FIN 470 Extra Credit AssignmentOptional Extra Credit Assignmen.docx
Finance 370 Case Study
1. Serina Robnett
Finance 370
Case Study of D’Leon
*Calculations *Industry average
a. Ratios are useful for evaluating financial statements and making comparisons. In finance,
the five major ratios are liquidity ratios, asset management ratios, debt management
ratios, profitability ratios, and market value ratios.
b. Current ratio: $2,680,112/1,144,800= 2.3x, 2.7x
Quick ratio: ($2,680,112-1,716,480)/1,144,800= .8x, 1.0x
The 2015 current ratio and quick ratio of D’Leon are, respectively, 2.3 and .8. When
looking at the projected current ratio for 2015, it is .4 above the industry average of 2.7x,
and D’Leon’s quick ratio is .2 below the industry average of 1.0x. This sheds light on
D’Leon’s future liquidity position; being that D’Leon’s projected 2015 current ratio is
above the industry average and its quick ratio is below the industry average, indicates a
strong and safe liquidity position for the company overall. In retrospect, the company’s
liquidity position has not always been secure. Starting in 2013, D’Leon’s current ratio
was 2.3x, making it .4 below the industry average of 2.7x, and its quick ratio was .8x, the
same as projected for 2015. Although the quick ratio suggests the firm was meeting its
short-term liabilities in 2013, it was possibly struggling to keep up with the payments on
its current liabilities. In 2014, D’Leon’s current ratio was 1.2x, 1.5 below the industry
average; this proves that D’Leon was suffering significantly to pay back its debts that
were maturing within the year. In 2014, the company’s quick ratio was .4x, .4 below the
industry average. This data represents a very weak liquidity position regarding its current
ratio and a relatively strong position regarding its quick ratio in 2014. Due to the 2015
current and quick ratio projections, it is safe to say that the financial position of D’Leon
is moving towards safer and more secure state.
Managers, bankers, and stockholders would all have an equal interest in the company’s
liquidity ratios being that the liquidity ratios are a strong indicator of the firm’s ability to
pay off its maturing debts within the fiscal year. If a firm’s liquidity ratios are not where
they should be in regards to the industry average, it may suggest to a manager that
different business strategies need to be implemented to improve the company’s financial
position; it may suggest to a banker that the company will be struggling to pay back its
debts; and it may suggest to a stockholder that the value of the stock for that company
may begin to decline. For these examples, it would be in the best interest of managers,
bankers, and stockholders to have an equally significant concern for the company’s
liquidity position indicated by the liquidity ratios.
c. Turnover: $7,035,600/1,716,480= 4.1x, 6.1x
DSO: $878,000/(7,035,600/365)= 45.5, 32.0
Total assets turnover: 7,035,600/$3,497,152= 2.0x, 2.6x
The 2015 inventory turnover for D’Leon is 4.1x and its days sales outstanding (DSO) is
45.5. The company’s turnover rate is 2.0 below the industry average. In comparison to
other companies in the industry, D’Leon is holding too much inventory and is not selling
it at a rate that is rapid enough to keep up with the industry’s average. Also, this suggests
a low or zero rate of return on investment—not a great sign for the stockholders of
D’Leon. Moreover, the DSO for D’Leon suggests that the company waits an average of
13.5 days longer than other companies within the industry to receive cash after making a
sale. Overall, its total assets turnover is .6 below the industry average, hinting to the fact
2. Serina Robnett
Finance 370
Case Study of D’Leon
that D’Leon has outdated inventory that needs to be eliminated. This suggests a large
volume of unproductivity and inefficiency within the company.
d. Debt-to-capital: ($1,114,800+400,000)/3,497,152= 44.17%, 40.00%
TIE: $492,648/70,008= 7.04x, 6.2x
D’Leon’s debt ratio indicates that it is 4.17% above the industry average, suggesting that
the creditors have supplied nearly half of D’Leon’s total funds. Due to D’Leon’s high
debt ratio, it may make creditors reluctant to lend funds to the company without requiring
D’Leon to increase its equity beforehand. The firm’s TIE is 7.04x, indicating that the
firm is covering its interest charges at a rate above the industry average and has a high
margin of safety. This firm has financial leverage is overall weak. Its TIE is positively
reflected in the financial data, but having the debt ratio resting above the industry average
is concerning.
