Professional Documents
Culture Documents
CASE STUDY REPORT SUBMITTED BY SANJAY PUDASAINI SANJAY K. YADAV SHEKHAR SHARMA SHRAWAN TAMRAKAR SIDDHANT THAKURI SUBHASH C. RAI SUDEEP KHANAL
SUBMITTED TO DR. RADHE SHYAM PRADHAN FACULTY OF MANAGEMENT KATHMANDU UNIVERSITY SCHOOL OF MANAGEMENT
02 JULY 2011
1) Current Ratio :
Current Liabilities Current Asset Inventory
2) Quick Ratio:
Current Liabilities Total Debt X 100 % Total Asset EBIT
3) Debt Ratio:
X 100 %
X 100 %
15) Market Price Per Share (MPS) 16) Dividend Pay Out Ratio
17) Altman Z score, Z = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X 4 + 0.999X 5 Where, X1 = X2 = X3 = X4 = X5 = 18) Du-Pont identity Returns on Equity = Total Assets Turnover X Net Profit Margin x Equity Multiplier =
x 100
x 100
BACKGROUND OF SILVER RIVER MANUFACTURING COMPANY (SRM) Silver River manufacturing company (SRM) is a large listed regional producer headed by Mr. Greg White that designs and produces farm and utility trailers, specialized livestock carriers, and mobile home chassis. The existing major markets are the farmers and boat companies. More than 85% of SRMs sales come from the southeastern part of the US, although a growing market for custom horse transport vans designed and produced by SRM is developing nationally and even internationally. Likewise, several major boat companies in Florida work closely with
3 | Financial Analysis of Silver River Manufacturing Company
SRM in designing trailers for their new offerings, and these boat-trailer packages are sold through the nationwide dealer networks of the boat companies. With few exceptions, the products manufactured by SRM are not subject to technological obsolescence or to deterioration, and in those instances where technology is a factor to be considered, SRM holds several patents with which it can partially offset some of the risks. Marion County National Bank (MCNB) is the official banker of SRM that has sanctioned short and long term credit facilities. MCNB considered SRM to be a financially sound and efficiently managed firm until the symptoms of illness of SRM surfaced. Being a close friend and a well wisher, Ms. Lesa Nix, Vice President of MCNB, informs Mr. White that the financial health of SRM worsened from 2004 through 2005 such that MCNB might consider calling back the credit facilities while SRM has made a commitment to expand its facility requiring an additional fund of $6.375 million . Mr. White had planned to obtain this additional money by a short term loan from
MCNB.
Although considered temporary, these adverse conditions affected the performance of companies like SRM such that they were on the verge of bankruptcy. The public confidence eroded coming to the year 2005 that was reflected in sharp decline in Market price of the stock of SRM.
and has been able to maintain excellent rapport with his suppliers and lenders. The demand for the products of SRM despite hit in the short run is in fact profitable in the long run. The plant and machinery and the size of the firm are strengths based on which SRM has been able to become a large producer and supplier of farm related equipments. Before 2004, SRM was sound in all respects of business which is evident from the following statement of changes in financial positions and analysis of key financial ratios.
Table6. Silver River Manufacturing Company Statement of Changes in Financial Position Year Ended December 31 (USD in'000) 2004 2005
Particulars
Sources of funds Net income after taxes Depreciation Funds from operations Long-term loan Net decrease in working capital Total sources Application of funds Mortgage change Fixed assets change Dividends on stock Net increase in working capital Total uses Analysis of changes in working capital Increase (decrease) in current assets Cash change AR change INV change CA change Increase (decrease) in current liabilities AP change NP change ACC change CL change Net increase (decrease) in working capital
6,351.70 1,657.50 8,009.20 3,187.50 11,196.70 267.75 2,339.62 1,587.93 7,001.40 11,196.70
Table 7. Silver River Manufacturing Company Ratio Analysis Year Ended December 31 Industry Average 2.50 1.00 Contractual Limits 2.00 1.00 Remarks 2005 Poor Poor
Particulars Liquidity ratios Current ratio Quick ratio Leverage ratios Debt ratio (%) Times interest earned Assets management ratios Inventory turnover (Cost) Inventory turnover
40.46 15.89
46.33 7.97
59.80 1.49
50.00 7.70
55.00
Poor Poor
7.14 9.03
4.55 5.59
3.57 4.19
5.70 7.00
Poor Poor
(Selling) Fixed asset turnover Total asset turnover Average collection period Profitability ratios Profit margin (%) Gross profit margin (%) Return on total assets Return on owners' equity Potential failure indicator Altman Z factor 11.58 3.06 36.00 11.95 2.60 35.99 12.10 2.04 53.99 12.00 3.00 32.00 Ok Poor Poor
6.71
4.75
2.89
1.81/2.99
Where,
X1 = X2 = X3 = X4 = X5 =
x 100
x 100
2003 1.EBIT 2. Total Assets 3. Net Sales 4.Total Market Value of shares (in $ 000)= Total earnings *P/E Ratio 5. Total Liabilities 6. Current Assets 19,318.73 55,944.31 170,997.50 62,128.31 22,637.63
41,179.81 7. Current Liabilities 8. Retained Earnings 13,393.88 10,037.68 20,706.01 14,801.45 45,562.17 15,367.72
Till 2004, SRM was able to maintain a high liquidity ratio in the form of current ratio and quick ratio of 2.68 and 1.08 that were above industry averages of 2.50 and 1.0 respectively and also above the contractual limit. Also, SRM was able to charge good prices for its products that contributed to its profit lines. The gross profit margin and net profit margin were above the industry averages. The Altman Z score was one of the strengths of SRM prior to 2005. Score of 6.71 and 4.75 for 2003 and 2004 respectively are above the bankruptcy prediction score of 2.99 indicating a sound financial position and least possibilities of bankruptcy at least up to two years down the line.
