Test 2

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Question 1: Prepare the cashflow.(Table of cashflow)

A positive increase in cash is shown from the operating activities and most of the cash
comes from the income statement activities. The interest expense was also moved to finance
section and the addition of the depreciation as non-cash charge helped to boost the cash flow.
The inventory has increased, thus decreasing the operating cash flow and this shows that
Anandam has adopted a more conservative working capital strategy for increasing the level of
the inventory on the balance sheet. The cash flow from investing activities shows that in the
last few years less cash has been invested for buying new PPE and this has a positive impact
on cash. However, this had increased in 2014.
Finally, the net cash flow from financing activities shows a positive trend, especially in
the last one year. The equity issue and the debt issue for the company has increased and this is
from where the financing has been generated by the company. The share issue has increased
the cash balance by $ 400 in each of the two years The case does not provide any evidence of
dividends. If we sum up all the above analysis, then we can conclude that the cash position of
the company is quite strong at present and it has enough cash to cover its obligations.
Question 2: Common size statement of the company
Common-size statement is an output of common-size analysis. It is a tool to evaluate
individual financial statement items or group of items of a specific base amount which is the
Revenue or Total sale for Income statement or the Total assets for the statement of financial
position.
In this case of Anandam manufacturing company, the common-size analysis shows that
majority of the sales, around 90% are derived through credit sales for the company. The cost
of sales as a percentage of sales declined for the company however, all the operating expenses
such as interest expense, selling, general and admin expense have all increased for the firm.
The operating and net profit percentage of the total sales is also following a negative trend
which is quite alarming for the management of the company. This is not a positive sign about
the profitability of the company.
The vertical balance sheet shows that cash as a percentage of the total assets has
decreased and similar is the situation with accounts receivables. However, the latter is a
positive trend for the company. The inventories are also decreasing as a percentage of total
assets and this suggests that the conservative working capital policy is working in the favor of
the company. On the other hand, the long term debt has increased as a percentage of total
assets for the company and the current liabilities have slightly decreased. The common-size
statements are shown below:

ANANDAM MANUFACTURING COMPANY


COMMON INCOME STATEMENT, APRIL1 TO MARCH 31
₹ (Indian Rupee)

2012-2013 2013-2014 2014-2015


Sales 10% 10% 10%

Cash Credit 90% 90% 90%

Total Sales 100% 100% 100%

Cost of goods sold 62% 26% 16%

Gross profit 38% 41% 40%

Operating expense: General, 4% 9.4% 12.5%


administration and selling expenses

Depreciation 5% 8.3% 8.3%

Interest expense (on borrowings) 3% 3.3% 4.3%

Profit before tax (PBT) 26% 20% 15%

Tax 7.8% 6% 4.5%

Profit after tax (PAT) 18.2% 14% 10.5%

For the first year of activity the company registered a profit of ₹364 000 with a gross
profit of ₹760000. The following year, the profit after tax has almost been multiplied by 2.
And in 2014-2015, we noticed a slow down in the growth because it is an increase of 25%
compared to the past year.
But it is still a lot higher than the growth in the sector these past 3 years which was
around 14% growth per year. So the profit of Anandam is growing at a higher rate than the
market. Furthermore, we notice that the gross profit in 2014-2015 increased from 38,5%
while the profit after sale registered only 20% of growth. So, we need to be careful about the
increase of the fixed costs. Indeed, this difference shows that the fixed expenses are growing
faster than the sales.

