ABC Learning - Why They Have Failed - Case Study Example

ABC Learning was providing education and childcare services to children and was the largest provider of education. The company with its presence in different parts of the world was ensuring towards growth. (ABC Website, 2010) ABC Because of the nature of its business had facility centres at various parts of the globe and had huge assets. The company also followed an policy of acquisition to grow. The company started in 1988 and within a few years had centres all around US, UK, Australia & New Zealand. The company expanded continuously and included some more centres and within some time became the number one provider of childcare service. (ABC Website) This was backed by some poor decision taken by the management. The company had huge debts in the process of acquiring new companies. The inability to pay back those resulted in the downfall of the empire. The company had filed for bankruptcy in 2008 on the backdrop of the subprime mortgage crisis. The company had huge debts and were unable to pay those. The overgrowing share prices also made people susceptible and since investments were pouring from all side didn’t catch the attention of the investors to look at the actual profits which resulted in overestimating the growth potential. (Kruger, 2010) It had resulted in the company falling in the debt spiral which finally made ABC Learning’s downfall. Major reason contributing to the failure of ABC Learning is that the financial statements didn’t provide those warnings to the investors and creditors which hurt the society at a large. The reason for the failure fact that despite showing growth the financial position was not strengthened. There are many reasons which led to the failure of ABC Learning. Some of the reasons are Firstly, the huge fixed cost which ABC had incurred at its centre was hard to absorb at the different centres due to the finite capacity the company has in terms of clients. (Andrew, 2009) The company due to the nature of its business had limited capacity for students. This made it difficult to absorb the fixed overheads thereby burdening the company. Secondly, the policy of the company to acquire business made a huge burden on the company as these cost were irrecoverable which resulted in the return on equity to fall thereby affecting the shareholders. (Bentley, 2009) Thirdly, the rapid rise in maintenance cost due to rise in fixed assets across various centres was taking its toll on the profits which resulted in profits to decrease. (Andrew, 2009) The rise in depreciation expenses and to replace the fixed assets took a toll on the profits which had an overbearing aspect on the growth prospects. Fourthly, issue of convertible preference shares into debt and equity further burdened the company with debt as the company had to pay regular interest on it. (Andrew, 2009) This made it difficult for ABC Learning to cope with the requirements of debt which further put them deep into the financial irregularities. Fifthly, the company had also altered their financial statement which also resulted in their downfall. (Friedland, 2004) The company to improve their financial performance had removed the impact created by assets and liabilities on the cash flow statement so that it was able to generate cash flow which hurt back as when it was disclosed it affected the accounting disclosure principle which raise suspicion on the accountability of ABC Learning. Sixthly, the company had also shown more gross profit than actually incurred by adding the receivable it received from disposing the properties and investment which resulted in the figures to inflate which also had an effect in the long run as the actual profits were low thereby affecting key ratios. (Bentley, 2009) Seventhly, the company financial condition was such poor that it was not able to meet its immediate obligations due to the debt component which can be seen from the current and quick ratios presented later. (Bentley, 2009) The rapid decrease in net profit resulted in ABC loosing its value. The rise in maintenance expense and decrease in net profit margins made the expenses to rise over the income making it difficult to pay the debt. This can be seen from the decrease in net profit ratio. Net Profit Margin “is defined as the profit generated per dollar of sales and is calculated after all the direct and indirect expense has been considered”. (Graff, 2006) Organisations prefer this to be high. It is calculated as “Earning before Interest and taxes (EBIT) / Sales X 100”. (Nicolas, 2003) The chart for ABC Learning looks as follows This highlights the fact that the continuous decrease in profits since 2007 contributed towards the fall of ABC Learning. This was due to the continuous rise in maintenance cost which made it difficult for ABC Learning to pay its debt and sustain the normal business cycles. This fact can also be substantiated from the fact that the company was heavily burdened with debt. The current ratio of the company was poor signalling there inefficiency to meet the current obligation. Current Ratio “measures the ability to pay the short term liabilities out of short term assets”. (Fengnian, Farmer, Lin & Avouris, 2010) This ratio helps creditors, suppliers and investor to identify the liquid position. It is calculated as “Current Assets / Current Liabilities”. The current ratio for ABC Learning looks as follows The ratio indicates the inefficiency of ABC Learning to pay its short term obligation. Having such a poor ratio highlights the fact that the company was overburdened with debt and was on the verge of collapse which happened finally. Such a poor ratio shows that the investment of the investors was unsafe and there was every likelihood of a default on the part of the company. (Sugaya, Jang, Hahn, Ogura, Komori, Shinoda & Yonei, 2005)This supports the fact that ABC Learning was not performing well and was one of the prime reasons for their downfall The quick ratio for ABC Learning confirms similar findings and shows that the company was overburdened with debt. Quick Ratio is also known as acid test ratio. “It measures the ability of the firm to meet its short term obligation when inventories are removed as inventories take some time to be converted into cash”. (Mear & Firth, 2009) It is calculated as “(Current Assets – Inventories) / Current