Jianqi Zhang jz4125@nyu.

edu

Finance for Marketing Decision

Spring 2020
Professor Paul Angotta
Due Date: 2/19/2020
Assessing a Company’s Future Financial Health: SciTronics

SciTronics is a medical device company. The financial performance of SciTronics from

2005 to the end of 2018 is analyzed based on the income statements and balance sheets provided.
The financial assessment and analysis are conducted by utilizing four types of performance
measures/financial ratios: profitability measures, activity measure, leverage and liquidity
measures. All calculated ratios were derived from the financial statements provided by the
company. The validity and quality of the financial statements determined the accuracy and
reliability of calculated financial ratios. Therefore, the quality of the financial statement should
be evaluated before calculations of ratios to ensure the reliability of further assessment of
financial status. By looking at these measures and ratios, the financial health of SciTronics can
be anticipated by the management team.

In terms of sales growth, SciTronics’ sales grew significantly at a 20.69% compound

annual growth rate during the four-year period ended December 31, 2008. Over the course of
four years, there were no acquisitions or divestitures, and sales grew from $115,000 to $244,000,
indicating SciTronics’ steady and continuing growth. SciTronics’ sales growth also indicates the
effectiveness of its business strategy, product development, and customer acceptance. However,
sales growth may result in the need of investment in different assets, and this requires further
assessment. In terms of profitability, SciTronics’ profit as a percentage of sales increased from
3.4% to 5.74% from 2005 to 2008, which demonstrates a strong financial return on sales. In
addition to return on sales, SciTronics’ management team and investors would need to know the
return on the funds invested, which is indicated by EBIAT (earnings before interest but after
taxes). At the end of 2008, SciTronics had a total of $112,000 of capital and $16,000 of EBIAT
(earnings before interest but after taxes). In comparison to the 8.11% of return on capital in 2005,
SciTronics increased its return on capital to 14.29% in 2008. Return on equity is as important as
return on capital from the perspective of investors, and it indicates how profitably SciTronics is
using investors’ funds. In 2008, SciTronics had $75,000 of owners’ equity and earned $14,000
after taxes. SciTronics’ return on equity improved from 8.2% in 2005 to 18.67% in 2008,
 Jianqi Zhang jz4125@nyu.edu

meaning that SciTronics was able to generate more profits with shareholders’ invested funds and
the earned return is worth the shareholders’ investment. Overall, in looking at SciTronics’
profitability measures from 2005 to 2008, SciTronics utilized investors’ funds efficiently to
produce greater profitability, demonstrating a better outlook of profits. Profitability has critical
influences in various aspects, including access to debt, capacity to self-finance, valuation of
stock, and willingness of management to issue stock. Therefore, SciTronics’ growing
profitability would have a positive impact on all aspects mentioned above.

The second type of financial measures to look at is activity ratios that indicate how well a
company employs its assets. Total asset turnover ratio represents the company’s effectiveness in
utilizing total assets. SciTronics’ total asset turnover deteriorated from 1.58 times in 2005 to 1.53
times in 2008. Although there was a slight decrease in total asset turnover, the change was still
relatively flat with an increase of $66,000 in total assets. This slight decrease in total asset
turnover was due to the rapid growth in assets in the past four years. Under total assets, one
crucial category of assets is account receivables. Average collection period was calculated to
determine the number of days between sales and actual payment. Assuming all sales are credit
sales, SciTronics’ average collection period improved from 104.3 days to 98.73 days over the
past four years. The shorter average collection period indicates the company collects payments
faster and better cash flow efficiency so that SciTronics has cash on hand to meet financial
obligations and operational needs. In 2008, SciTronics needed $29,000 of inventory for
operations, and it had an inventory turnover of 2.55 times which improved from 2.05 times in
2005. This means that SciTronics became more effective in employing inventory. The last
activity ratio is fixed asset turnover ratio. SciTronics had net fixed assets of $18,000 and sales of
$244,000 in 2008, and its fixed asset turnover ratio in 2008 decreased from 16.33 times to 13.55
times, revealing SciTronics became less efficient in generating sales from its fixed assets. One
possible explanation is that more money was devoted to property and equipment in 2008 than
previous years, which can be seen from the balance sheet. To accommodate sale growth and
future expansion, the management probably decided to purchase more equipment and expand the
plant in 2008, but these fixed assets possibly had not been put into their maximum utilization yet.
One thing to note, financial documents provided net values, but SciTronics did not mention any
depreciation of fixed assets in the footnote. The unavailable information about depreciation made
the financial assessment less accurate. Overall, SciTronics showed improvement in the average
 Jianqi Zhang jz4125@nyu.edu

collection period and inventory turnover ratio which indirectly confirm the company’s strong
sales growth. As discussed above, the decreased fixed asset turnover might be due to more
money devoted to plant and equipment, which also contributed to the slight drop in total asset
turnover. Fixed assets utilization would require further monitoring and improvement by the
management.