ANANDAM MANUFACTURING COMPANY


COMMON SIZE BALANCE SHEET
₹ (Indian Rupee)
2012-2013 2013-2014 2014-2015

Assets

Fixed asset (net of depreciation) 74.2% 44.6% 51.3%

Current assets

Cash and cash equivalents 1.6% 1.8% 1.2%

Accounts receivable 11.7% 26.8% 22.9%

Inventories 12.5% 26.8% 24.6%

Total asset 100% 100% 100%

Equity & Liabilities

Equity share capital 46.9% 28.6% 21.8%

Reserve & Surplus 14.2% 18.5% 20.5%

Long term borrowings 28.7% 22.1% 27.3%

Current liabilities 10.2% 30.8% 30.4%

Total Equity & Liabilities 100% 100% 100%

The value of the company has increased over these past 3 years. It has almost been
multiplied by 4. When we look further, at the long term equilibrium for example, the firm has
a ₹400,000 margin to cover current activities. (1200+364+736-1900). The second year, this
long term equilibrium increased to ₹1,372,000 which is a very large margin to cover the short
term activities. We see that this margin is much more appreciated because the difference
between account receivable, inventories and current liabilities in 2013-14 (3000-1728) is
₹1,272,000. The short term activities needs are covered by the long term margin. It means
that the company is in good health in 2013-14. In 2014-2015, the long term equilibrium is
₹1,676,000 and the short term needs are ₹1,570,000. Again, the long term ressources can
cover the short term needs.
We can conclude that the company can answer to the short term needs thanks to its
resources so it is a solid company. The reserve and surplus are growing year after year and
the cash available stays stable around ₹100,000. It is not too high, so it shows that the value
added by the company to the production is reinvested to make more profits. The firm also
used each year the increase in share capital to finance itself. The investors have confidence in
Anandam and invest more in the project.
Question 3:
In this case of the Anandam manufacturing company, the horizontal financial
statements in the long-term, which 2012-2013 is the base year gives a quite bright side of the
Anandam statement . The horizontal financial statements are shown in the tables below:

ANANDAM MANUFACTURING COMPANY


INCOME STATEMENT TREND ANALYSIS FOR APRIL 1 TO MARCH 31
₹ (Indian Rupee)

Particulars: 2012-2013 (Base year) 2013-2014 2014-2015

Amount
Amount Amount
% ('000) % %
('000) ('000)

Cash sales 200 100% 480 140% 800 300%

Credit sales 1800 100% 4320 140% 7200 300%

Total Sales 2000 100% 4800 140% 8000 300%

Cost of sales 1240 100% 2832 128% 4800 287%

Gross profit 760 100% 1968 159% 3200 321%

Operating costs

S, G & A expenses 80 100% 450 463% 1000 1150%

Depreciation 100 100% 400 300% 660 560%

Operating Profit 580 100% 1118 93% 1540 166%

Interest Expenses 60 100% 158 163% 340 467%

EBT 520 100% 960 85% 1200 131%


Income Tax 156 100% 288 85% 360 131%

Net Profit 364 100% 672 85% 840 131%

Anandam’s income statement trend analysis indicates a reduced 2013-14 net earnings
(85%) compared to the base year and 2014-15 (100% and 131%), respectively. This trend is
attributed to increased operating expenses such as energy and transportation costs. As per the
above table, it is evident that administration, selling and general expenses rose to 463% in
2013-2014. These costs cover energy and transportation expenses. However, the 131%
increase in profits in 2014-2015 means that the management could control their resources
effectively. Increased revenues (to 300%) in the 2014-2015 year was attributed by increased
demand is also another factor that could have triggered a 131% increment in the company net
earnings in 2015.

ANANDAM MANUFACTURING COMPANY


BALANCE SHEET TREND ANALYSIS FOR APRIL 1 TO MARCH 31
₹ (Indian Rupee)

Particulars: 2012-2013 (Base year) 2013-2014 2014-2015

Amount Amount Amount


% % %
('000) ('000) ('000)

Net Book Value of


Fixed Assets 1900 100% 2500 32% 4700 147%

Current Assets

Cash & cash


equivalents 40 100 150% 106 165%

Trade receivables 300 100% 1500 400% 2100 600%

Inventories 320 100% 1500 369% 2250 603%

Total Assets 2560 100% 5600 119% 9156 258%

Equity & Liabilities

Equity Share Capital


(shares of $10 each) 1200 100% 1600 33% 2000 67%

Reserves & Surplus 364 100% 1036 185% 1876 415%

Total Equity 1564 100% 2636 69% 3876 148%


Long term borrowings 736 100% 1236 68% 2500 240%

Current liabilities 260 100% 1728 565% 2780 969%

Total Liabilities 996 100% 2964 198% 5280 430%

Total Equity&
Liabilities 2560 100% 5600 119% 9156 258%

Anandam’s net fixed assets showed a decreasing trend in 2013-2014 (32%) compared
to the base year 2012-2013 (100%) but then it increased to 147% in 2014-2015. A similar
trend was also witnessed in total equity, albeit the decrement in 2013-2014 went down to
69%. The total assets indicated an escalating trend from 2013-2015 (from 100% to 119% to
258%). Similarly, and to the most remarkable increased movement are Anandam’s total
liabilities. They drastically escalated from 198% to 430% in 2014 and 2015 from the base
year of 100% in 2012. The same trend was also witnessed in the company’s total equity
combined with total liabilities by the same measures. The highly increasing trend in
Anandam’s liabilities is attributed to the management’s taking of Mortgage loans in funding
the business from the tune of ₹1,236,000 to ₹2,500,000 between 2014 and 2015 for
expansion purposes of the manufacturing activities.
However, on the other hand, if the determination of the base year is changed to the year
immediately preceding it for consideration in a short operating cycle, the result may be
opposite. It's growth of Anandam is there but the rate is less than the previous year.
The statements above have also been generated and the income statement shows that the
sales growth has declined from 140% to 66.67% which is quite alarming for the management
of the company. The operating profit and the net profit for the company have both declined
from 84.62% to 25%. This shows that the profitability of the company is declining
significantly and the decline in the sales is a major factor contributing to this.
The declining profitability is also due to the decrease in the gross profit of the company.
The cash balance for the company is showing a negative growth and it has reduced from
150% to 6% in 2014. The long term debt on the other hand, had increased from 67.93% to
102.27% and this is a serious risk for the company because taking large debt might reduce the
credit rating of the firm and the decision for the loan approval might be rejected. Finally, the
total assets have declined from 118.75% to 63.50%.