Du-Pont Identity Returns on Equity = Total Assets Turnover X Net Profit Margin x Equity Multiplier =
Du pont Identity Net Profit Margin Total Assets Turnover Equity Multiplier Return on Equity
x
2003 5.50 3.06 1.68 28.27
x
2004 3.44 2.60 1.86 16.64
Before 2004, when the operations of SRM were controlled and demand of their products were growing, SRM had maintained Total Assets Turnover, Equity multiplier and Net Profit Margin in better form compared to the industry averages. In fact, his debt ratio was less than the industry average allowing more room for procurement of debt. After 2004, however, the scenario changed drastically. Notwithstanding the adversities in demand for farm equipments, SRM increased its investment in production of the products and used aggressive marketing techniques to enhance sales and acquire more market share with a misconception that sales and market share would curb their financial problems. It lowered its sales prices and applied liberal credit terms in its false quest to increase sales and market share. However, the growth of 8% (2004) and 6% (2005) in sales resulted in increment in Costs of Goods sold and decline in profits. As these growth rates were far lower than expected, SRM ended with piling inventories. In addition, the lax credit terms resulted in huge receivables with
7 | Financial Analysis of Silver River Manufacturing Company
an average collection period of 54 days, a huge negative deviation of 22 days compared to the industry average. It was obvious, SRM started lagging behind timely repayments to its suppliers. The inventories grew by 74% (2004) and additional 41% in 2005. The receivable was bound to follow the league to an all time growth of 59% in 2005. As expected, the borrowings from MCNB fell too short to manage the working capital. By 2005 December, the payables had risen by 6 percentage points to 20% of the total assets.
Table 1: Silver River Manufacturing Company Balance Sheet Year Ended December 31 Particulars Assets Cash Accounts receivable Inventory Current assets Land, buildings, plant and equipment Accumulated depreciation Net fixed assets Total assets Liabilities and equities Short-term bank loans Accounts payable Accruals Current liabilities Long-term bank loans Mortgage Long-term debt Total liabilities Common stock Retained earnings Owners' equity Total liabilities and equities 2003 5,148.31 17,097.75 18,933.75 41,179.81 17,760.75 (2,996.25) 14,764.50 55,944.31 3,187.50 6,763.88 3,442.50 13,393.88 6,375.00 2,868.75 9,243.75 22,637.63 23,269.00 10,037.68 33,306.68 55,944.31 2004 4,002.48 18,462.00 33,028.87 55,493.35 20,100.37 (4,653.75) 15,446.62 70,939.97 5,100.00 10,506.01 5,100.00 20,706.01 9,562.50 2,601.00 12,163.50 32,869.51 23,269.00 14,801.45 38,070.45 70,939.96 (USD in'000) 2005 3,905.77 29,356.86 46,658.62 79,921.25 22,873.50 (6,693.75) 16,179.75 96,101.00 18,232.50 19,998.39 7,331.28 45,562.17 9,562.50 2,339.62 11,902.12 57,464.29 23,269.00 15,367.72 38,636.72 96,101.01
SRM increased its borrowing both short and long term to meet its deficit in working capital but with growing receivables and payables, it simply could not. The total debt had jumped to a record 60% of total assets in 2005 that was a growth of 20 percentage points as compared to the total debt of 2003. Furthermore as a result of reduction in prices for aggressive marketing, the cost of goods sold elevated from an average of 79% (2003) to 85% of sales by 2005. Its expenses being a variable
of sales kept on mounting ultimately steeply depressing the net profit margin to a mere 0.39% in 2005 from 5.5% of 2003.
