THE FIRST PART OF THE CASE, PRESENTED IN CHAPTER 3, DISCUSSED THE SITUATION

THAT COMPUTRON INDUSTRIES WAS IN AFTER AN EXPANSION PROGRAM. THUS FAR, SALES

HAVE NOT BEEN UP TO THE FORECASTED LEVEL, COSTS HAVE BEEN HIGHER THAN WERE

PROJECTED, AND A LARGE LOSS OCCURRED IN 2001, RATHER THAN THE EXPECTED PROFIT.

AS A RESULT, ITS MANAGERS, DIRECTORS, AND INVESTORS ARE CONCERNED ABOUT THE

FIRM’S SURVIVAL.

DONNA JAMISON WAS BROUGHT IN AS ASSISTANT TO FRED CAMPO, COMPUTRON’S

CHAIRMAN, WHO HAD THE TASK OF GETTING THE COMPANY BACK INTO A SOUND FINANCIAL

POSITION. COMPUTRON’S 2000 AND 2001 BALANCE SHEETS AND INCOME STATEMENTS,

TOGETHER WITH PROJECTIONS FOR 2002, ARE SHOWN IN THE FOLLOWING TABLES. ALSO,

THE TABLES SHOW THE 2000 AND 2001 FINANCIAL RATIOS, ALONG WITH INDUSTRY

AVERAGE DATA. THE 2002 PROJECTED FINANCIAL STATEMENT DATA REPRESENT JAMISON’S

AND CAMPO’S BEST GUESS FOR 2002 RESULTS, ASSUMING THAT SOME NEW FINANCING IS

ARRANGED TO GET THE COMPANY “OVER THE 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 DATA. 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 MANUFACTURING FACILITIES TO OPERATE EFFICIENTLY. IN

OTHER WORDS, THE LAGS BETWEEN SPENDING MONEY AND DERIVING BENEFITS WERE LONGER

THAN COMPUTRON’S MANAGERS HAD ANTICIPATED. FOR THESE REASONS, JAMISON AND

CAMPO SEE HOPE FOR THE COMPANY--PROVIDED IT CAN SURVIVE IN THE SHORT RUN.

JAMISON MUST PREPARE AN ANALYSIS OF WHERE THE COMPANY IS NOW, WHAT IT MUST

DO TO REGAIN ITS FINANCIAL HEALTH, AND WHAT ACTIONS SHOULD BE TAKEN. YOUR

ASSIGNMENT IS TO HELP HER ANSWER THE FOLLOWING QUESTIONS. PROVIDE CLEAR

EXPLANATIONS, NOT YES OR NO ANSWERS.

Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc. Mini Case: 3 - 1

CHAPTER 4 – Analysis of Financial Statements:

MINI CASE ( Corresponds to PPTs & Class) (10-3)

BALANCE SHEETS

2002E 2001 2000___ ASSETSCASH $ 14,000 $ 7,282 $ 9,000SHORT-TERM INVESTMENTS 71,632 0 48,600ACCOUNTS RECEIVABLE 878,000 632,160 351,200INVENTORIES 1,716,480 1,287,360 715,200 TOTAL CURRENT ASSETS $2,680,112 $1,926,802 $1,124,000GROSS FIXED ASSETS 1,197,160 1,202,950 491,000LESS ACCUMULATED DEPRECIATION 380,120 263,160 146,200 NET FIXED ASSETS $ 817,040 $ 939,790 $ 344,800TOTAL ASSETS $3,497,152 $2,866,592 $1,468,800

LIABILITIES AND EQUITYACCOUNTS PAYABLE $ 436,800 $ 524,160 $ 145,600NOTES PAYABLE 600,000 720,000 200,000ACCRUALS 408,000 489,600 136,000 TOTAL CURRENT LIABILITIES $1,444,800 $1,733,760 $ 481,600LONG-TERM DEBT 500,000 1,000,000 323,432COMMON STOCK 1,680,936 460,000 460,000RETAINED EARNINGS (128,584) (327,168) 203,768 TOTAL EQUITY $1,552,352 $ 132,832 $ 663,768TOTAL LIABILITIES AND EQUITY $3,497,152 $2,866,592 $1,468,800

NOTE: “E” INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS.

