Ratio Analysis Financial Management Case: Assessing Martin Manufacturing’s Current Financial Position Martin Manufacturing Company Historical and Indu...
Ratio Analysis Financial Management Case: Assessing Martin Manufacturing’s Current Financial Position Martin Manufacturing Company Historical and Industry Average Ratios Ratio
Industry
Actual 2007
Actual 2008
Actual 2009
Current Ratio
1.7
1.8
2.5
1.5
Quick Ratio
1.0
0.9
1.4
1.2
Inventory Turnover (times)
5.2
5.0
5.3
10.2
Average Collection Period
50.7 days
50.8 days
58.0
46 days
1.5
1.5
1.6
2.0
45.8%
54.3%
57%
24.5%
2.2
1.9
1.6
2.5
Gross Profit Margin
27.5%
28%
27%
26%
Net Profit Margin
1.1%
1.0%
0.7%
1.2%
Return on Total Assets (ROA)
1.7%
1.5%
1.1%
2.4%
Return on Equity (ROE)
3.1%
3.3%
2.6%
3.2%
Price/Earnings (P/E) Ratio
33.5
38.7
34.48
43.4
Market/Book(M/B) Ratio
1.0
1.1
0.88
1.2
Total Asset Turnover (times) Debt Ratio Time Interest Earned Ratio
Average 2009
b) Liquidity Ratio Time series analysis:
The firm has increased its ability to pay its current liabilities out of its current assets; thereby it has reduced its short term liquidity risk or the chance of being technically insolvent. Though its quick ratio is lowest in 2008, there is an upward trend in quick ratio as well. Cross sectional analysis: Firms’ liquidity ratios are significantly higher than the industry average which indicates that it has excessive investment in current assets and thereby it is avoiding unnecessary liquidity risk and sacrificing chance of getting additional return.
1
Ratio Analysis Financial Management Activity Ratio Time series analysis: Firm’s inventory turnover and total asset turnover are stable, but its average collection period
has increased over the years. The increasing trend of average collection period indicates a symptom of collection problem. Cross sectional analysis: Inventory turnover is significantly lower than the industry average, which is an indicator of too much inventory held by the firm relative to its sales. The average collection period is higher
than the industry average which indicates that firm has collection problem or firm provides too much flexible credits than typical firm in the industry and eventually it is sacrificing return. Total asset turnover is significantly lower than industry average. Vis-à-vis the typical firm in
the industry, the sales volume is not sufficient for volume of committed assets as indicated by its low total asset turnover. Debt Ratio Time series analysis:
The firm is getting more levered over the years and thereby placing itself at higher financial risk. On the other hand, its time interest earned ratio has decreased over the year which indicates that firm ability to service debt has decreased. The decreasing trend of time interest earned ratio and increasing trend of debt ratio may lead the firm toward high financial risk. Cross sectional analysis: The debt ratio of the firm is much higher than that of average firm in the industry. That means, the financial leverage and financial risk taken by the firm is much higher than that of taken by
the typical firm in the industry. Firm’s time interest earned ratio is lower than the industry average. So the financial risk taken by the firm is also fueled by its low time interest earned ratio which eventually may lead the firm toward dangerous situation.
2
Ratio Analysis Financial Management Profitability Ratio: Time series analysis: The Gross profit margin is stable but Net Profit Margin, Return on Asset (ROA) and Return on
Equity (ROE) are deteriorating. The increasing trend of financial leverage and current asset can be blamed for this deterioration. Cross sectional analysis: The firm’s gross profit margin is higher than industry average. But its ROA, ROE and net profit margin are significantly lower than that of typical firm in the industry. This lower return might be due to higher financial leverage and excessive current assets used by the firm than that of used by the typical firm in the industry. Market Ratio: Time series analysis:
Both price/earnings (P/E) and market/book (M/B) ratios are getting worse over the years. This indicates that company is losing investors’ confidence upon it. Cross sectional analysis: The comparison of the P/E ratio and M/B ratio of the firm with the typical firm in the industry indicates that investors have lower confidence on the firm than on the average firm in the industry. Investors have lower confidence on Martin Company, as they perceive that Martin,s ability to earn future profit will face more and increasing uncertainty.
C) Martin manufacturing has high liquidity ratio which is due to its excessive investment in current assets. High investment in current assets is represented by its low inventory turnover,
low total asset turnover and high average collection period. Assets, 57% of which financed by liabilities, fails to generate appropriate level of sales. Therefore, high interest associated with large debt is depressing it profitability. These problems are being identified by the investors which are reflected in company’s weak market ratio.