Table 2: Silver River Manufacturing Company Income Statement as at December 31 Particulars Net sales Cost of goods sold Gross profit Administrative and selling Depreciation Miscellaneous expenses Total operating expenses EBIT Interest on short-term loans Interest on long-term loans Interest on mortgage Net income before tax Taxes Net income Dividends on stock Additions to retained earnings 2003 170,997.50 135,267.74 35,729.76 12,789.79 1,593.75 2,027.49 16,411.03 19,318.73 318.75 637.50 259.83 18,102.65 8,689.27 9,413.38 2,353.35 7,060.03 2004 184,658.25 150,131.22 34,527.03 15,344.64 1,657.50 3,557.25 20,559.39 13,967.64 561.00 956.25 235.58 12,214.81 5,863.11 6,351.70 1,587.93 4,763.77 (USD in'000) 2005 195,731.63 166,642.58 29,089.05 16,880.96 2,040.00 5,724.72 24,645.68 4,443.37 1,823.25 956.25 211.90 1,451.97 696.95 755.02 188.76 566.26
In effect, market lost its confidence on the stock of SRM due to the deteriorating Earnings Per share to $0.22 (2005) from $2.69 (2003) and crashed the stock price to $1.02 in 2005 that was to the tune of $17.79 in 2003. Financial ratio table shows the financial ratios of SRM for 2003, 2004 and 2005. It can be observed that every performance indicator of the SRM's business was worsening through the years and in comparison to the industry averages as well. The liquidity, profitability, leverage, returns and the market indicators all gave way. Of them, the heightened business activities of SRM severely hampered the liquidity and returns. The deteriorating Altman z scores 6.71 (2003), 4.75 (2004), 2.89 (2005) further indicated an increasing probability of failure if corrective actions were not taken immediately that would reverse the so considered short term problem of SRM. With birds eye view of the business through the Du-pont identity it can be observed that the Asset management failed resulting in huge inventories and receivables, the reduction in prices resulted in deteriorating profit margin and to make over, SRM was deep down in debt more than it actually could manage. The following realization of Mr. White properly summarizes the cause of the problem:
9 | Financial Analysis of Silver River Manufacturing Company
If you cut prices to where you are losing money on every sale, you won t make it up with volume. The strategy of high sales growth and market share can work only when it is possible to preserve reasonable profit margins at the same time. Failure to do just that is what got us in trouble.
Case problem We have been charged with the task to project the financial performance of SRM by Mr. White for year 2006 and 2007 and analyze the prospects and issues in these years that will be relevant for further business decisions to Mr. White and to negotiate with MCNB for extension and new credit facilities. We also need to evaluate whether to extend new short term credit facility of $6.375 million to SRM assuming the expectations of SRM for 2006 and 2007 materialize. The tasks can be outlined as following: 1. Analyze SRMs ability to retire its loans in 2006 and/or 2007. 2. Analyze SRMs ability to pay dividends as well as maintain minimum cash balance. 3. Analyze from the banks perspective regarding extension of existing loans and possibilities of extending of loans. 4. Analyze the alternatives for SRM should the bank withdraw the credit facilities
For this purpose, we have been provided with sales growth projections, expected growth in expenses. Further, we have been asked to prepare the projections based on following assumptions: 1. 2. 3. 4. 5. Mr. White's forecasts (in the table below) shall materialize MCNB shall disburse additional short term loan of $6,375,000.00 to SRM SRM shall be able to repay the loan by the sales from new plant by June end 2006 The company does not pay out dividends in the projected years. Cash is the balancing figure in the calculations in the projected balance sheets for 2006 and 2007.
Expectations Weighted Avg. Sales Growth Cost of Goods Sold Administrative Expenses Miscellaneous Expenses Average Collection Period Inventory Turnover (cost) PE Ratio 2006 6% 82.50% 8% 1.75% 32 days 5.7 times 5.5 2007 9.50% 80% 7.50% 1.25% 32 days 5.7 times 6.5 Remarks of previous year sales of sales of sales of sales par with industry average par with industry average
16% 48%
16% 48%
The Financial Projections Based on the assumptions and actual data provided in the case for 2005, the following projected financial statements are prepared.