QUESTION 4: What are the various ratios computed to analyze financial statements?
Ratio analysis focuses on one or more elements of a company’s financial condition or
performance. Ratios are among the widely used tools of financial analysis because they
provide clues for underlying conditions
The ratios are organized into the four types of financial statement analysis:
profitability, liquidity and efficiency; solvency; market prospects.
The profitability ratios measure a company’s ability to provide financial rewards
sufficient to attract and retain financing. The liquidity ratios measure the company’s ability to
meet its short-term obligations. And the solvency ratios measure the company’s ability to
meet its long-term obligations. And market prospects mean the ability to generate positive
market expectations. Overall, all the ratios under such categories represent a company’s
overall performance level as well as its risk level

CATEGORY TYPE OF RATIO INTERPRETATION


Profitability It describes a company’s
ability to earn gross

gross profit profit from each sale


gross profit margin=
net sales A firm should neither
have a high ratio nor a
low ratio.
net income It measures the net
net profit margin=
sales
profit of a firm with
respect to sale.
A firm should neither
have a high ratio nor a
low ratio
net income It measures how well
Return on asset ( ROA )=
total assets
assets have been
employed in the
company’s management

net income It indicates how well the


Return on equity (ROE)=
total equity
company employed the
shareholders’ equity to
earn net profit
Liquidity and Net Working Capital It represents current
efficiency = Current Assets−Current Liabilities assets financed from
long-term capital
sources that do not
require short-term
repayment
NWC > 0 => company
have enough assets
converted into cash
within the next year to
pay its current
obligations
Higher NWC =>
Stronger liquidity
position
Current assets It measures the short-
Current ratio=
Current liabilities
term debt paying ability
of the company.
Lower current ratio =>
Less likely to be paid in
full
If current ratio > 1,
company is deemed to
be liquid more than
enough current assets to
cover the current
liabilities
Quick assets
Acid−test ratio=
Current liabilities
Quick assets=Current asset−Inv −Prepaid expense
Net sales It measures how many
ARturnover =
Average accountsreceivable
times a company
Beginning AR+ Ending AR
Average AR=
2 collects its receivables
each year.
Higher accounts
receivable turnover =>
Faster the cash
collection on accounts
receivable
Cost of goods sold It measures the number
Inventory turnover =
Average inventory
of times inventory (inv)
Beginninginv + Ending inv
Average inv=
2 is sold and replaced
during the year.
Higher inventory
turnover => Protects a
company obsolete
inventory item
Cost of good sold It measures used to
Account Payable turnover=
Average AP
quantify the rate at
Beginning AP+ EndingAP
Average AP=
2 which a company pays
off its suppliers
365 Days in receivables
Days∈receivables=
AR turnover
provides insight into
how frequently a
company collects its
account receivable
It represents the number
of days it will take the
company to collect on
accounts receivables
365 Days in inventory is
Days∈inventory=
Inventory turnover
useful measure in
evaluating inventory
liquidity
It estimates how long it
takes to sell the
inventory –the greater
the customers’demand
for the product, the
quicker it will be sold
365 Days in payables is
Days∈ payables=
Inventory
useful measure
evaluating how long the
business takes to pay its
credit suppliers
Net sales It reflects a company’s
Total asset turnover=
Total asset
ability to use its assets
to generate sales
Higher TAT => More
efficient utilisation of
assets
Solvency Total liabilies It measures what portion
Debt ratio=
Total asset
of a company’s assets
are contributed by
creditors
A larger debt ratio
implies less opportunity
to expand through use
of debt financing
Total equity It provides
Equity ratio=
Total asset
complementary
information by
expressing total equity
as percent of total asset
Total assets It measures what portion
EM ratio=
Total equity
of a company’s assets
are contributed by
creditors
Designed to measure the
use of debt financing
A larger EM ratio
implies less opportunity
to expand through use
of debt financing
PBIT It measures of the
¿ interest earned =
Interest expense
ability of a company’s
operations to provide
protection to long-term
creditors
It measures how

Net Income optimistic an investor is


Earning per share (EPS)=
on the future growth
No . common share outstanding
prospects of a company
Market price per ordinary share
Price−earningsratio= Higher price-earning
EPS
ratio => more
Market opportunity a company
prospects has for growth
Annual cash dividends per share It identifies the return,
Dividend yield=
Market price per share
in terms of cash
dividends, on the
current market price per
share of the company’s
ordinary shares

QUESTION 5: Compute the ratios based on case Exhibit 3?