Financial leverage is measured by various leverage ratios to evaluate the relationship of

funds provided by creditors to the funds provided by owners. As an indirect measure of leverage,
the ratio of total assets divided by owners’ equity increased from 1.52 at year-end 2005 to 2.12 at
year-end 2008. The higher ratio indicates increasing financial leverage and greater debt. At year-
end 2008, SciTronics’ total liabilities were 52.83% of its total assets in comparison to 34.4% in
2005. The growth of the company’s liabilities was greater than the growth of its assets. Times
interest earned ratio is another ratio that relates the level of debt to economic value and
performance. SciTronics’ operating income was $26,000 in 2008 and its interest expenses were
$2,000, and its times interest earned improved from 10 times to 13 times. This improvement
indicates SciTronics’ financial ability to meet the interest obligations on its debt. Its profitability
increases at a faster rate in relation to the growth of interest expenses, thus its earnings are more
than enough to cover interest expenses. SciTronics owed its suppliers $6,000 at year-end 2008,
which represented 8.1% of cost of goods sold and was a decrease from 11.6% at year-end 2005.
These percentages show that SciTronics became more prompt in paying suppliers than before.
Overall, based on these leverage ratios, the financial riskiness of SciTronics was relatively higher
than before but had not become a huge concern. Even though the company had more total
liabilities and increased leverage, these made SciTronics look financially riskier. SciTronics’
growing profitability and earnings were still able to cover interest expenses and pay its suppliers.
In this case, SciTronics’ use of borrowed funds improved its profitability and return on equity,
and it would not lead to financial distress as long as not used in excessive amounts.

One measure of a company’s liquidity is current ratio, which compares current assets to
current liabilities. Current liabilities are due to be paid within one year, therefore, current ratio
measures the company’s financial ability to pay obligations due within one year, assuming that
current assets are convertible into cash. The company could have a slight issue with cash on hand
but not a huge concern currently. SciTronics’ current ratio decreased from the ratio of 3.9 to 2.77
 Jianqi Zhang jz4125@nyu.edu

at year-end 2008. The company still could cover its short-term debt with its current assets, but
the ability was weaker than 2005. Quick Ratio demonstrated the same trend as it excluded
inventory from the current assets. In contrast to 2005, the liquidity of SciTronics deteriorated,
indicating financial riskiness was relatively higher. However, current assets were still sufficient
to pay off its current liabilities.

After assessing SciTronics’ financial performance during the 2005 – 2008 period, it can
be concluded that the company was at a stage of rapid growth, and the company had a better
outlook than 2005. The sales and profits as a percentage of sales grew greatly from 2005 to 2008,
indicating SciTronics’ ability to maximize profitability while reducing its cost. It also brought
more return on equity to investors. Upon the analysis of various ratios, the improved return on
equity from 8.2% in 2005 to 18.7% in 2008 resulted from an increase in its return on sales, a
decrease in its asset turnover, and an increase in its financial leverage. Although there was a
decrease in asset turnover, a higher return on equity and capital indicates the utilization of assets
was not completely ineffective. As activity measures, lower total assets turnover and fixed assets
turnover were accompanying with better average collection period and inventory turnover. Slight
decrease in asset turnover would not become a big issue as long as attention is brought up to
management and further improvement is taken into consideration.

In comparison to 2005, SciTronics’ financial strength and its access to external sources of
finance improved. Profitability strongly influences the company’s access to debt. Besides, the
increase in inventory turnover and decrease in average collection period proved that there were
more demands in SciTronics’ products and services. SciTronics experienced rapid sales growth
and achieved higher profitability during this four-year period, which would positively influence
its access to external finance and capacity to self-finance. External funding is needed during the
stage of rapid development and growth. Profitability and return on equity indicate the company
has a better financial outlook in the future, which would strengthen investors’ confidence. Even
though the company had increasing leverage and lower liquidity, SciTronics still had a strong
ability to repay liabilities with its current assets and the trend of increasing sales growth and
profitability. The management just needs to closely monitor the growth of liabilities in order to
prevent it from impacting the company’s financial health and becoming a burden.

As a result of my analysis, I would ask the management three questions:

 Jianqi Zhang jz4125@nyu.edu

(1) How would SciTronics maintain sales growth in order to sustain profitability in the
future?
(2) How did SciTronics manage the fixed assets over the past four years? There was a
deterioration on the fixed asset turnover ratio, which represents the company’s
effectiveness to produce sales from fixed assets investment. Also, why did the balance
sheet not include depreciation of property and equipment in footnotes, and what’s the
cost on this part?
(3) Since both current ratio and quick ratio deteriorated from 2005 to 2008, what actions
would management take to prevent further deterioration on liquidity?

Source:

Piper, Thomas R. "Assessing a Company's Future Financial Health." Harvard Business School

Background Note 911-412, November 2010. (Revised May 2012.)