Bagang, Charmaine G. Machine Problem No.

July 15, 2011

REPORT: FINANCIAL RATIO ANALYSIS

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Summary of Martin Manufacturing Company Ratios (2007-2009, Including 2009 Industry Average) Actual Ratio Current Ratio Quick Ratio Inventory turnover Average collection period (days) Total Asset turnover Debt Ratio Times interest earned ratio Gross profit margin Net profit margin Return on total assets Return on common equity Price/earnings ratio Market/book ratio 1.5 45.8% 2.2 27.5% 1.1% 1.7% 3.1% 33.5 1.0 1.5 54.3% 1.9 28.0% 1.0% 1.5% 3.3% 38.7 1.1 1.6 57.0% 1.6 27.0% 0.7% 1.1% 2.5% 34.5 2.8 2 24.5% 2.5 26.0% 1.2% 2.4% 3.2% 43.4 1.2 2007 1.7 1 5.2 50.7 Actual 2008 1.8 0.9 5 55.8 Actual 2009 2.5 1.3 5.3 57.9 Industry Average 2009 1.5 1.2 10.2 46

1. LIQUIDITY Year 2007 2008 2009(actual) 2009(industry ave) Current Ratio 1.7 1.8 2.5 1.5

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Current Ratio Graph

2009(industry ave) 2009(actual) Year 2008 2007 0 0.5 1 1.5 2 2.5

Current Ratio

High current ratio at 2009 is an indication that the firm is liquid and has the ability to pay its current obligations in time and when they become due. But, having a current ratio higher than the industry average is also not good for the firm. Actual current ratio at 2009 is very high compared to the industry average of 1.5 at 2009. This big gap suggests that the firm may not be using its' current funds efficiently. The firm hoards its assets instead of using them to grow the business. In the balance sheet, you can see that most of the forms current assets are on accounts receivable and inventories. Current ratio of 2007 slightly increased by 10% at 2008. At 2009, a big increase in current ratio happened. Increasing value of current ratio every year is a good sign for the firm because it represents improvement in the liquidity position of the firm.

Year

Quick Ratio

2007

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2008 2009(actual) 2009(industry ave)

0.9 1.3 1.2

Quick Ratio
2009(industry ave) 2009(actual) 2008 2007 0 0.2 0.4 0.6 0.8 1 1.2 1.4

Year

Quick Ratio

Actual quick ratio at 2009 is higher than the industry average at 2009. This indicates that the firm can meet its current financial obligations with the available quick funds on hand. But a higher quick ratio also means that a firm is either keeping too much cash or is having a problem collecting its accounts receivable. In 2008, quick ratio decreased, but at 2009, the firms quick ratio had a big increase. In the case of Martin Manufacturing Company, the firm has a difficulty in collecting its accounts receivable and this can be seen on the firms balance sheet. The firms accounts receivable amounted to $805,556.

A quick ratio of 1.0 or greater is occasionally recommended. For Martin Manufacturing Company, it is recommended that they must be strict regarding their credit policies. The company must also evaluate its credit terms and credit policies because they seem to be ineffective. The firm could also adjust also its credit terms.
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2. Activity Year 2007 2008 2009(actual) 2009(industry ave) Inventory turnover 5.2 5 5.3 10.2

Inventory turnover
2009(industry ave) 2009(actual) 2008 2007 0 2 4 6 Inv. turnover 8 10 12

Inventory turnover is consistent for the past three years. At 2008, inventory turnover decreased slightly. At 2009, inventory turnover improved. These ratios for the past three years indicate that the firm has a slow turnover in its operating cycle in a given year. The firm has a difficulty in managing and selling its inventory efficiently. Compared to the industry average, it is too low. This implies poor sales of the firm and, therefore, excess inventory. Amount of inventories on the firms balance sheet at 2009 amounted at $700,625. The low inventory turnover of the firm indicates that there is a risk they
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Year

are holding obsolete inventory which is difficult to sell. Holding obsolete inventory may eat. However, the company may be holding a lot of inventory for legitimate reasons. Year 2007 2008 2009(actual) 2009(industry ave) Average collection period 50.7 55.8 57.9 46