Ratio Sector Anandam Financial Years


Average 2012-2013 2013-2014 2014-2015

Current ratio 2.3:1 2.538:1 1.793:1 1.603:1

Acid test ratio (quick ratio) 1.2:1 1.308:1 0.926:1 0.794:1

Receivable turnover ratio 7 times 6 times 2.88 times 3.43 times

Receivable days 52 days 61 days 127 days 106 days

Inventory turnover ratio 4.85 times 3.875 times 1.888 times 2.13 times

Inventory days 75 days 94 days 193 days 171 days

Long-term debt to total debt 0.24 0.74 0.417 0.473

Debt-to-equity ratio 0.35 0.637 1.12 1.36

Gross profit margin 0.4 0.38 0.41 0.4

Net profit margin 0.18 0.182 0.14 0.105

Return on equity 0.22 0.233 0.255 0.217

Return on total assets 0.1 0.142 0.12 0.092

Total assets turnover ratio 1.1 0.781 0.857 0.874

Fixed asset turnover ratio 2 1.053 1.92 1.702

Current asset turnover ratio 3 3.03 1.548 1.795

Interest coverage ratio 10 times 9.67 times 7.08 times 4.53 times

Working capital turnover ratio 8 times 5 times 3.5 times 4.77 times
Return on fixed assets 0.24 0.192 0.2688 0.179

Based on the calculated ratios for Anandam’s Manufacturing Company, this subsection
evaluates ratios categorized into liquidity solvency, operating performance, and asset-use
approaches. These metrics help assess the company’s financial capacity compared to the
industry averages.

Anandam’s liquidity ratio is lower than that of the industry average in 2014 and 2015,
respectively. The company’s current ratio of 1.793:1 and 1.603:1 metrics in 2014 and 2015
are lower than the 2.3:1 industry average. It is only in 2013 that the ratio (2.538) was higher
than the industry average. A similar trend was witnessed in its quick ratio. The percentage
decreased to below the 1.20:1 industry average (0.926:1-0.794:1) in 2014 and 2015).

Regarding Anandam’s solvency and capital structure ratios, it is evident that they show
an increasing trend in the years under analysis. The trend was unfavorable as it shows that the
entity used to finance its business assets with more debt than equity. The company registered
63.7%, 112% and 136% D/E ratios in 2013, 2014 and 2015, respectively. The ratio was far
more than the 35% industry average. The same case happens with long-term debt-to-total
debt; it is higher than the industry average. The interest-coverage metric decreases in the
years under analysis from 9.67, 7.08 and 4.53 times from 2013-2015. This means that the
ability of the company to meet short-term debts is constricting as years go by.

Regarding investment ratios, Anandam’s ROTA and ROE ratio indicate a decreasing
trend from 2013-2015 at a rate below the sector’s averages of 10% and 22%, respectively, for
both ratios. These ratios imply that Anandam’s investment gains have been decreasing over
the years, and the trend have been increasing the company’s risks as debt is rising without a
consequent increase in gains.

Anandam’s gross profit margin indicated an increasing trend of 38%, 41% and 40%
from 2013 to 2015. The increment was fair as it coincided with the industry average at 40%
in 2015. Unluckily, the Net Profit margin showed a downward trend of 18.2%, 14% and
10.5% in the three years of analysis. This was attributed to the increased operational costs of
the company.

Lastly, on efficiency ratios, the company’s total asset turnover is fair as it increased
from 0.78-0.874 between 2013 and 2015, albeit it slightly lagged below the sector average by
0.03. Anandam’s working-turnover ratios were 5, 3.5 and 4.77 in 2013,2014 and 2015,
respectively. The metrics are below the industry average, indicating that the company was not
adequately efficient in utilizing its net assets to generate revenues.

Question 6: Based on these ratios and their comparison with industry ratios, would
you, as a loan officer, grant the loan request?
As a loan officer, I cannot grant the loan. As per given data, the ratio of the company fell
down in financial 2015. Key ratio of the company is also below the industry average ratio, for
example current ratio of the company is 1.60 while the average sector is 2.3. Most
importantly, the debt-to-equity ratio of the entity is extremely high, 1.36 compared to the
average ratio of the sector which is only 0.35. It is too risky to approve a loan for a company
that has too much debt which means they may not pay the debt.

Question 7: What areas of improvement can you suggest for the future?

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