INCOME STATEMENTS

2002E 2001 2000___ SALES $7,035,600 $5,834,400 $3,432,000COST OF GOODS SOLD 6,100,000 5,728,000 2,864,000OTHER EXPENSES 312,960 680,000 340,000DEPRECIATION 120,000 116,960 18,900 TOTAL OPERATING COSTS $6,532,960 $6,524,960 $3,222,900 EBIT $ 502,640 ($ 690,560) $ 209,100INTEREST EXPENSE 80,000 176,000 62,500 EBT $ 422,640 ($ 866,560) $ 146,600TAXES (40%) 169,056 (346,624) 58,640NET INCOME $ 253,584 ($ 519,936) $ 87,960

EPS $1.014 ($5.199) $0.880DPS $0.220 $0.110 $0.220BOOK VALUE PER SHARE $6.209 $1.328 $6.638STOCK PRICE $12.17 $2.25 $8.50SHARES OUTSTANDING 250,000 100,000 100,000TAX RATE 40.00% 40.00% 40.00%LEASE PAYMENTS 40,000 40,000 40,000SINKING FUND PAYMENTS 0 0 0

NOTE: “E” INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS.

Mini Case: 3 - 2 Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc.

RATIO ANALYSIS

INDUSTRY 2002E 2001 2000 AVERAGE CURRENT 1.1 2.3 2.7QUICK 0.4 0.8 1.0INVENTORY TURNOVER 4.5 4.8 6.1DAYS SALES OUTSTANDING (DSO) 39.0 36.8 32.0FIXED ASSETS TURNOVER 6.2 10.0 7.0TOTAL ASSETS TURNOVER 2.0 2.3 2.5DEBT RATIO 95.4% 54.8% 50.0%TIE -3.9 3.3 6.2EBITDA COVERAGE -2.5 2.6 8.0PROFIT MARGIN -8.9% 2.6% 3.6%BASIC EARNING POWER -24.1% 14.2% 17.8%ROA -18.1% 6.0% 9.0%ROE -391.4% 13.3% 18.0%PRICE/EARNINGS -0.4 9.7 14.2PRICE/CASH FLOW -0.6 8.0 7.6MARKET/BOOK 1.7 1.3 2.9BOOK VALUE PER SHARE $1.33 $6.64 N.A.

NOTE: “E” INDICATES ESTIMATED. THE 2002 DATA ARE FORECASTS.

Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc. Mini Case: 3 - 3

A. WHY ARE RATIOS USEFUL? WHAT ARE THE FIVE MAJOR CATEGORIES OF RATIOS?

ANSWER: RATIOS ARE USED BY MANAGERS TO HELP IMPROVE THE FIRM’S PERFORMANCE,

BY LENDERS 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 RATIOS ARE: LIQUIDITY, ASSET

MANAGEMENT, DEBT MANAGEMENT, PROFITABILITY, AND MARKET VALUE.

B. CALCULATE THE 2002 CURRENT AND QUICK RATIOS BASED ON THE PROJECTED

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 RATIOS AS BEING USEFUL (1) TO MANAGERS TO

HELP RUN THE BUSINESS, (2) TO BANKERS FOR CREDIT ANALYSIS, AND (3) TO

STOCKHOLDERS FOR STOCK VALUATION. WOULD THESE DIFFERENT 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 QUICK 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 (DSO),

FIXED ASSETS TURNOVER, AND TOTAL ASSETS TURNOVER. HOW DOES

COMPUTRON’S UTILIZATION OF ASSETS STACK UP AGAINST OTHER FIRMS IN ITS

INDUSTRY?

