GEMINI ELECTRONIC CASE STUDY: FINANCIAL RATIO RATIO ANALYSIS ANALYSIS The fnancial ratio was i!ie i!ie into "o#r $arts:% i&
Li'#iit( ) $artic#larl( interestin* to short%ter+ creitors it is "oc#s on c#rrent assets an c#rrent lia,ilit( General r#le "or the c#rrent ratio sho#l ,e at least -:.
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For the Ge+ini Electronic the c#rrent ratio is consistent an it is increase in (ear -//0& 1#t we note that Ge+ini Electronics is sli*htl( less li'#i than the a!era*e fr+ in the in#str( ,eca#se the c#rrent ratio is lower than the in#str( a!era*e& ii&
Assets +ana*e+ent •
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iii& iii&
1oth 1oth f2e f2e asset assets s t#rno t#rno!er !er an total total asset asset t#rno! t#rno!er er are are less less than than in#st in#str( r( a!era a!era*e3 *e3 inica inicati tin* n* that that Ge+ini Ge+ini Electr Electroni onics cs is #sin* #sin* its asset asset ine4c ine4cien ientl( tl( than than the in#st in#str( r( a!era*e in *eneratin* sales& In ter+ o" collectin* recei!a,les 5(o#r sales +one(63 Ge+ini Electronics was ,eco+in* slow #rin* (ear -//7& One o" the ca#ses is +an( retailers 5clients6 e+ane +ore *enero#s creit ter+s than net 8/ a(s3 which stanar in the in#str(& 1esies that3 interest was also not char*e on o!er#e acco#nt& Lon*% on*%te terr+ e, e,tt $a( $a(in in* * a,i a,ili lit( t( Ge+ini Electronics9 e,t ratio an e,t e'#it( ratio inicate that Ge+ini Electronics is +ore le!era*e than the a!era*e fr+ in in#str(& Leverage means the amount of debt used to nance a rm's assets. A rm with signicantly signicantly more debt than equity is considered to be highly leveraged.] The hi*her le!era*e e2$lains Ge+ini Electronics Electronics $oor fnancial $er"or+ance $er"or+ance relati!e to the electro electronics nics in#str( in#str( ,eca#se ,eca#se the le!era*e co++its Ge+ini Electronic Electronics s to interest payments that +#st ,e $ai re*arless o" econo+ic an +ar;et conitions& •
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>hen re"errin* to the Ge+ini Electronics cases the le!era*e was hi*h ,eca#se o" all the assets were fnance with ter+ loans& This is the "actors o" the le!era*e ,eco+in* hi*h&
DEFI NI TI ONof' Lever ageRat i o' Co mp an i e sr e l yonami x t u r eo fowner s 'equi t y anddebt t ofi nanc et hei roper at i ons .Al ev er ager at i oi sany o neo fs e v e r a lfi n an c i a lme as u r e me nt st h atl o okath ow mu c hc api t alc ome si nt hef or m ofdebt( l oans ) ,or as s es s est heabi l i t yofac ompan yt omee tfi nan ci alobl i gat i ons.
BREAKI NG DOWN' Lev er ageRat i o' T oomu c hde btc a nb ed an ge r o usf o rac omp an ya ndi t si n v es t o r s .Un co nt r o l l e dd eb tl e v el sc anl e adt o c r e di td own gr a de so rwo r s e .Ont heo t h erha nd ,t o of e wd ebt sc a na l s or a i s eq ue s t i o ns .I fac o mp an y ' s oper at i onscangener at eahi gherr at eofr et ur nt hant hei nt er es tr at eoni t sl oans ,t hent hedebti shel pi ngt o f uelgr owt hi npr ofi t s .A r el uc t anc eori nabi l i t yt obor r ow ma ybeas i gnt hatoper at i ngmar gi nsar es i mpl y t oot i ght . Ther ear es ev er aldi ff er ents pec i fi cr at i ost hatma ybec at egor i z edasal e ver ager at i o,butt hemai nf ac t or s c ons i der edar ei nc l udedebt ,equi t y,a s s e t sandi nt er es tex pens es.
