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MGM625-0903A-01 Applied Finance for Decision-Making - Phase 1 Individual Project 2 - Essay Example

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Be sure to focus on working capital, current ratio, short-term and long-term debt. End with a bulleted summary addressing the CFOs concerns as related to these areas.
The balance sheet of Superior Living gives a clear idea of the…
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MGM625-0903A-01 Applied Finance for Decision-Making - Phase 1 Individual Project 2
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Applied Finance for Decision Making Look at Superiors balance sheet and analyze it. Be sure to focus on working capital, current ratio, short-term and long-term debt. End with a bulleted summary addressing the CFOs concerns as related to these areas.
The balance sheet of Superior Living gives a clear idea of the company’s financial state over the three years. This report aims at analyzing the balance sheet with special focus on the working capital, current ratio, short–term and long-term debts, in order to identify potential issues and concerns.
Working Capital:
The working capital of the firm is the difference between the current assets and the current liabilities, in other words, the assets set aside by the company in order to run the day to day operations (Samuels et al, 2000). The working capitals for the three years are computed as follows:
Year/ ($ 000s)
2001
2002
2003
Current Assets
73,700
79,200
83,900
Current Liabilities
34,200
37,100
41,950
Working Capital
39,500
42,100
41,950
The working capital of the firm is sufficiently higher than the current liabilities and it has remained almost steady for the three years, with a slight decrease in 2003. In case Superior Living is planning on entering new projects and investments, it will be essential to increase the current level of working capital.
Liquidity (Current and Quick Ratios):
The current ratio of the company is the ratio of the current assets to the current liabilities. It indicates the liquidity position of the firm and its ability to cover the current liabilities with the liquid assets. The quick ratio is computed as the ratio of the ready cash assets (current assets – inventories – prepaid expenses) to the current liabilities. The liquidity ratios for Superior Living are computed as follows:
Year/ ($ 000s)
2001
2002
2003
Current Assets
73,700
79,200
83,900
Current Liabilities
34,200
37,100
41,950
Current Ratio
2.15
2.13
2.00
Quick Ratio
0.59
0.58
0.55
It is evident that the current ratio is around 2 for the three years, indicating the strong liquidity position of the company. It is interesting to note that the inventories form a large portion of the current assets and they cannot be readily liquefied. The quick ratio is around 0.55 which is much lower than the ideal 1:1, indicating that the short term cash needs in case of solvency will not be met (Burks and Wilks, 2007). Hence the company needs to improve the cash assets.
Short-Term and Long-Term Debts:
The short-term (due within a year) and long-term debts (due in more than one year) of the Superior Living are listed in the table below. The debt to equity or the gearing ratio is computed as the ratio of the long-term debt to the equity (Samuels et al, 2000). The values are tabulated below:
Year/ ($ 000s)
2001
2002
2003
Short-Term Debts
1,200
1,300
1,450
Long-Term Debts
3,000
3,100
3,400
Equity
121,500
127,500
132,550
Debt-Equity Ratio
0.02
0.02
0.03
The gearing ratio of the company is very low (2% - 3%) over the three years. Though the long-term debt has increased by $400,000 over the three years, the debt to equity ratio has not increased. The company is not utilizing its borrowing abilities as an optimum gearing ratio would be around 50%.
Summary:
Based on the analysis conducted on the balance sheets of Superior Living, the following are the important findings and the potential areas of concern.
The working capital has remained stable and sufficient to cover the current operations and hence has to be increased in case of new projects and investments.
Though the current ratio is high, the quick ratio indicates that the ready cash assets are to be improved and the inventories have to be reduced.
The company is not utilizing its borrowing abilities and should focus on a more balanced debt-equity ratio.
Bibliography
Burke, L. and Wilks, C., (2007), Management Accounting – Decision Management, 4th edn, CIMA Publishing
Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., (2000), Management of Company Finance, 6th edn, Thomson Learning, London Read More
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