ANSWER: INVENTORY TURNOVER02 = SALES/INVENTORY

= $7,035,600/$1,716,480 = 4.10.

DSO02 = RECEIVABLES/(SALES/360)

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

Mini Case: 3 - 4 Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc.

Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc. Mini Case: 3 - 5

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 SALES OUTSTANDING HAS BEEN STEADILY INCREASING. WHILE

THE FIRM’S FIXED ASSETS TURNOVER RATIO IS BELOW ITS 2000 LEVEL, IT IS

ABOVE THE 2001 LEVEL. THE FIRM’S TOTAL ASSETS TURNOVER RATIO IS

BELOW ITS 2000 LEVEL AND JUST SLIGHTLY BELOW ITS 2001 LEVEL.

THE FIRM’S INVENTORY TURNOVER AND TOTAL ASSETS TURNOVER ARE BELOW

THE INDUSTRY AVERAGE. THE FIRM’S DAYS SALES OUTSTANDING IS ABOVE THE

INDUSTRY AVERAGE (WHICH IS BAD); HOWEVER, THE FIRM’S FIXED ASSETS

TURNOVER IS ABOVE THE INDUSTRY AVERAGE. (THIS MIGHT BE DUE TO THE

FACT THAT COMPUTRON IS AN OLDER FIRM THAN MOST OTHER FIRMS 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 FIRMS IN THE INDUSTRY.) THE FIRM’S OPERATING CAPITAL

REQUIREMENT RATIO IS HIGHER THAN THE INDUSTRY AVERAGE, INDICATING

THAT COMPUTRON REQUIRES MORE DOLLARS OF CAPITAL TO GENERATE A DOLLAR

OF SALES THAN THE AVERAGE FIRM IN THE INDUSTRY.

D. CALCULATE THE 2002 DEBT, TIMES-INTEREST-EARNED, AND EBITDA COVERAGE

RATIOS. HOW DOES COMPUTRON COMPARE WITH THE INDUSTRY WITH RESPECT TO

FINANCIAL 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

Mini Case: 3 - 6 Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc.

ABOVE ITS 2000 LEVEL 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), RETURN

ON ASSETS (ROA), AND RETURN ON EQUITY (ROE). WHAT CAN YOU SAY ABOUT

THESE RATIOS?

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 AVERAGE. 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 = (NI + DEP)/SHARES = ($253,584 + $120,000)/250,000

= $1.49.

PRICE/CASH FLOW = $12.17/$1.49 = 8.2.

BVPS = COMMON EQUITY/SHARES OUTSTANDING = $1,552,352/250,000 = $6.21.

Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc. Mini Case: 3 - 7

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 INDUSTRY AVERAGE.

F. PERFORM A COMMON SIZE ANALYSIS AND PERCENT CHANGE ANALYSIS. WHAT DO THESE ANALYSES TELL YOU ABOUT COMPUTRON?

ANSWER: FOR THE COMMON SIZE BALANCE SHEETS, DIVIDE ALL ITEMS IN A YEAR BY THE TOTAL ASSETS FOR THAT YEAR. FOR THE COMMON SIZE INCOME STATEMENTS, DIVIDE ALL ITEMS IN A YEAR BY THE SALES IN THAT YEAR.

Common Size Balance SheetsAssets

2000 2001 2002E Ind.Cash 0.6% 0.3% 0.4% 0.3%ST Invest. 3.3% 0.0% 2.0% 0.3%AR 23.9% 22.1% 25.1% 22.4%Invent. 48.7% 44.9% 49.1% 41.2%Total CA 76.5% 67.2% 76.6% 64.1%Net FA 23.5% 32.8% 23.4% 35.9%TA 100.0% 100.0% 100.0% 100.0%Liabilities and Equity

