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Bagang, Charmaine G. July 15, 2011
Machine Problem No. 1
REPORT:
FINANCIAL RATIO
ANALYSIS
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Summary of Martin Manufacturing Company Ratios (2007-2009, Including 2009 Industry
Average)
Actual Actual Actual Industry Average
Ratio 2007 2008 2009 2009
Current Ratio 1.7 1.8 2.5 1.5
Quick Ratio 1 0.9 1.3 1.2
Inventory turnover 5.2 5 5.3 10.2
Average collection period
(days)
50.7 55.8 57.9 46
Total Asset turnover 1.5 1.5 1.6 2
Debt Ratio 45.8% 54.3% 57.0% 24.5%
Times interest earned ratio 2.2 1.9 1.6 2.5
Gross profit margin 27.5% 28.0% 27.0% 26.0%
Net profit margin 1.1% 1.0% 0.7% 1.2%
Return on total assets 1.7% 1.5% 1.1% 2.4%
Return on common equity 3.1% 3.3% 2.5% 3.2%
Price/earnings ratio 33.5 38.7 34.5 43.4Market/book ratio 1.0 1.1 2.8 1.2
1. LIQUIDITYYear Current Ratio
2007 1.7
2008 1.8
2009(actual) 2.5
2009(industry
ave)
1.5
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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 themto 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 1
0 0.5 1 1.5 2 2.5
2007
2008
2009(actual)
2009(industry ave)
Current Ratio
Year
Current Ratio Graph
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2008 0.9
2009(actual) 1.3
2009(industry
ave)
1.2
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.
0 0.2 0.4 0.6 0.8 1 1.2 1.4
2007
2008
2009(actual)
2009(industry ave)
Quick Ratio
Year
Quick Ratio
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2. ActivityYear Inventory turnover
2007 5.2
2008 5
2009(actual) 5.3
2009(industry ave) 10.2
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
0 2 4 6 8 10 12
2007
2008
2009(actual)
2009(industry ave)
Inv. turnover
Year
Inventory turnover
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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 Average collection period
2007 50.7
2008 55.8
2009(actual) 57.9
2009(industry
ave)
46
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
0
10
20
30
40
50
60
70
2007 2008 2009(actual) 2009(industry
ave)Aver
ageco
llectionperio
din
days
Year
Average collection period
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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 1.5
2008 1.5
2009(actual) 1.6
2009(industry
ave)
2
0 0.5 1 1.5 2
2007
2008
2009(actual)
2009(industry ave)
Total Asset turnover
Year
Total Asset turnover
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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. DebtYear Debt
Ratio
2007 45.8%
2008 54.3%
2009(actual) 57.0%
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2009(industry ave) 24.5%
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
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
2007 2008 2009(actual) 2009(industry
ave)
De
btRatio
(Percentage
)
Year
Debt Ratio
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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 2.2
2008 1.9
2009(actual) 1.6
2009(industryave)
2.5
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.
0 0.5 1 1.5 2 2.5
2007
2008
2009(actual)
2009(industry ave)
Time interest earned ratio
Year
Times interest earned ratio
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4. ProfitabilityYear Gross Profit
Margin
2007 27.5%
2008 28.0%
2009(actual) 27.0%
2009(industry ave) 26.0%
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.
25.0%
25.5%
26.0%
26.5%
27.0%
27.5%
28.0%
28.5%
2007 2008 2009(actual) 2009(industry
ave)GrossPro
fitMargin
(Percentage
)
Year
Gross Profit Margin
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Year Net Profit
Margin
2007 1.1%
2008 1.0%2009(actual) 0.7%
2009(industry
ave)
1.2%
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 on Total
Assets
2007 1.7%
2008 1.5%
0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2%
2007
2008
2009(actual)
2009(industry ave)
NetProfit Margin (Percentage)
Year
Net Profit Margin
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2009(actual) 1.1%
2009(industry
ave)
2.4%
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 on common
equity
2007 3.1%
2008 3.3%
2009(actual) 2.5%
2009(industry 3.2%
0.0% 0.5% 1.0% 1.5% 2.0% 2.5%
2007
2008
2009(actual)
2009(industry ave)
Return on Total Assets
Return on Total Assets
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ave)
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. MarketYear P/E
Ratio
2007 33.5
2008 38.7
2009(actual) 34.5
2009(industry
ave)
43.4
0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5%
2007
2008
2009(actual)
2009(industry ave)
Axis Title
AxisTit
le
Return on common equity
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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 M/B Ratio
2007 1.0
2008 1.1
2009(actual) 0.9
2009(industry
ave)
1.2
0.0 10.0 20.0 30.0 40.0 50.0
2007
2008
2009(actual)
2009(industry ave)
P/E Ratio
Year
P/E Ratio
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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 13th
edition. Pearson Education,
Inc.
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
M/BRatio
M/B Ratio Graph
M/B Ratio