Average collection period

Average collection period in days 70 60 50 40 30 20 10 0 2007 2008 Year 2009(actual) 2009(industry ave)

Average collection period for the past three years is increasing. But if you will compare these three periods with its industry average, all of them are high. Increasing average collection every year means that Martin Manufacturings accounts receivable are not as liquid or are not converted quickly to cash. The firm has a difficulty in implementing its credit policies. Compared to the industry average, average collection periods for the past three years are all high. These mean that Martin Manufacturing Company has a long collection period compared to the average collection period in the industry. This implies too liberal and
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inefficient credit collection performance. It is difficult to provide a standard collection period of debtors. It is recommended that the firm may change its credit term that will be useful in lessening their accounts receivable. The firm must also put an effort in managing its credit collection performance. It seems that the firm is not strict in terms of collecting accounts receivable. It is also recommended that the firm must be strict regarding their credit policies to improve credit collection performance.

Year

Total Asset turnover

2007 2008 2009(actual) 2009(industry ave)

1.5 1.5 1.6 2

Total Asset turnover

2009(industry ave) 2009(actual) 2008 2007 0 0.5 1 Total Asset turnover 1.5 2

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Year

For 2007 and 2008, total asset turnover remained the same. At 2009, total asset turnover slightly increased. Turnovers for 2007, 2008, and 2009 are still low for the industry average. Low total asset turnover means that the firms sales are slow. This may indicate a problem with one or more of the asset categories composing total assets - inventory, receivables, or fixed assets. The small business owner should analyze the various asset classes to determine where the problem lies. In this case, the problem would be on inventories and accounts receivable. The firm is holding a large value of accounts receivable and inventory. Problem in inventory arises because Martin Manufacturing Company may be holding obsolete inventory and not selling inventory fast enough. Another problem also arises with the firms accounts receivable; the firm's collection period is too long compared to the industry average. There is also a possibility that a problem also arises at the firms fixed assets, such as plant and equipment, could be sitting idle instead of being used to their full capacity. All of these problems point at the low total asset turnover ratio of the firm. It is recommended that the firm must resolve its issues on accounts receivable and inventory problems to improve total asset turnover. The firm could focus first in resolving its accounts receivable problem because its amount is larger than the amount of inventory for 2009. The firm could improve its credit collection by improving its credit policies and credit terms. The firm should study carefully which credit term would best suit their need to increase total asset turnover. Second problem that the firm must consider is regarding its inventory. The firm must not be holding too large amount of inventory.

3. Debt Year Debt Ratio 2007 2008 2009(actual)

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45.8% 54.3% 57.0%

2009(industry ave)

24.5%

Debt Ratio
60.0% Debt Ratio (Percentage) 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2007 2008 Year 2009(actual) 2009(industry ave)

Martin Manufacturing Companys indebtedness increased over 2007-2009 periods and is currently above the industry average. However, ratios are not consistent with the average of the industry. Compared to the average on the industry, these ratios are all high. Ratios at 2008 and 2009 are greater than 0.5. This indicates that most of Martin Manufacturing Companys assets are financed through debt. In this case, Martin Manufacturing Company is said to be "highly leveraged," not highly liquid. Thus, the firm with a high debt ratio (highly leveraged) could be in danger if creditors start to demand repayment of debt. Also, this indicates that the firms degree of indebtedness. High debt ratio brings greater risk for the companys operation. This means that the firm has a low borrowing capacity, which in turn will lower the firm's financial flexibility. Also, this shows that the company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If a lot of debt is used to finance increased operations (high debt to equity), the company could generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest), then the shareholders benefit as more earnings are being spread among the same amount of shareholders. However, the cost of this debt
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financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave shareholders with nothing.

