CASE STUDY: RATIOS AND FINANCIAL PLANNING AT S&S AIR

1. The calculations for the ratios listed are: Current ratio = $3,138,220 / $2,162,080 Current ratio = 1.45 times Quick ratio = ($3,138,220 1,238,500) / $2,162,080 Quick ratio = 0.88 times Cash ratio = $365,040 / $2,162,080 Cash ratio = 0.17 times Total asset turnover = $20,077,000 / $15,453,900 Total asset turnover = 1.30 times Inventory turnover = $14,985,000 / $1,238,500 Inventory turnover = 12.10 times Receivables turnover = $20,077,000 / $1,534,680 Receivables turnover = 13.08 times Total debt ratio = ($15,453,900 9,466,820) / $15,453,900 Total debt ratio = 0.39 times Debt-equity ratio = ($2,162,080 + 3,825,000) / $9,466,820 Debt-equity ratio = 0.63 times Equity multiplier = $15,453,900 / $9,466,820 Equity multiplier = 1.63 times Times interest earned = $2,038,000 / $362,000 Times interest earned = 5.63 times Cash coverage = ($2,038,000 + 655,000) / $362,000 Cash coverage = 7.44 times Profit margin = $1,005,600 / $20,077,000 Profit margin = 0.0501 or 5.01% Return on assets = $1,005,600 / 15,453,900 Return on assets = 0.0651 or 6.51%

Return on equity = $1,005,600 / $9,466,820 Return on equity = 0.1062 or 10.62%

2.

Boeing is probably not a good aspirant company. Even though both companies manufacture airplanes, S&S Air manufactures small airplanes, while Boeing manufactures large, commercial aircraft. These are two different markets. Additionally, Boeing is heavily involved in the defense industry, as well as Boeing Capital, which finances airplanes. S&S is above the median industry ratios for the current and cash ratios. This implies the company has more liquidity than the industry in general. However, both ratios are above the 3 rd quartile, so there are companies in the industry with higher liquidity ratios than S&S Air. The company may have more predictable cash flows, or more access to short-term borrowing. If you created an inventory to current liabilities ratio, S&S Air would have a ratio that is lower than the industry median. The current ratio is above the industry median, while the quick ratio is above the industry median. This implies that S&S Air has about the same inventory to current liabilities as the industry median. S&S Air has about the same inventory as the industry median, so the inventory to current liabilities ratio is about the same as the median for the industry. The turnover ratios are all higher than the industry median; in fact, all three turnover ratios are above the upper quartile. This may mean that S&S Air is more efficient than the industry. The financial leverage ratios are all below the industry median, but above the lower quartile. S&S Air generally has less debt than comparable companies, but still within the normal range. The profit margin for the company is about the same as the industry median, the ROA and ROE are both below the industry median, but above the lower quartile. Overall, S&S Airs performance seems good, although the liquidity ratios indicate that a closer look may be needed in this area.

Below is a list of possible reasons it may be good or bad that each ratio is higher or lower than the industry. Note that the list is not exhaustive but merely one possible explanation for each ratio. Ratio Current ratio Quick ratio Cash ratio Total asset turnover Good Better at managing current accounts. Better at managing current accounts. Better at managing current accounts. Better at utilizing assets. Bad May be having liquidity problems. May be having liquidity problems. May be having liquidity problems. Assets may be older and depreciated, requiring extensive investment soon. Could be experiencing inventory shortages. May have credit terms that are too strict. Decreasing receivables turnover may increase sales. Increasing the amount of debt can

Inventory turnover Receivables turnover

Better at inventory management, possibly due to better procedures. Better at collecting receivables.

Total debt ratio

Less debt than industry median

means the company is less likely to experience credit problems. Debt-equity ratio Less debt than industry median means the company is less likely to experience credit problems. Less debt than industry median means the company is less likely to experience credit problems. Less debt than industry median means the company is less likely to experience credit problems. Less debt than industry median means the company is less likely to experience credit problems. Company may be controlling costs better than the industry or charging a higher margin. Company is performing above many of its peers. Company is performing above many of its peers.

Equity multiplier

TIE

Cash coverage

Profit margin

increase shareholder returns. Especially notice that it will increase ROE. Increasing the amount of debt can increase shareholder returns. Especially notice that it will increase ROE. Increasing the amount of debt can increase shareholder returns. Especially notice that it will increase ROE. Increasing the amount of debt can increase shareholder returns. Especially notice that it will increase ROE. Increasing the amount of debt can increase shareholder returns. Especially notice that it will increase ROE. Costs may be too high.

ROA ROE

Assets may be old and depreciated relative to industry. Profit margin and EM could still be increased, which would further increase ROE.

4.

To calculate the internal growth rate, we first need to find the ROA and the retention ratio, so: ROA = NI / TA ROA = $1,005,600 / $15,453,900 ROA = 0.0651 or 6.51% b = Addition to RE / NI b = $800,600 / $1,005,600 b = .7961 Now we can use the internal growth rate equation to get: Internal growth rate = (ROA b) / [1 (ROA b)] Internal growth rate = [0.0651(0.7961)] / [1 0.0651(0.7961)] Internal growth rate = 0.0546 or 5.46% To find the sustainable growth rate, we need the ROE, which is: ROE = NI / TE ROE = $1,005,600 / $9,466,820 ROE = 0.1062 or 10.62%

Using the retention ratio we previously calculated, the sustainable growth rate is: Sustainable growth rate = (ROE b) / [1 (ROE b)] Sustainable growth rate = [0.1062(0.7961)] / [1 0.1062(0.7961)] Sustainable growth rate = 0.0924 or 9.24% The internal growth rate is the growth rate the company can achieve with no outside financing of any sort. The sustainable growth rate is the growth rate the company can achieve by raising outside debt based on its retained earnings and current capital structure.