It is detrimental for higher-level management in a company to assess the long-term financial health of the institution. Throughout history there have been depictions of several corporations taking on lucrative and highly ambitious initiatives to increase the wealth of the company. These companies come to find out their programs could not be funded as anticipated. This paper will show how proper strategy and a step –by-step process will successfully be able to assess a company’s financial future.
In this case we will be looking at performance measures based upon the income statements and balance sheets of SciTronics (A medical device company). It is imperative that the measures are grouped into three types: (1) profitability measures (sales), (2) activity (asset management) measures, and (3) leverage and liquidity measures. (Piper, 1-6)
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1. By assessing the performance of SciTronics during the 2005-2008 periods we see that it’s profitability ratio increased. The company is heading in the right direction. In terms of sales we can see in the below table that the company has increased it’s net income.
2. SciTronics financial strength and its access to external sources have improved. This is evident from the financial ratios of profitability and leverage.
a. What will management do to maintain current liabilities that had been increased during the 05-08 period? b. As seen in Table 1 the salary and employee expenses are very high in the company. We can see by looking at Sell, General and Admin that it has decreased which is good. The company doesn’t want to pay out to employees too much. This interpretation varies with different companies. Most companies want their employees income to be anywhere from 12% to 22% of their total sales. By looking at the market average we can see that with pharmaceutical companies it is a little different. It is apparent that selling, general and administrative includes the sum of all indirect and direct selling expenses but a valid question to ask management would be: Why is this number so high in comparison to the market average, and what can we do to lower this number?
c. Will SciTronics continue to expand their fixed assets such as property and equipment? This is imperative to know because it will increase the value of the company in turn making it more financially stable. If need be, it could then use these assets as collateral towards loans.
If SciTronics came to my bank and asked for a $126,000,000 loan to support their growth in business I would approve the loan because of careful examination of their financial statements including analyzing the profitability, leverage, activity, and liquidity ratios.
(1) Profitability Measures
Sales growth provides the company with a measure to determine how well their product is doing in the market.
* During the four-year period ended December 31, 2008, SciTronics’ sales grew at a 20.69% compound rate. There were no acquisitions or divestitures. * SciTronics’ profit as a percentage of sales in 2008 was 5.74% * This 5.74% represented an increase from 3.40% in 2005.
* SciTronics had a total of $159,000,000 of capital at year-end 2008 and earned, before interest but after taxes (EBIAT), $16,00,000. Its return on capital was 10% earned in 2008, which represented an increase from the 4% earned in 2005. * Scitronics has $75,000,000 of owner’s equity and earned $14,000,000 after taxes in 2008. Its ROE was 18.67%, which represented an improvement from the 8.20% earned in 2005.
Figure A below:
* This figure shows an initial decrease in the profit as a percentage of sales however are followed by a steep increase in 2008. Profitability is quite obviously very important to a company. It allows the company to have access to debt, have a proper valuation of the company’s common stock, the ability to finance its own programs, and the pervasiveness of management to issue stock. This is depicted in Figure A as an indefinite increase from 05-08.
* Return on equity indicates how profitable SciTronics is utilizing shareholders’ funds. (Piper, 7) To shareholders of a company, this is equally as important as EBIAT.
(2) Asset Management Measures
A company must use Activity ratios to determine how well it is using its assets. If improper use of assets occurs there is a need for financing for the company. This is turn leads to more interest costs and also brings about lower return on capital. * Total asset turnover for SciTronics in 2008 can be calculated by dividing $244,000(net sales) into $159,000. The turnover deteriorated from 1.58 times in 2005 to 1.53 times in 2008 * SciTronics has $66,000 invested in accounts receivables at year-end 2008. Its average sales per day were $668.49 during 2008 and its average collection period was 98.73 days. This represented an improvement from the average collection period of 104.29 days in 2005.
* SciTronics apparently needed $29,000 of inventory at year-end to support its operations during 2008. Its activity during 2008 measured by the COGS was $74,000. It therefore had an inventory turnover of 2.55 times. This represents an improvement from 2.05 times in 2005. * SciTronics had net fixed assets of $18,000 and sales of $244,000 in 2008. Its fixed asset turnover ratio in 2008 was 13.56 times, and deterioration from 16.33 times in 2005.
* As seen in Figure C, there is an improvement in inventory turnover from 2.05 in 2005 to 2.55 in 2008. This is very important because this indicates to the company its effectiveness with which the company uses its inventory. (Piper, 8) (3) Leverage and Liquidity Measures
The different types of leverage ratios measure the relationship of funds supplies by creditors to the funds supplies by the owners of the company. Return of equity will improve when the use of borrowed funds from creditors or owners is appropriated correctly.
* SciTronic’s ratio of total assets divided by OE increased from 1.52 at year-end to 2.12 at year-end 2008. * At year-end 2008, SciTronic’s total liabilities were 34.41% of its total assets, which compares with 32.41% in 2005. * The market value of SciTronic’s equity was $175,000,000 at Dec 31, 2008. The total debt ratio at market was 32.43%. * SciTronic’s earning before interest and taxes (Operating income) were $26,000,000 in 2008 and its interest charges were $2,000,000. It’s times interest earned been 13 times.
This represented an improvement from the 2005 level of 10 times. * SciTronics owed its suppliers $6,000,000 at year-end 2008. This represented 8.11% of COGS and was a decrease from the ratio of 11.63% year-end 2005. * The financial riskiness of SciTronics decreased between 2005 and 2008.
Liquidity ratios measure a company’s ability to meet financial obligations as they become current. (Piper, 10)
* SciTronics held $133,000,000 of current assets at year-end 2008 and owed $48,000,000 to creditors, due to be paid within one year. SciTronics’ current ratio was 2.77, a decrease from the ratio of 3.90 at year-end 2005. * The quick ratio for SciTronics at Year-end 2008 was 2.17, a decrease from the ratio of 2.90 at year-end 2005.
* This figure depicts an increasing level of financial leverage. In this figure total assets divide total liabilities. We can see that financial leverage increased throughout the years until 2008.
Piper, Thomas. Assessing a Company’s Future Financial Health. 911th ed. Vol. 9. Boston, MA.: Harvard Business Review, 2012. Print. Ser. 412.