Year

Times interest earned ratio

2007 2008 2009(actual) 2009(industry ave)

2.2 1.9 1.6 2.5

Times interest earned ratio

2009(industry ave) 2009(actual) 2008 2007 0 0.5 1 1.5 2 2.5

Year

Time interest earned ratio

a Martin Manufacturing Companys time interest earned ratio decreased over 2007-2009 periods and is currently below the industry average. This shows that the company has fewer earnings available to meet its interest payments. Failing to meet these obligations could force a company into bankruptcy. A low time interest earned ratio of the firm also suggests that the business is more vulnerable to increases in interest rates.
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4. Profitability Year Gross Profit Margin 2007 2008 2009(actual) 2009(industry ave) 27.5% 28.0% 27.0% 26.0%

Gross Profit Margin

Gross Profit Margin (Percentage) 28.5% 28.0% 27.5% 27.0% 26.5% 26.0% 25.5% 25.0% 2007 2008 Year 2009(actual) 2009(industry ave)

Martin Manufacturing Companys gross profit margin indicates that the firms margin is stable and is consistent with the industry average. Gross profit margin at 2009 is higher than the industry average as presented in the graph. This means that Martin Manufacturing Company is more liquid. Thus, it has more cash flow to spend on research & development expenses, marketing or investing which will be good for the company.

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Year

Net Margin

Profit

2007 2008 2009(actual) 2009(industry ave)

1.1% 1.0% 0.7% 1.2%

Net Profit Margin

2009(industry ave) 2009(actual) 2008 2007 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2%

Year

NetProfit Margin (Percentage)

At 2009, net profit margin is lower than the industry average. This low profit margin indicates a low margin of safety. It also entails that the firm has a higher risk which means that a decline in sales will erase profits and result in a net loss. This low profit margin is also exhibited for 2007-2009 periods. These three ratios for the past three years are all below the industry average. Year Return Assets 2007 2008 1.7% 1.5% on Total

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2009(actual) 2009(industry ave)

1.1% 2.4%

Return on Total Assets

2009(industry ave) 2009(actual) Return on Total Assets 2008 2007 0.0% 0.5% 1.0% 1.5% 2.0% 2.5%

Martin Manufacturing Companys ROA decreased for 2007-2009 periods. Compared to the industry average, the firms ROA is low. The firms decreasing ROA indicates major upfront investments in assets, including accounts receivables, inventories, production equipment and facilities. It is possible that the company experienced a decline in demand which left the firm high and dry. The firm overinvested in assets that it cannot sell to pay its bills anymore. Thus, the result can be financial disaster.

Year

Return equity

on

common

2007 2008 2009(actual) 2009(industry

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3.1% 3.3% 2.5% 3.2%

ave)

Return on common equity

2009(industry ave) Axis Title 2009(actual) 2008 2007 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% Axis Title

There was a sudden decrease in the firms ROE from 2008 to 2009. This actual value at 2009 is also below the industry average. A decreasing Return on Equity indicates that Martin Manufacturing Company has been less effective in using contributions from stockholders to generate earnings for the company. Decreasing return on equity indicates weak earnings growth for the company. It also means a decrease in business equity. Also, this means a decrease in the intrinsic value of the company. 5. Market Year P/E Ratio 2007 2008 2009(actual) 2009(industry ave) 33.5 38.7 34.5 43.4

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P/E Ratio
2009(industry ave) 2009(actual) 2008 2007 0.0 10.0 20.0 30.0 40.0 50.0

Year

P/E Ratio

Martin Manufacturing Companys price-to earnings ratio increased at 2007-2008 but also decreased at 2008-2009. These three ratios are all below the industry average. When this ratio is lower than the industry average, this means that recent profit levels are no longer the main factor in pricing. This might be because investors expect a worse performance next year or because sentiment is now the dominant factor.

Year 2007 2008 2009(actual) 2009(industry ave)

M/B Ratio 1.0 1.1 0.9 1.2

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M/B Ratio Graph

1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 M/B Ratio

M/B Ratio

As presented in the graph below, there was a sudden decrease at 2008-2009 periods. At 2009, M/B ratio reached 0.9. Because M/B ratio is less than 1, it is said to be that the ratio has an overvalued stock.

References: Gitman, L., 2003. Principles of Managerial Finance 10th edition. Pearson Education, Inc. Van Horne J., 2010. Fundamentals of Financial Management 13 th edition. Pearson Education, Inc.

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