Analyzing Mark X Company’s financial statements and projecting the expected numbers for the coming years we make a decision on whether or not Mark X Company qualifies for the loan extension of $6,375,000. The strength of Mark X as a company is its fixed assets turnover ratio, which rose from 1990 to 1992. This tells us Mark X’s ability to generate net sales from each addition of a fixed asset. Sales generated from the fixed assets are greater than the costs of the fixed assets, which imply that the fixed assets that were purchased are good investments for the company. This is really the only positive ratio they have at the moment. Weaknesses we found in Mark X were its debt ratio, which increased from 40.47% in 1990 to 46.33% in 1991 and from 46.33% to 59.80% in 1992. This shows us Mark X’s amount of debt relative to its assets is increasing and that its debt is equal to more than half of its assets by 1992. The current ratio and quick ratio has also indicated negative change, both decreasing between 1990 and 1992.
The current ratio is a liquidity ratio that measures a company’s ability to pay short term obligations, while the quick ratio shows a company’s ability to pay its short-term obligations with its most liquid assets. Both ratios are steadily decreasing, indicating to us the position of the company has become less and less favorable. The company’s asset management ratios also show decreasing numbers. The inventory turnover ratios have decreased as well as the total asset turnover. This explains the number of times a company’s inventory is sold and replaced during a period. The company’s days sales outstanding (ACP) also rose from 36.00 in 1990 to 53.99 in 1992.
This shows us that Mark X’s average number of days to collect revenues after a sale has increased. This number is unfavorable because this means the company’s cash is tied up in accounts receivable for longer period. The profit margin ratio also fell from 5.50% in 1990 to 3.44% in 1991, and then from 3.44% to 0.39% in 1992. This is a ratio of profitability calculated as net income divided by revenues, showing us that the company’s profitability has dropped substantially.
Similarly, the gross profit margin and the return on total assets has decreased over the past three years, the gross profit margin dropping from 19.48% in 1990 to 14.76% in 1992, and the return on total assets dropping from 16.82% in 1990 to 0.79% in 1992. This shows us the company’s financial health has declined, and the proportion of money left over from revenues after accounting for cost of goods sold has decreased. The return on equity using the extended DuPont Equation shows how the ROE was 28.26% in 1990, and quickly fell to 1.95% in 1992, well below the industry average.
Looking at the data from 1990-1992, we feel that the bank should not lend the requested money to Mark X. Based on their data’s ratio-analysis; the companies leverage and liquidity are both dropping. The liquidity ratios show that not only does Mark X have problems obtaining cash, but these problems have been getting worse. Notice that their current assets consist of a very high percentage of inventories. This will make the task of converting its current assets into cash in a short period of time difficult. The leverage ratios show that their debt levels are not only extremely high, but they are only getting worse. Its TIE ratio is decreasing also; showing that Mark X’s ability to pay interests is decreasing.
The problems do not stop there. Their efficiency ratios indicate that even though their fixed assets are increasingly being used to promote sales during 1990 and 1991, which is shown by their fixed asset turnover ratio, the decreasing total assets turnover ratio shows that Mark X’s total assets are not being efficiently used, so their overall asset management is becoming less efficient. Finally, their profitability ratios are showing that their ability to generate profit is decreasing. One of the major factors in the possible denial of the new loan is the lack of payments on their short term loans.
Mark X could pay off their outstanding short-term loans by the end of 1993. The 1993 forecasted balance sheet shows a cash balance of $35,874 (all dollar values in thousands). Their current outstanding short term bank loans are projected to be $24,608. Assuming that the company can survive on a cash balance of $11,266, it would be possible for Mark X to pay off all the short term debt by the end of the year. There is a potential that the bank could withdraw its line of credit and demand immediate repayment of the two existing loans. If that happens, Mark X has very limited plans of action.
If the bank were to demand immediate payment of all outstanding loans, Mark X would have a real mess on their hands. They would need to make payments of $18,233 for the short term debt and $9,563 for the long term debt. This means that Mark X would need to pay $27,796 within a period of 10 days. Their total ending cash at the end of the 1992 year is only $3,906 which would only be a small chunk of the outstanding loans. The company now would be forced to demand payment from their accounts receivables which are valued at $29,357 and would cover the total of the loan. However, they would need to collect the entire amount in under 10 days to pay the bank back. If they do not succeed in obtaining the $27,796, their only other option is file for bankruptcy.
The validity of comparative ratio analysis could be considered questionable in a couple of different situations. The first thing is that there could be some uncontrollable changes and the second is that the companies are not comparable in size. Large businesses have the advantage of economies of scale. For example, a large company can have larger earnings per fixed asset because they have a much larger market share than a small company that uses the same technology. You should also be careful comparing different years without taking the state of the economy into consideration. In recessions, it would not be smart to compare the earnings per share to a previous year before the recession. This may make it possible to lay blame on the wrong reasons and not properly evaluate the state of the company. The ratios should be used to measure areas that are controllable by them. In the situation of a recession, there is nothing that the company can do about it.
The sensitivity analysis is a technique that indicates how much NPV will change in response to a given change in an input variable, other things held constant. We perform a sensitivity analysis to show how sensitive the results are to things such as the sales growth rate, the cost of goods sold percentage, and the administrative expense ratio. If the results don’t vary too much when a given variable is changed to a less favorable value, than the bank would have greater confidence in extending its line of credit.
Based on the analyses, Karen should recommend the extension of the existing short and long term loans and grant the additional $6,375,000. We feel the loan should be given because the projections show substantial improvement in many areas of the financial statements. Cash on hand in 1993 alone significantly increases about $32 million. Accounts payable and receivable both show improvements while the ratios continue to recover and regain strength. The Altman Z score of Mark X is projected to rise well above the industry average reducing their chances of bankruptcy.
Contractual requirements for current, quick and debt ratios should be changed to require a higher standard of financial security for the bank. During the first quarter after the grant of additional funds, the bank should also continue the requirement of quarterly financial statements and continue to calculate the key ratios and the trends in these ratios to identify any deficiencies. If improvements aren’t shown after the 1993 appropriate measures will be taken by the bank.