Lever ageRat i osf orEval uat i ngSol vencyandCapi t alSt r uct ur e Themos twel l k no wnfi nanc i al l e ver ager at i oi st hedebt t oequi t yr at i o.I ti sex pr es sedas : T ot al debt/T ot al Equi t y
Fo re x a mp l e ,i fac o mp an yh as$ 10 Mi nd eb tan d$ 20 Mi ne qu i t y ,i th asad eb t t o e qu i t yr a t i oo f0 . 5 0= ( $10M/ $20M) .Ahi ghdebt / equi t yr at i ogener al l yi n di c at est hatac ompan yha sb eenaggr es s i v ei nfi nan ci ng i t sgr owt hwi t hdebt .Thi sc anr es ul ti nv ol at i l eear ni ngsasar es ul toft headdi t i onali nt er es tex pens e,andi f i ti sv er yhi gh,i tmayi nc r eas et hec hanc esofadef aul torbank r upt c y . Thefi nanc i al l ev er ager at i oi ssi mi l ar ,butr epl ac esdebtwi t has set si nt henumer at or : Av g.T ot al As s et s /Av g.T ot al Equi t y
Leverage Wh i l es o meb us i n es s e spr i d et h ems e l v e sonb ei n gd eb t f r e e,mo s tc o mp an i e sh av eha dt ob or r o wa to ne poi ntoranot hert obuyequi pment ,bui l dnewoffic esorc utpa yr ol lc hec k s.Fort hei n ves t or ,t hec hal l engei s det er mi ni ngwhet hert heor gani z at i on’ sdebtl ev el i ss us t ai nabl e.
I sha v i ngdebt ,i nandofi t s el f ,har mf u l ?Wel l ,y e san dno.I ns omec as es ,bor r o wi ngma ya ct ual l ybea p os i t i v es i g n.Co ns i de rac omp an yt h atwa nt st ob ui l dane w pl a ntbe c au seofi n cr ea s edd ema ndf ori t s pr oduc t s .I tma yha vet ot ak eoutal oanors el lbondst opa yf ort hec ons t r uc t i onandequi pmentc os t s ,but i t ’ sex pec t i ngf ut ur es al est omor et hanmak eupf oran yas s oc i at edbor r owi ngc os t s .
The pr obl em i s when t he use ofdebt ,al so known as l ever agi ng,becomes excessi ve.Wi t hi nt er est p ay me nt st a k i n g al a r g ec h un ko uto ft o pl i nes al e s ,ac ompa nywi l lh av el e s sc a sht of u ndmar k e t i n g, r e se ar c ha ndde v el o pme nta ndo t h eri mp or t a nti n v es t me nt s .
L ar g ed eb tl o ad sc a n ma k eb us i n es s e sp ar t i c u l a r l yv u l n er a bl ed ur i n ga ne c on omi cd own t u r n .I ft h e c or por at i ons t r uggl est omak er egul ari nt er es tpa yment s ,i nv es t or sar el i k el yt ol os ec onfi denc eandbi d do wnt hes har epr i c e.I nmor ee xt r emec as es ,bank r upt c ybec omesav er yr eal pos s i b i l i t y .
Fort hes er eas ons ,s eas onedi n ves t or st ak eagoodl ookatl i abi l i t i esbef or epur c has i ngc or por at es t oc kor bond s.Asawa yt oqui c k l ysi z eupbus i ne ss esi nt hi sr eg ar d,t r ader sha v ede v el opedanumberofr at i o s t hath el ps epar at eheal t h yb or r ower sf r om t hos es wi mmi ngi ndebt .
LI QUI DI TY Ac l a s soffi na nc i a lme t r i c st h ati su s edt od et er mi n eac o mp an y ' sabi l i t yt opayoffi t ss hor t t er msdebt s obl i gat i ons .Gener al l y ,t hehi ghert hev al ueoft her at i o,t hel ar gert hemar gi nofs af e t yt hatt hecompany pos s es s est oc o v ers hor t t er m debt s . Ac ompan y ' sa bi l i t yt ot ur ns hor t t er m as s et si nt oc as ht oc ov e rd ebt si soft heut mos ti mpor t anc ewhe n c r edi t or sar es eek i ngpa yment .Bank r upt c yanal y s t sandmor t gageor i gi nat or sf r equent l yus et hel i qui di t y r at i ost ode t er mi newhet herac ompan ywi l l beabl et oc ont i nuea sagoi ngc onc er n.
