN IMPROVEMENT IN THE DSO WOULD TEND TO AFFECT THE STOCK PRICE. FOR EXAMPLE, IF THE COMPANY COULD IMPROVE ITS COLLECTION PROCEDURES AND THEREBY LOWER ITS DSO FROM 44.9 DAYS TO THE 32-DAY INDUSTRY AVERAGE WITHOUT AFFECTING SA LES, HOW WOULD THAT CHANGE RIPPLE THROUGH THE FINANCIAL STATEMENTS (SHOWN IN THOUS ANDS BELOW) AND INFLUENCE THE STOCK PRICE?

ACCOUNTS RECEIVABLE $1,945 OTHER CURRENT ASSETS NET FIXED ASSETS 1,552 TOTAL ASSETS $3,497

$ 878 1,802 817 $3,497

DEBT EQUITY LIABILITIES PLUS EQUITY

ANSWER: SALES PER DAY = $7,035,600/360 = $19,543. ACCOUNTS RECEIVABLE UNDER NEW POLICY = $625,376. = $19,543 32 DAYS

FREED CASH = OLD A/R - NEW A/R = $878,000 - $625,376 = $252,624. J. DOES IT APPEAR THAT INVENTORIES COULD BE REDUCED, AND, IF SO, HO W SHOULD THAT ADJUSTMENT AFFECT COMPUTRON S PROFITABILITY AND STOCK PRICE. ANSWER: THE INVENTORY TURNOVER RATIO IS LOW. IT APPEARS THAT THE FIRM EITHER HA S EXCESSIVE INVENTORY OR SOME OF THE INVENTORY IS OBSOLETE. IF INVENTORY WERE R EDUCED, THIS WOULD IMPROVE THE LIQUIDITY RATIOS, THE INVENTORY AND TOTAL ASSETS TURNOVER, AND THE DEBT RATIO, WHICH SHOULD IMPROVE THE FIRM S STOCK PRICE AND PROF ITABILITY.

K. IN 2001, THE COMPANY PAID ITS SUPPLIERS MUCH LATER THAN THE DUE DATES, AND IT WAS NOT MAINTAINING FINANCIAL RATIOS AT LEVELS CALLED FOR IN ITS B ANK LOAN AGREEMENTS. THEREFORE, SUPPLIERS COULD CUT THE COMPANY OFF, AND ITS BA NK COULD REFUSE TO RENEW THE LOAN WHEN IT COMES DUE IN 90 DAYS. ON THE BASIS OF DATA PROVIDED, WOULD YOU, AS A CREDIT MANAGER, CONTINUE TO SELL TO COMPUTRON ON CREDIT? (YOU COULD DEMAND CASH ON DELIVERY, THAT IS, SELL ON TERMS OF COD, BUT THAT MIGHT CAUSE COMPUTRON TO STOP BUYING FROM YOUR COMPANY.) SIMILARLY, IF YO U WERE THE BANK LOAN OFFICER, WOULD YOU RECOMMEND RENEWING THE LOAN OR DEMAND IT S REPAYMENT? WOULD YOUR ACTIONS BE INFLUENCED IF, IN EARLY 2002, COMPUTRON SHOW ED YOU ITS 2002 PROJECTIONS PLUS PROOF THAT IT WAS GOING TO RAISE OVER $1.2 MILL ION OF NEW EQUITY CAPITAL? ANSWER: WHILE THE FIRM S RATIOS BASED ON THE PROJECTED DATA APPEAR TO BE IMPROVING , THE FIRM S LIQUIDITY RATIOS ARE LOW. AS A CREDIT MANAGER, I WOULD NOT CONTINUE TO EXTEND CREDIT TO THE FIRM UNDER ITS CURRENT ARRANGEMENT, PARTICULARLY IF I DI DN T HAVE ANY EXCESS CAPACITY. TERMS OF COD MIGHT BE A LITTLE HARSH AND MIGHT PUS H THE FIRM INTO BANKRUPTCY. LIKEWISE, IF THE BANK DEMANDED REPAYMENT THIS COULD ALSO FORCE THE FIRM INTO BANKRUPTCY. CREDITORS ACTIONS WOULD DEFINITELY BE INFLUENCED BY AN INFUSION OF EQUITY CAPITAL IN THE FIRM. THIS WOULD LOWER THE FIRM S DEBT RATIO AND CREDITORS RISK EXPOSURE. L. IN HINDSIGHT, WHAT SHOULD COMPUTRON HAVE DONE BACK IN 2000?

ANSWER: BEFORE THE COMPANY TOOK ON ITS EXPANSION PLANS, IT SHOULD HAVE DONE AN E XTENSIVE RATIO ANALYSIS TO DETERMINE THE EFFECTS OF ITS PROPOSED EXPANSION ON TH E FIRM S OPERATIONS. HAD THE RATIO ANALYSIS BEEN CONDUCTED, THE COMPANY WOULD HAV E GOTTEN ITS HOUSE IN ORDER BEFORE UNDERGOING THE EXPANSION.

M. TIO ANALYSIS?

WHAT ARE SOME POTENTIAL PROBLEMS AND LIMITATIONS OF FINANCIAL RA

ANSWER: SOME POTENTIAL PROBLEMS ARE LISTED BELOW: 1. COMPARISON WITH INDUSTRY AVERAGES IS DIFFICULT IF THE FIRM OPERATES MANY DIFFERENT DIVISIONS. 2. 3. DIFFERENT OPERATING AND ACCOUNTING PRACTICES DISTORT COMPARISONS. SOMETIMES HARD TO TELL IF A RATIO IS GOOD OR BAD.

4. DIFFICULT TO TELL WHETHER COMPANY IS, ON BALANCE, IN A STRONG OR WEAK PO SITION. 5. 6. AVERAGE PERFORMANCE IS NOT NECESSARILY GOOD.

SEASONAL FACTORS CAN DISTORT RATIOS.

7. WINDOW DRESSING TECHNIQUES CAN MAKE STATEMENTS AND RATIOS LOOK BETTER. N. WHAT ARE SOME QUALITATIVE FACTORS ANALYSTS SHOULD CONSIDER WHEN EVALUATING A COMPANY S LIKELY FUTURE FINANCIAL PERFORMANCE? ANSWER: TOP ANALYSTS RECOGNIZE THAT CERTAIN QUALITATIVE FACTORS MUST BE CONSIDER ED WHEN EVALUATING A COMPANY. THESE FACTORS, AS SUMMARIZED BY THE AMERICAN ASSO CIATION OF INDIVIDUAL INVESTORS (AAII), ARE AS FOLLOWS: 1. 2. 3. 4. 5. 6. 7. ARE THE COMPANY S REVENUES TIED TO ONE KEY CUSTOMER? TO WHAT EXTENT ARE THE COMPANY S REVENUES TIED TO ONE KEY PRODUCT? TO WHAT EXTENT DOES THE COMPANY RELY ON A SINGLE SUPPLIER? WHAT PERCENTAGE OF THE COMPANY S BUSINESS IS GENERATED OVERSEAS? COMPETITION FUTURE PROSPECTS LEGAL AND REGULATORY ENVIRONMENT