2000 2001 2002E Ind.AP 9.9% 18.3% 12.5% 11.9%Notes pay. 13.6% 25.1% 17.2% 2.4%Accruals 9.3% 17.1% 11.7% 9.5%Total CL 32.8% 60.5% 41.3% 23.7%LT Debt 22.0% 34.9% 14.3% 26.3%Com. Stock 31.3% 16.0% 48.1% 20.0%Ret. Earnings 13.9% -11.4% -3.7% 30.0% Total equity 45.2% 4.6% 44.4% 50.0%Total L&E 100.0% 100.0% 100.0% 100.0%

Common Size Income statement

2000 2001 2002E Ind.Sales 100.0% 100.0% 100.0% 100.0%COGS 83.4% 98.2% 86.7% 84.5%Other exp. 9.9% 11.7% 4.4% 4.4%Depr. 0.6% 2.0% 1.7% 4.0% EBIT 6.1% -11.8% 7.1% 7.1%

Mini Case: 3 - 8 Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc.

Int. Exp. 1.8% 3.0% 1.1% 1.1% EBT 4.3% -14.9% 6.0% 5.9%Taxes 1.7% -5.9% 2.4% 2.4%NI 2.6% -8.9% 3.6% 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 INDUSTRY. COMPUTRON HAS MORE SHORT-TERM DEBT THAN

INDUSTRY, BUT LESS LONG-TERM DEBT THAN 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 ROW BY THE VALUE IN THE FIRST YEAR OF THE ANALYSIS.

Percent Change Balance SheetsAssets

2000 2001 2002ECash 0.0% -19.1% 55.6%ST Invest. 0.0% -100.0% 47.4%AR 0.0% 80.0% 150.0%Invent. 0.0% 80.0% 140.0%Total CA 0.0% 71.4% 138.4%Net FA 0.0% 172.6% 137.0%TA 0.0% 95.2% 138.1%Liabilities and Equity

2000 2001 2002EAP 0.0% 260.0% 200.0%Notes pay. 0.0% 260.0% 200.0%Accruals 0.0% 260.0% 200.0%Total CL 0.0% 260.0% 200.0%LT Debt 0.0% 209.2% 54.6%Com. Stock 0.0% 0.0% 265.4%Ret. Earnings 0.0% -260.6% -163.1% Total equity 0.0% -80.0% 133.9%Total L&E 0.0% 95.2% 138.1%

Harcourt, Inc. items and derived items copyright © 2002 by Harcourt, Inc. Mini Case: 3 - 9

Percent Change Income statement

2000 2001 2002ESales 0.0% 70.0% 105.0%COGS 0.0% 100.0% 113.0%Other exp. 0.0% 100.0% -8.0%Depr. 0.0% 518.8% 534.9% EBIT 0.0% -430.3% 140.4%Int. Exp. 0.0% 181.6% 28.0% EBT 0.0% -691.1% 188.3%Taxes 0.0% -691.1% 188.3%NI 0.0% -691.1% 188.3%

WE SEE THAT 2002 SALES GROW 105% FROM 2000, AND THAT NI GROWS 188% FROM 2000. SO 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 OVERVIEW

OF COMPUTRON’S FINANCIAL CONDITION AS PROJECTED FOR 2002. WHAT ARE

THE FIRM’S MAJOR 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. HOWEVER, IF THE FIRM’S ASSETS WERE OLDER THAN OTHER FIRMS

IN ITS INDUSTRY THIS COULD POSSIBLY ACCOUNT FOR THE HIGHER RATIO.

(COMPUTRON’S FIXED ASSETS WOULD HAVE A LOWER 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

HIGHER 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 RATIOS ARE POOR (EXCEPT FIXED ASSETS TURNOVER); ITS DEBT

MANAGEMENT RATIOS ARE POOR, MOST OF ITS PROFITABILITY RATIOS ARE LOW

(EXCEPT PROFIT MARGIN); AND ITS MARKET VALUE RATIOS ARE LOW.