3Ex a mp l eRa t i o s : r entr at i o i . Cur
-me as u r e swh et h ero rn otafi r mh asen ou ghr e s ou r c e st op a yi t sde bt so v er
t h en ex t1 2mo nt h s. For mul a:
AsofMar c h31,2014,f orex ampl e,Mi c r os of t ’ sbal anc es heetl i s t edt hef ol l owi ng: Cur r entAs s et s :
Cur r entLi abi l i t i es :
Cash and cash equivalents
$11,572,000
Short-term investments
$76,853,000
Net receivales
$1!,"21,000
#nventor
$1,"20,000
%ther current assets
$3,7!0,000 &ccounts 'aale
Total current assets
cur r ent Mi c r os of t ’ s 3 . 2 2
$","58,000
$109,006,000
Short-term det
$2,000,000
%ther current liailities
$21,"!5,000
r at i o=$109, 006, 000/$33, 903, 000=
Thehi ghert her at i o, t hemor eabl eac ompanyi st opayoff Total current liabilities $33,903,000 i t sobl i gat i ons .Whi l e ac c ept abl er at i osv ar ydependi ngon t hes pec i fi ci ndus t r y ,a r at i obet ween1. 5and3i sgener al l y c ons i der edheal t hy .I nv es t or sandanal y st swoul dc ons i derMi c r os of t ,wi t hac ur r entr at i oof3. 22,fi nanc i al l y heal t hyandc apabl eofpay i ngoffi t sobl i gat i ons . Ar at i ounder1=ac ompan yunabl et opa yoffi t sobl i gat i onsi ft he ybec omedueatt hatpoi nti nt i me.Ar at i o u nd er1d oe sno tn ec es s ar i l yme ant h atac omp an ywi l l g oba nk r up th owe v er ,i td oe si n di c a t et h ec omp an y i snoti ngoodfi nanc i al heal t h.Ar at i ot hati st oohi ghmayi ndi c at et hatt hec ompanyi snoteffic i ent l yus i ng i t sc ur r entas set sors hor t t er mfi nanc i ng.
i i . Qui c kr at i o-meas ur est heabi l i t yofac ompan yt opa yi t sc ur r entl i abi l i t i eswhent he yc ome duewi t h onl yqui c kas s et s .Qui c kas s et sar ec ur r entas s et st hatc anbec on v er t edt oc as h wi t hi n90da ysori nt hes hor t t er m.Eg:Cas h,c as hequi v al ent s ,s hor t t er mi nv es t ment sor mar k et abl es ec ur i t i es ,andc ur r entac count sr ec ei v abl e.
i i i . Oper at i ngcashflow r at i o. -A measur eofhow wel lc ur r entl i abi l i t i es ar ecover edbyt hecashflow g en er a t e df r o m ac omp an y ' so per a t i o ns . For mul a:
ASSETMANAGEMENT-me as u r e sh ow e ffic i e nt l yafi r mu s esi t sa s s et st og en er a t es a l e s ,s oah i g he r r at i oi sal wa y smor ef a v or abl e,meant hec ompan yi sus i ngi t sas s et smor eeffic i ent l y .Lowerr at i osmean t hatt hecompanyhavemanagementorpr oduct i onpr obl ems. Fori ns t anc e,ar at i oof1meanst hatt henets al esofac ompan y=t heav er aget ot alas s et sf ort hey ear .I n ot herwor ds ,t hec ompanyi sgener at i ng1dol l arofs al esf orev er ydol l ari nv es t edi nas set s . Thet o t alas s ett ur no v err at i oi sage ner aleffic i en cyr at i ot hatme as ur esho w effic i ent l yac ompan yus esal l ofi t sas s et s .Thi sgi v e si n v es t or sandc r edi t or sani deaofho w ac ompan yi smanagedan du sesi t sas s et s t op r o du cep r o du ct san ds a l e s . For mul a
Exampl e
Sa l l y ' sT ec hCo mpa nyi sat e c hs t ar tu pc o mp an yt h atma nuf a ct ur e san ew t a bl e tc o mp ut er .Th ei n v es t o r want st ok no w ho w wel l Sa l l yus eshera ss et st opr oduc es al es ,s oheas k sf orherfi nanc i al s t at eme nt s . Her ei swhatt hefinanc i al s t at ement sr epor t ed: •
Be gi n ni n gAs s et s :$ 50 , 0 00
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En di n gAs s e t s :$ 10 0, 0 00
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Ne tSal e s:$ 25 , 0 00
Thet ot al as sett ur nov err at i oi scal c ul at edl i k et hi s :
Asyouc ans ee,Sal l y ' sr at i oi sonl y. 33.Thi smeanst hatf orev er ydol l ari nas set s ,Sal l yonl ygener at es33 c ent s .I not herwor ds ,Sal l y ' sst ar tupi nnotv er yeffic i entwi t hi t sus eofas set s .