Table 9: Silver River Manufacturing Company Pro Forma Income Statement (Projected) Worksheet for Year End 2007 (USD in'000) Particulars Net sales Cost of goods sold Gross profit Administrative and selling Depreciation Miscellaneous expenses Total operating expenses EBIT Interest on short-term loans Interest on long-term loans Interest on mortgage Net income before tax Taxes Net income Dividends on stock Additions to retained earnings 2005 195,731.63 166,642.58 29,089.05 16,880.96 2,040.00 5,724.72 24,645.68 4,443.37 1,823.25 956.25 211.90 1,451.97 696.95 755.02 188.76 566.26 2006 Projected 207,475.53 171,167.31 36,308.22 16,598.04 2,422.50 3,630.82 22,651.36 13,656.86 3,937.20 956.25 190.54 8,572.87 4,114.98 4,457.89 4,457.89 2007 Projected 227,185.71 181,748.57 45,437.14 17,038.93 1,823.00 2,839.82 21,701.75 23,735.39 3,937.20 956.25 171.52 18,670.42 8,961.80 9,708.62 9,708.62
Table 10: Silver River Manufacturing Company Pro Forma Balance Sheets (Projected) Worksheet for Year End 2007 (USD in'000) Particulars Assets Cash 11 | Financial Analysis of Silver River Manufacturing Company 2005 2006 Projected 2007 Projected 46,021.25
36,060.50 18,442.27 30,029.35 84,532.12 29,248.50 (9,116.25) 20,132.25 104,664.37 20,194.29 31,885.71 98,101.25 30,125.96 (10,939.20) 19,186.76 117,288.01
Land, buildings, plant and equipment 22,873.50 Accumulated depreciation Net fixed assets Total assets Liabilities and equities Short-term bank loans Accounts payable Accruals Current liabilities Long-term bank loans Mortgage Long-term debt Total liabilities Common stock Retained earnings Owners' equity Total liabilities and equities (6,693.75) 16,179.75 96,101.00
18,232.50 19,998.39 7,331.28 45,562.17 9,562.50 2,339.62 11,902.12 57,464.29 23,269.00 15,367.72 38,636.72 96,101.01
24,607.50 15,994.88 9,301.13 49,903.51 9,562.50 2,103.75 11,666.25 61,569.76 23,269.00 19,825.61 43,094.61 104,664.37
24,607.50 16,794.62 11,626.41 53,028.53 9,562.50 1,893.75 11,456.25 64,484.78 23,269.00 29,534.23 52,803.23 117,288.01
Similarly, with the help of ratio derivation formula in page 2 and 3, the financial ratios for year 2006 and 2007 are derived as follows:
Table 11: Silver River Manufacturing Company 12 | Financial Analysis of Silver River Manufacturing Company
2005
2006 Projected
2007 Projected
Industry Average
Contractual limits
Remarks
Improvement 2.0 Current ratio 1.75 1.69 1.85 2.50 1.00 Quick ratio Leverage ratios 55 Debt ratio (%) Times interest earned Assets management ratios Inventory turnover (Cost) Inventory turnover (Selling) Fixed asset turnover Total asset turnover Average collection period Profitability ratios Profit margin (%) Gross profit margin (%) Return on total assets 0.39 14.86 0.79 2.15 17.50 4.26 10.34 4.27 20.00 8.28 18.39 2.90 18.00 8.80 17.50 Good Improvement Good Improvement Good Improvement Improvement 3.57 4.19 12.10 2.04 53.99 5.70 6.91 10.31 1.98 32.00 5.70 7.13 11.84 1.94 32.00 5.70 7.00 12.00 3.00 32.00 Good Improvement Poor but improving Poor Good Improvement Improvement 59.80 1.49 58.83 2.69 54.98 4.69 50.00 Improvement 7.70 Improvement 0.73 1.09 1.25 1.00 Above and average
5 4.5
4 3.5
2 1.5 1
C rrent ratio
0.5 0 2003 2004 2005 2006 Projected 2007 Projected 2006 Revised 2007 Revised
Liquidity Ratios
2.5
ick ratio
70
60
50
20
10
2003
2004
2005
2007 Revised
Leverage Ratios
80
70
60 50
40
20 10
0
2003 2004 2005 2006 2007 2006 2007 Projected Projected Revised Revised
80
70 60 40
30 20 10
0
Profit
2003
2004
2005
Profitability ratios
argi ( )
50
argi ( )
30
verage collectio
eriod
250.00
200.00
150.00
100.00
50.00
2003 2004 2005 2006 2007 2006 Projected Projected Revised 2007 Revised
Based on Mr. Whites expectation of repaying all short term loans by mid 2006, the performance of SRM reflected in the following revised financial statements and key ratios table:
Table 12: Silver River Manufacturing Company Pro Forma Income Statement (Revised) Worksheet for Year End 2007 (USD in'000)
!
