Fly-By-Night Case Essay
A). When looking at the balance sheet, the first noticeable signal among assets is the rapid increase in accounts receivable in years 12, 13, and 14. It means that there are more products sold in credit than in cash and direct useable funds.
Another signal is the sudden increase in inventories in years 12, 13, and 14. The previous three years, inventories slightly decreased. Only from year 11 to year 12 inventories almost triples and keeps increasing significantly the next two years. It shows there is has been a change in the production system making is less efficient.
The last signal among assets is the increase in property, plant, and equipment for the years 13 & 14. It is likely that the increase is a result from the less efficient production in year 12. By buying new equipment, they expected to be able to meet the production needs.
Then, the first noticeable signal among liabilities and shareholders’ equity is the increase in current portion of long-term debt in years 13 & 14. The acquired extra debt is most likely a result from acquiring property, plant, and equipment.
Another signal is the increase in accounts payable for year 13 & 14. It is a result from the extended terms of payments. In year 12, the company had 26 days to pay which increased to 48 days in year 13 and increased even further in year 14 to 84 days. The company keeps buying products but does not have the resources to pay for it and takes longer to pay vendors.
Next, when looking at the income statement it is noticeable there is an increase in deprecation which is due to acquiring property, plant, and equipment. There is an increase in interest expense which is due to acquiring more debt. Then in year 14, it results in an operating loss since the expenses are higher than income (positive income tax).
Lastly, when looking at the cash flows the most noticeable is the negative change in cash flow for operations. To be able to keep your liquidity high or ability to pay current expenses, you need to generate cash through net cash flow from operations. Only due to the increase in net cash flow from acquiring property, plant, and equipment the total cash flow decreases.
B). Yes, the company can avoid bankruptcy. Only FBN needs to make some strategy and implementation changes. The income statement shows that sales have increased significantly from year 12 to year 14. As the company’s transactions with the U.S. Air Force, U.S. Navy, and the Federal Reserve Bank are covering 60-70% of total revenues, the company has secured income up to years 16-17. The conclusion is that the main concerns of the company are liquidity, costs, and efficiency.
The board of directors needs to improve cash levels to lower the liquidity risk. As exhibit 5 shows the current and quick ratio of FBN have decreased over the past years which is the main cause for the high liquidity risk. There a few ways to do this. One option would be to negotiate with customers over the terms of accounts receivable to generate cash faster. Another option would be to issue shares to increase the level of cash.
Another issue is the increase of inventory. A high level of inventory increases costs for FBN such as holding costs. The company should have insight in the market conditions so it can produce the needed products efficiently. There needs to be some inventory available for emergency situations or unexpected orders, but the number should be as low as possible.
Finally, the total expenses are higher than sales in year 14 which signals that the company either needs to improve efficiency or cut costs. Depreciation costs have increased significantly due to the increased sales and therefore the acquirement of plant, property, and equipment. The ROA has decreased to 0%. In order to get a positive profit margin, costs need to be cut. On the other side, effectiveness and efficiency of the assets need to be improved to generate net sales from the fixed-assets investments.