DebtRat i o-t hedebtr at i os howsac ompany ' sabi l i t yt opayoffi t sl i abi l i t i eswi t hi t sas set s .I not her wor ds ,t hi sshowshowmanyas set st hec ompanymus ts el l i nor dert opayoffal l ofi t sl i abi l i t i es . Thi sr at i omeas ur est hefi nanc i al l ev er age ofac ompany .Compani eswi t hhi gherl ev el sofl i abi l i t i es c ompar edwi t has s et sar ec ons i der edhi ghl yl e v er agedandmor er i s k yf orl ender s . Thi shel psi nv es t or sandc r edi t or sanal y s i st heo v er al l debtbur denont hec ompan yaswel l ast hefi r m' s abi l i t yt opa yofft hedebti nf ut ur e,unc er t ai nec onomi ct i mes .
For mul a
Mak es ur ey ouus et het ot al l i abi l i t i esandt het ot al as set si ny ourc al c ul at i on.Thedebtr at i os howst he ov er a l lde btbur de n o ft hecompan y—no tj us tt hecur r entdebt .
Ana l y si s Al owerr at i osi smor ef av or abl et hanahi gherr at i o. Al owerdebtr at i o:amor es t abl ebus i nes swi t ht hepot ent i al ofl ongev i t ybec aus ehasl owerov er al l debt . Eac hi ndus t r yhasi t sownbenc hmar k sf ordebt ,but. 5i sr eas onabl er at i o. •
Adebtr at i oof. 5i sof t enc ons i der edt obel es sr i s ky .
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Ar at i oof1:t ot al l i abi l i t i es=t ot al as set s .I not herwor ds ,t hec ompanywoul dhav et os el l off al l ofi t sas s et si nor dert opayoffi t sl i abi l i t i es .Obv i ous l y ,t hi si sahi ghl yl ev er agefi r m.Onc e i t sas s et sar es ol doff ,t hebus i nes snol ongerc anoper at e.
Exa mpl e Da v e' sGui t arShopi st hi nk i ngaboutappl y i ngf orane wl oan.Thebankas k sf orDa v e' sbal anc et oe x ami ne hi sov er al ldebt l ev el s . Thebank erdi s cov er st hatDav ehast ot al as set sof$100, 000andt ot al l i abi l i t i esof$25, 000.Dav e' sdebt r at i owoul dbec al c ul at edl i k et hi s :
Asy o uc ans ee ,Da v eo nl yh asade btr at i oof. 2 5.I not h erwor d s ,Da v eh as4t i me sasman yas s e t sa she hasl i abi l i t i es .Thi si sar el at i v el yl owr at i oandi mpl i est hatDav ewi l l beabl et opaybac khi sl oan.Dav e s houl dn' tha v eapr obl em ge t t i ngappr o v edf orhi sl oan.
PROFI TABI LI TYMeasur es t heamountofne ti nc omeear nedwi t heac hdol l arofs al esgener at edbyc ompar i ngt hene t i n comeandne ts al esofac ompan y .I not herwor ds ,t hepr ofi tmar gi nr at i osho wswhatper c ent ageofs al es ar el ef tov eraf t eral l e xpens esar epai dbyt hebus i nes s.
Ana l y si s Thepr ofi tmar gi nr at i odi r ec t l ymeas ur eswhatper c ent ageofs al esi smadeupofne ti nc ome.I no t her wor ds ,i tmeas ur esho w muc hpr ofi t sar epr oduc edatac er t ai nl e v el ofs al es . Thi sr at i oal s oi ndi r ec t l ymeas ur eshowwel l ac ompan ymanagesi t sex pens esr el at i v et oi t sne ts al es .That i swh yc ompani esst r i v et oac hi ev ehi gherr at i os .The Si nc emos toft het i megener at i ngaddi t i onalr e v e n u e s i smuc hmor edi ffic ul tt hanc ut t i nge x pens es , manager sgener al l yt endt or educ es pendi ngbudge t st oi mpr o v et hei rpr ofi tr at i o.
