Financial Statement and Cash Flow Analysis - Essay Example

? Mini Case: Financial ment and Cash Flow Analysis By ID PART A: 1. Calculate Jaedan’s free cash flow. Free cash flow is useful in determining the company’s flow of cash. It takes into consideration the company’s investments in capital expenditures that are critical in maintaining sustained growth. Basically, free cash flow is expressed as cash from operations net of capital expenditures necessary to maintain company’s growth. Free cash flow= cash from operations- capital expenditures The free cash flow represents the financial ability of the company; that is its ability to engage in investment activities that goes beyond the planned investment activities (Walter, Harrison, & Horngren, 2003). However, noting that many investment activities of companies are quite significant, caution should be taken when implementing any investment activity that falls above the budgeted investments. Cash from operations is also referred to as earnings before interest net of depreciation and amortization. Therefore; Free cash flow= 17,237,000+800,000 =18,037,000 2. Calculate Jaedan’s liquidity. A company’s liquidity ratios are used in determining the organizations capacity to meet its short-term obligations when they fall due. Liquidity ratios are important to the investors when conducting fundamental analysis of the firm. High values imply that a firm has adequate assets compared to liabilities and should therefore can pay off short-term debts with ease. Current ratio helps to assess the company’s current assets ability to pay-off current liabilities. The liquidity ratios include: Current ratio= Current Assets/ Current liabilities =15,066,000/4,342,000 =3.5 Industry current ratio= 3.26 Quick ratio also is also known as acid test ratio. It is more stringent and refined than current ratio. The ratio uses assets that are highly liquid. The main asset left out in the numerator component is inventory which is quite difficult to liquidate in timely period and at market value. Quick ratio is highly conservative as it focuses on short-term investments, cash and accounts receivable. Quick Ratio= (Cash & Equivalents + Short-Term Investments + Accounts Receivable) ? Current Liabilities = (3,689,000+1,836,000+5,423,000)/4,342,000 =2.52 Industry ratio= 2.19 Cash ratio is the highly conservative among the three liquidity ratios. The ratio simply concerns assets that can be utilized to pay short-term debts thereby disregarding short-term investments and receivables. The fact behind exclusion of short-term investments and receivables is that they cannot be monetized as soon as the firm may be requiring the funds. Cash Ratio = Cash & Equivalents ? Current Liabilities = 3,689,000/4,342,000 =0.85 3. Calculate Jaedan’s debt and profitability ratios. Debt Ratio Debt ratio helps to compare company’s total debt to its total assets. It sheds light on the leverage applied by the company. A lower ratio indicates that the company is less reliant on money borrowed from others (Nobes & Parker, 2000). Therefore the lesser the percentage the stronger the company’s equity position and the higher the ratio the riskier the company is. Debt ratio= Total liabilities/Total assets = 4,342,000/ (8,851,000+15,066,000) = 4,342,000/23,917,000 = 0.18 or 18% Industry ratio= 39.36% Profitability ratios are helpful in comparing how profitable a firm is in the industry. These ratios include: Gross margin ratios Gross margin is the difference between company sales and the cost of such sales. Simply, it is the amount that a company keeps as gross profit. Gross margin is expressed in percentage terms and a higher margin indicates that the company is making more profit. Gross margin= Gross profit/ Sales =19,658,000/42,000,000 =0.47 or 47% Industry ratio= 23.74% Operating margin Operating margins indicates how much a firm makes of from its sales. It indicates company’s performance as it accounts for other important costs of operating income, besides costs of sales. Operating margin= (Operating income/loss)/ Sales Operating Income= Earnings before interest, Depreciation and Tax =17,237,000+800,000 =18,037,000 Operating Margin= 18,037,000/42,000,000 =0.43 or 43% Industry ratio= 20.89% Net Margin Net margin indicates the amount of revenue the company retains after netting off all the expenses. Net Margin= (Net Income/ Loss)/ Sales =11,577,456/42,000,000 =0.28 or 28% Industry ratio=17.97% Free cash flow margin Free cash flow measures the revenue that turns to be free cash flow. Further, this ratio measures the company’s profitability achieved based on assets - irrespective of whether they are financed by debt or equity holders. Free cash flow margin= Free cash flow/ sales = 18,037,000/42,000,000 = 0.43 or 43% Return on Assets (ROA) This ratio measures the company’s capacity to convert assets into profit. Return on Assets (ROA) = (Net Income + after tax interest expense)/ Average total assets Where: After interest Expense= (1-tax rate)* interest expense After interest Expense= (1-0.34)*304,600 =201,036 Therefore; ROA= (11,577,456+201,036)/ (8,851,000+15,066,000) =11,778,492/10,357,600 =1.14 or 114% Industry ratio= 41.87% Return on Equity (ROE) This ratio measures firm’s return on investments by shareholders. Similar to other ratios, it is also expressed in percentage terms. Return on Equity (ROE) = Net Income/ Average shareholders’ Equity = 11,577,456/ 8,500,000 =1.36 or 136% Industry ratio= 68.30% 4. Calculate Jaedan’s market ratios. Market ratios include price/ earnings and market/ book ratios. Market/ book ratio Market to book ratio measures the company’s worth within a given period compared to capital invested by existing and past shareholders. The ratio shows the comparison of the firm’s current market price with its book value (Albrecht, et al., 2008). A higher ratio indicates that the management is making efforts to create more value. Market/ book ratio= Market price per stock/ book value per stock =56.82/40 =1.42 Industry ratio= 4.32 Price Earnings (P/E) ratio is the ratio of market price per share to earnings per share. This ratio helps the investors in making decisions relating to whether they should invest in shares of a given company or not. P/E ratio indicates how much the market is able to pay for company earning. Price/ Earnings ratio= Market price per share/ Earning per share EPS= Net Earning/ Outstanding shares =11,577,456/1,000,000 =11.6 Industry ratio= 5.97 Part B: 5. Three financial strengths and three weaknesses of Jaeden Industries. Financial strengths Compared to industry averages, the company is in a favorable liquidity position. It has a current ratio of 3.5 and a quick ratio of 2.52, which are slightly above industry averages. This means that the company can meet its short-term liabilities when they fall due. In addition, all the profitability ratios computed are way above the industry averages. For instance, gross margin ratio of 47% against 23.74%, operating margin of 43% against 20.89% and net margin of 28% against 17.97%, in the industry. These ratios indicated that Jaedan is highly profitable compared to other firms in the industry. Moreover the company uses less debt financing in its capital structure as indicated by debt ratio of 18%, against 39.36% industry ratio. Even though the company has a portion of debt financing in its capital structure, the advantage of maintain low amount of debt is that the company suffers less finance cost. Further, it also indicates that the company makes sufficient net profits which are partially ploughed back to finance the company after paying dividends. Both return on assets and return on equity ratios shows that the company has good returns. In addition, the ratios are far much beyond the industry averages indicating that the company has put its assets into maximum utilization hence better returns on shareholders’ equity. The company also has favorable price earnings ratio of 11.6 that is higher than market average of 5.97. This indicates that the investor will be willing to pay for the company’s shares twice as they would for other compares in the market. The company has stringent credit policy which is very critical in maintaining its liquidity position. This is evident from its terms of trade whereby it allows its customers 35 days to pay for the credit sales. On the other hand the company has negotiated a pro-longed payment period for its credit purchased meaning that it takes a bit longer to settle its debts. This policy would, therefore, ensure that the company always has enough cash to cater for its short-term financial needs. Financial weaknesses The company paid in capital in excess of par is quite high meaning that the company is required to pay higher dividends compared to shares issued at par. According to market/ book ratio, it is evident that the company worth compared to industry average is quite low. This means that the price of shares has significantly dropped overtime. The company has preferred stocks as one way of financing despite having a balance of one million common shares that are issued and not paid for. This makes the company to suffer more in terms of interest as preferred shares attract higher interest which precedes that of common shares (Nobes & Parker, 2000). Recommendations with rationale on how Jaeden’s management could improve upon these weaknesses With the outstanding common shares, I would recommend the company to first call the remaining amounts before sourcing capital from preference shares and in excess of par for paid in common shares. This will help the company in utilizing the available common shares and avoid sources that are more expensive to the company. In respect to lower market/ book ratio, the management should consider consolidating the existing shares in order to boost its market value.   References Albrecht, S., et al. (2008). Accounting Concepts and Applications, 8th edn . Sidney: Thomson Learning. Nobes, C.W., & Parker, R. (2000). Comparative International Accounting. Editura: Prentice Hall Walter, T., Harrison, J., & Horngren, T. (2003). Financial Accounting Second Edition. New Jersey: Prentice Hall Englewood Cliffs Read More