Free Cash Flow Ratio - Report Example

The financial ment and cash flow Part A Jaedan’s free cash flow: Free cash flow is the amount of cash available annually for the investorsof a firm after all expenses including investment are covered. The free cash flow is calculated by the following formula FCF= EBIT*(1- tax rate) + Depreciation- New Investment Calculation of Free Cash Flow Particulars Amt(in$) EBIT 13119000 Depreciation 800000 Tax rate 35% Change in fixed Assets 2932000 Change in current assets 4,530,181 Change in accounts Payable 190000 Change in accruals 150000 Change in Net Working capital 4,190,181 Operating Cash Flow 9458540 Free Cash Flow 2,336,359 The free cash flow of Jaeden is $ 2336359. 2) Jaedan’s liquidity: For analyzing the liquidity position of Jaeden two ratios namely the current ratio and the quick ratio are being used. These are the best ratios to measure the ability of the firm to meet its short term debt obligations. Out of current ratio and quick ratio, the quick ratio is more accurate measure because it makes use of those current assets which can be converted to cash at the earliest. Hence inventory is excluded from this as inventory can be converted to cash only when it is sold. The table below shows the liquidity position of the firm   Jaeden Industry Average   Particulars 2009 2010 2009 2010 Liquidity Ratios Total current assets   15066000     Total current Liabilities   4342000     Current ratio 2.65 3.46983 2.89 3.26 Total current assets   15066000     Inventories   4118000     Total Current Liabilities   4342000     Quick ratio 1.84 2.521419 1.42 2.19 3) Jaedan’s debt and profitability ratios: In ratio analysis debt ratios help in identifying the debt repaying capacity of the firm and profitability ratios on the other hand show the earnings capability of the firm. The table below shows the debt and profitability ratios of the firm: Profitability Ratios Particulars Jaeden Industry Average   2009 2010 2009 2010 Operating Profit   13119000     Net Sales   42000000     Operating Profit Margin 25.59% 31% 19.32% 20.89% Gross Profit   15540000     Net Sales   42000000     Gross Profit Margin 30% 37% 22.19% 23.74% Net Profit   8410908     Net Profit Margin 16.25% 20% 15.11% 17.97% Debt Ratios Particulars Jaeden Industry Average   2009 2010 2009 2010 Total Assets   23917000     Common Stock   4000000     Paid up capital   4500000     Retained earnings   7929000     Total Equity   16429000     Assets To Equity 170.35% 145.58% 165.82% 163.13% Total Current Liabilities   4342000     Long term Bonds   3046000     Total Assets   23917000     debt ratio 40.72% 30.89% 41.93% 39.36% EBIT   13119000     Interest Expense   375200     Times Interest Earned 26.33 34.96535181 15.72 16.81 4) Jaedan’s market ratios: The market ratios generally measure the response of the investor to a company’s stock and also the cost involved in issuing of stock. These ratios are primarily concerned with the return an investor gets for his investment and also the relationship between the return and the value of the investment in the shares of the company. The table below is showing the market ratios namely the P/E ratio and the market to book value ratio. Market ratio Jaeden Industry Average 2009 2010 2009 2010 P/E ratio 6.84 6.76 5.41 5.97 Market to Book Value 4.23 3.46 4.19 4.32 5. Highlight at least three financial strengths and three weaknesses Jaeden Industries may have. Based on the ratio analysis done above a clear picture of the company’s strengths and weakness can be identified. They are summarized as under: Strengths: The liquidity position of the firm is its strong point. Both the current ratio and the quick ratio are well above the industry average thereby indicating that the firm has the capability to meet its short term financial obligations well. As the quick ratio of the industry raised itself in the year 2010 the firm too made efforts to increase its quick ratio and it was well above the industry average. What is observed is that the ratios are not too much higher than the industry average indicating that the firm has managed its working capital well. The profitability of the firm is well above the industry average. It means that the industry has outperformed the market in making profits. Having the profitability ratios higher than the industry average is always preferred. In the above case the important profitability ratios like the net profit margin and operating profit margin are all well above the industry margin. Other potential strengths for the company are its free cash flows. The company has generated a free cash flow of $2336359 which is quite substantial. The free cash flows of the firm can be channelized by the firm in other activities like expansion, giving dividends, increasing product lines etc. It can be used as a means to bring further income for the company (Siddique, 2006, p.623). Weakness From ratio analysis it has been observed that the market position of the firm is declining. It is not enjoying the same position in the market as it used to enjoy in the past. This has been evident from the falling ratios. Though the P/E ratio is above the market average yet the ratio has fallen as compared to the previous year 2009. This shows that the investors have somewhat low rated the company as compared to the previous year. The average collection period of the period is perceived as a potential risk for the firm. What has been observed is that the terms of trade being similar the average collection period has almost doubled. It is well above 35 days and it is allowing the customer to pay back for a time much longer than the industry average. This may increase the propensity of doubtful debts for the firm in the future. Another weakness observed is the firm’s payment period. The average payment period to its creditors like the suppliers has increased. This might have happened due to lengthening of the firm’s average collection period. The lengthening of the average collection period shall lead to poor credit rating of the company and this will be a risk for the firm for this might lead to fall in its already declining stock price. 6. Provide recommendations along with rationale on how Jaeden’s Management may improve upon these weaknesses. Few recommendations that can help Jaeden to eliminate the potential risk are mentioned below: In order to eliminate the risk of its falling market prices what the company can do is that it can give away its surplus cash in form of dividends. The giving of dividends will be perceived by the investors as something good and this would motivate them to further invest in the company (Peterson, 1999, p.172). As a result there are chances for the falling share prices to once more get a foothold in the market. The free cash flows can be channelized for this purpose. The average collection period of the firm needs to be minimized. This can be done by offering attractive discounts to the debtors for speedy recovery of the debts. Instead of lengthening the collection period, more discounts should be allowed for payments before the due date. Moreover there should be effective communication in place that can keep the debtors intimidated about their impending deadlines. The average payable period can be shortened by decreasing the average collection period as both are interlinked. A contingency fund can be created out of the free cash flow to make use of it to make the payments right on time. The company can also go for few cost cutting measures like decreasing the operational cost which can be done by negotiating with its clients at rates lower than before. References Peterson, P. P. (1999). Analysis of Financial Statements. John Wiley & Sons. Siddique, S. A. (2006). Managerial Economics And Financial Analysis. New Age International. Read More