lt a Z factor Retur o ow ers' equity
Profit
verage collectio
eriod
urre t ratio
Particulars Net sales Cost of goods sold Gross profit Administrative and selling Depreciation Miscellaneous expenses Total operating expenses EBIT Interest on short-term loans Interest on long-term loans Interest on mortgage Net income before tax Taxes Net income Dividends on stock Additions to retained earnings
2005 195,731.63 166,642.58 29,089.05 16,880.96 2,040.00 5,724.72 24,645.68 4,443.37 1,823.25 956.25 211.90 1,451.97 696.95 755.02 188.76 566.26
2006 Revised 207,475.53 171,167.31 36,308.22 16,598.04 2,422.50 3,630.82 22,651.36 13,656.86 1,968.20 956.25 190.54 10,541.87 5,060.10 5,481.77 1,370.44 4,111.33
2007 Revised 227,185.71 181,748.57 45,437.14 17,038.93 1,823.00 2,839.82 21,701.75 23,735.39 956.25 171.52 22,607.62 10,851.66 11,755.96 2,938.99 8,816.97
Table 13:Silver River Manufacturing Company Pro Forma Balance Sheets (Revised) Worksheet for Year End 2007 (USD in'000) Particulars 2005 2006 Revised 2007 Revised
Assets Cash Accounts receivable Inventory Current assets Land, buildings, plant and equipment Accumulated depreciation Net fixed assets Total assets Liabilities and equities Short-term bank loans Accounts payable Accruals Current liabilities Long-term bank loans Mortgage Long-term debt Total liabilities Common stock Retained earnings Owners' equity Total liabilities and equities 3,905.77 29,356.86 46,658.62 79,921.25 22,873.50 (6,693.75) 16,179.75 96,101.00 11,106.44 18,442.27 30,029.35 59,578.06 29,248.50 (9,116.25) 20,132.25 79,710.31 20,175.54 20,194.29 31,885.71 72,255.54 30,125.96 (10,939.20) 19,186.76 91,442.30
18,232.50 19,998.39 7,331.28 45,562.17 9,562.50 2,339.62 11,902.12 57,464.29 23,269.00 15,367.72 38,636.72 96,101.01
15,994.88 9,301.13 25,296.01 9,562.50 2,103.75 11,666.25 36,962.26 23,269.00 19,479.05 42,748.05 79,710.31
16,794.62 11,626.41 28,421.03 9,562.50 1,893.75 11,456.25 39,877.28 23,269.00 28,296.02 51,565.02 91,442.30
Table 14:Silver River Manufacturing Company Ratio Analysis Year Ended December 31, 2007 (Revised) 19 | Financial Analysis of Silver River Manufacturing Company
Particulars Liquidity ratios Current ratio Quick ratio Leverage ratios Debt ratio (%) Times interest earned Assets management ratios Inventory turnover (Cost) Inventory turnover (Selling) Fixed asset turnover Total asset turnover Average collection period Profitability ratios Profit margin (%) Gross profit margin (%) Return on total assets Return on owners' equity
2005
2006 Revised
2007 Revised
Industry Average
1.75 0.73
2.36 1.17
2.54 1.42
2.50 1.00
59.80 1.49
46.37 4.38
43.61 21.05
50.00 7.70
From the Table 9 and 10 given above, it is clear that if the bank were to maintain the present credit lines and grant an additional $6.375 million short term loan effective from Jan 01, 2006, the company would be able to retire all $ 24,607,500 existing on Dec 31, 2006 because cash balance as on Dec 31, 2006 is $ 36,060,500 and even after retiring the $ 24,607,500 loan , the
remaining cash balance $ 11,453,000 will be more than the requirement of cash balance @ 5 % of sales (i.e. $ 10,373,780).
From the Tables 12, 13 and 14 given above, it is clear that if the bank were to maintain the present credit lines and grant an additional $6.375 million short term loan effective from Jan 01, 2006, the company would be able repay all existing short term bank loans by June 2006 and at the same time pay regular dividend of 25 % and maintain minimum cash requirement of 5 % of sales. From Table 14, it is clear that almost all ratios improve with this policy and hence, this policy is good.
From the Perspective of MCNB MCNB should extend the existing short and long term loans and grant the additional $ 6.375 million to SRM. SRM bears good prospect of turnaround in 2006 and 2007 but only if can expand its operation with new plant