Liabilities”. The ratio looks as follows This ratio shows that when stock was removed then the situation was even grimmer. It highlights the fact that the company was not able to pay its creditors. Also the fact that the company had huge inventories resulted in the ratio to be low. Business of similar models are bound to have inventories due to books, and other accessories would make the quick ratio low but such a low ratio indicates that the creditors funds were at risk and this was mainly backed by interest paid on debts and huge debts which resulted in such a poor show. This also signifies poor management and presents a reason for the company downfall of ABC Learning. This can also be substantiated from the return on equity for the shareholders which show a continuous fall. Return on Equity “is defined as the profit earned as compared to the equity shareholders i.e. earning per dollar of equity”. (Tezel, Ginette, 2003) It is calculated as “Net Profit available to ordinary shareholders / Average Equity (excluding minority interest and preference capital) X 100”. The return on equity for ABC Learning looks as follows It shows that the increase in cost has decreased the return for the equity shareholders. This continuous decrease itself shows that there were concerns as the company was not able to pay its shareholders from the profit. (Elliot, 2009) This ratio justifies the reason for the failure of ABC Learning as the findings shows that it can affect the morale of the investors thereby affecting the share price in the market. This had affected the prospects of the company to raise money through equity for development which forced the management to look towards redeemable convertible preference shares which further affected the debt paying capacity and decreased the return to the shareholders. The gearing ratio for ABC Learning also shows the fact that the company was heavily burdened with debt which resulted it in loosing the market and failing. Debt to Equity Ratio “determines the proportion of long term debt in relation to the shareholders fund and long term debt”. (Kam & Vishwanath, 1999) This ratio helps to identify the financial soundness. It is calculated as “Long Term Debts / Equity X 100 The ratio for ABC Learning looks as follows This highlights the fact that the company was burdened with debt. Having such a high ratio signifies the fact that the management was in effective and the measures to grow and policies were ineffective. (McGrattan & Prescott, 2003) The ratio shows that the company was in debt and needed immediate measures to bring down but since the company had borrowed a lot and had creditors their image was also suffering. This resulted in the company to fail and having such a high leverage ratio is a consideration as it can hamper the ability of the firm to borrow which led to the downfall of ABC Learning. The debt coverage ratio for ABC Learning also shows that the company was heavily burdened with debt and to ensure steady income to meet the interest related to the debt was a cumbersome job. Debt Coverage Ratio is defined as “the ability to pay the monthly debt on the loan taken on the mortgage of property”. (Banker, 2006) It is widely used by banks. It is calculated as “Non Current Liabilities / Net Cash Flow from Operating Activities”. The ratio for ABC Learning looks as follows The ratio shows that the company was slowly loosing its ability to pay the current liabilities. The cash from operating activity except in one year was never adequate to pay the debt ever. This was a serious concern from the beginning but the inability of the company to deal with it created a situation where it was impossible for ABC Learning to get out. The company was on a debt burden and was unable to generate funds from the normal business cycle to pay off those. This resulted in the company to fall and as a result the company was not able to withstand the pressure arising from debt and failed. This thus highlights the inability of the company to generate funds to meet its debt resulted in their downfall. Another measure which highlights the reason for the downfall of ABC Learning is the interest coverage ratio. Interest Coverage ratio “measures how well a companies is able to meet its interest cost from in comparison to the finance expenses”. (Dothan, 2006) It is calculated as “EBIT / Net Finance Expenses”. The ratio for ABC Learning is as follows The above ratio highlights the inability of ABC Learning to pay interest on the debt burden. This creates suspicion and doubts as to why banks and other lending institutes were lending money to ABC Learning because the findings shows that for the past few years the company has been unsound. The ratio shows the inability to pay the interest which makes the original sum to be paid in a doubt. This ratios shows that since the company was unable to pay the interest on the burden since a long time it was bound to fail and it was finally seen by the downfall and the interest leverage ratio shows the same. A look at the adjusted shareholders fund also shows demarcating facts which also show that the company was on the brink of downfall. The findings from the adjusted shareholders funds reveal the following information This highlights the fact the value of the shareholders has eroded. This was due to the fact that the company was overburdened with debt which resulted in the shareholder loosing its value. This is seen from the above data that the value of shareholders was falling continuously and this had resulted in the companies’ downfall. The financial result of the company falls in line with this finding which also shows that the company was not able to meet its obligation which resulted it to get engulfed in the debt spiral which finally let towards the downfall of the company. The financial ratio thus highlights the risk financial statement presented for ABC Learning and justifies the reason for their failure. It also shows that the inability of the company to pay its debt was the prime reason for the downfall. This thus throws light on the importance of good management backed by the proper disclosure in the financial statements so that the investors and other agencies are able to gauge the actual performance based on the true values provided in the financial statement. 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