I. USE THE FOLLOWING SIMPLIFIED 2002 BALANCE SHEET TO SHOW, IN GENERAL

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 SALES, HOW WOULD THAT CHANGE

“RIPPLE THROUGH” THE FINANCIAL STATEMENTS (SHOWN IN THOUSANDS BELOW)

AND INFLUENCE THE STOCK PRICE?

ACCOUNTS RECEIVABLE $ 878 DEBT $1,945OTHER CURRENT ASSETS 1,802NET FIXED ASSETS 817 EQUITY 1,552 LIABILITIES TOTAL ASSETS $3,497 PLUS EQUITY $3,497

ANSWER: SALES PER DAY = $7,035,600/360 = $19,543.

ACCOUNTS RECEIVABLE UNDER NEW POLICY = $19,543 32 DAYS

= $625,376.

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, HOW

SHOULD THAT ADJUSTMENT AFFECT COMPUTRON’S PROFITABILITY AND STOCK

PRICE.

ANSWER: THE INVENTORY TURNOVER RATIO IS LOW. IT APPEARS THAT THE FIRM EITHER

HAS EXCESSIVE INVENTORY OR SOME OF THE INVENTORY IS OBSOLETE. IF

INVENTORY WERE REDUCED, 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 PROFITABILITY.

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 BANK LOAN AGREEMENTS. THEREFORE, SUPPLIERS COULD CUT THE

COMPANY OFF, AND ITS BANK 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 YOU WERE THE BANK LOAN OFFICER, WOULD YOU RECOMMEND RENEWING THE

LOAN OR DEMAND ITS REPAYMENT? WOULD YOUR ACTIONS BE INFLUENCED IF,

IN EARLY 2002, COMPUTRON SHOWED YOU ITS 2002 PROJECTIONS PLUS PROOF

THAT IT WAS GOING TO RAISE OVER $1.2 MILLION 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 DIDN’T HAVE ANY EXCESS CAPACITY.

TERMS OF COD MIGHT BE A LITTLE HARSH AND MIGHT PUSH 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 EXTENSIVE RATIO ANALYSIS TO DETERMINE THE EFFECTS OF ITS PROPOSED

EXPANSION ON THE FIRM’S OPERATIONS. HAD THE RATIO ANALYSIS BEEN

CONDUCTED, THE COMPANY WOULD HAVE “GOTTEN ITS HOUSE IN ORDER” BEFORE

UNDERGOING THE EXPANSION.

M. WHAT ARE SOME POTENTIAL PROBLEMS AND LIMITATIONS OF FINANCIAL RATIO

ANALYSIS?

ANSWER: SOME POTENTIAL PROBLEMS ARE LISTED BELOW:

1. COMPARISON WITH INDUSTRY AVERAGES IS DIFFICULT IF THE FIRM

OPERATES MANY DIFFERENT DIVISIONS.

2. DIFFERENT OPERATING AND ACCOUNTING PRACTICES DISTORT COMPARISONS.

3. 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 POSITION.

5. “AVERAGE” PERFORMANCE IS NOT NECESSARILY GOOD.

6. 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

CONSIDERED WHEN EVALUATING A COMPANY. THESE FACTORS, AS SUMMARIZED

BY THE AMERICAN ASSOCIATION OF INDIVIDUAL INVESTORS (AAII), ARE AS

FOLLOWS:

1. ARE THE COMPANY’S REVENUES TIED TO ONE KEY CUSTOMER?

2. TO WHAT EXTENT ARE THE COMPANY’S REVENUES TIED TO ONE KEY PRODUCT?

3. TO WHAT EXTENT DOES THE COMPANY RELY ON A SINGLE SUPPLIER?

4. WHAT PERCENTAGE OF THE COMPANY’S BUSINESS IS GENERATED OVERSEAS?

5. COMPETITION

6. FUTURE PROSPECTS

7. LEGAL AND REGULATORY ENVIRONMENT