e. Operating margin: $492,648/$7,035,600= 7.00%, 7.3%
Profit margin: $253,584/$7,035,600= 3.60%, 3.5%
Basic earning power (BEP): $492,648/$3,497,152= 14.09%, 19.01%
Return on assets (ROA): $253,584/$3,497,152= 7.25%, 9.1%
Return on Equity (ROE): $253,584/$1,952,35213.0%, 18.2%
The firm’s operating margin is below the industry average which means its operating
costs are low. Due to D’Leon’s low operating margin, its profit margin is above the
industry average. The BEP of the firm is below the industry average, suggesting that the
firm lacks ability to generate operating income off its assets when compared to other
firms in the industry. Both the ROA and ROE of D’Leon are much lower than the
industry average, suggesting weak financial returns for the company and its investors.
f. Price/earnings ratio: $12.17/($253564/250,000)= 12.0x, 14.2x
Market/book ratio: $12.17/(1,952,352/250,000)= 1.56x, 2.4x
Based on the price/earnings ratio and data of the firm, investors are willing to pay
D’Leon 2.2x less per dollar of reported profits in comparison to the industry average. The
firm’s market/book ratio is .84 below the industry average, suggesting that D’Leon is not
held in high regards by investors when compared to other companies within the same
industry. This indicates that D’Leon is likely viewed by investors as having a higher risk
with low growth, thus, they are willing to pay less for a dollar of D’Leon’s book value.
g. DuPont equation: 3.60% x 2.01% x 1/(1– .4417) 13%
Major strengths of D’Leon include the firm’s current and quick ratios, however, this is
partially due to excess cash, receivables, and inventory relative to its sales, which
suggests that the firm’s assets are not being managed properly, a major weakness of the
firm. This is also revealed in the firm’s low inventory and total asset turnover and high
DSO. The low inventory and total asset turnovers show that D’Leon is holding too much
inventory, or inventory that is obsolete and no longer worth its stated value, creating
inefficiencies and unproductivity. Also, the 45.5 DSO proves that D’Leon is not
receiving cash quickly enough after making sales. These are all factors of
mismanagement of D’Leon’s assets that are likely contributing to the high current and
quick ratios. Another strength of this company resides in its above-industry average profit
margin. This proves that D’Leon is generating a high return on its sales. Key weaknesses
of the company are first shown in its debt ratio. D’Leon is borrowing a significant
amount of money from creditors, which in turn will make lenders weary of the company
3. Serina Robnett
Finance 370
Case Study of D’Leon
in the future in regards to borrowing purposes. Furthermore, the company has very low
BEP, ROA, and ROE. The low BEP and ROA point to the fact the company does not
generate a significant amount of income off its assets, and the low ROE suggests that the
company does not have a high rate of return for its stockholders, making D’Leon
undesirable for potential investors. Overall, D’Leon’s financial condition is showing
improvement for 2015, but the entirety of the company does not prove much financial
leverage compared to other companies in its industry.
h. New DSO: 32 days, 32.0 days
Sales per day: $7,035,600/365= $19,275.62
New accounts receivable: $19,275.62 x 32= $616,820
Freed cash: $878,000-$616,820= $216,180
If D’Leon implemented new business strategies that would better manage the DSO and
reduce it to the industry average of 32.0 days as well as reduce the accounts receivable of
the firm, it’s benefits would be seen through an increase in freed cash. The $216,180 in
freed cash could be used to reinvest in the company, reduce its debt, repurchase
additional stock, or even expand the business.
i. Currently, the turnover ratios of the company are relatively low. A higher turnover ratio
for a firm reduces inefficiencies, increases productivity, and increases profitability. If
D’Leon were to implement procedures to increase the turnover rate, this would result in a
deflation of the current and quick asset ratios. Also, this would improve the total asset
ratio for the company. If the company can effectively reduce the turnover ratio, it can
reduce its debt ratio as well. Furthermore, reducing the turnover rate of D’Leon will help
the company generate a positive rate of return. It is important the D’Leon devises a
strategy to up its turnover rates, for it will have several, positive succeeding effects on the
company’s prosperity.
j. Under the company’s current financial status, as a creditor, I would not continue to issue
loans to D’Leon—their turnover rate is too low, their debt ratio is too high, and the
company does not generate enough income on its BEP and ROA. If the loan is renewed
under these current conditions, there is a lingering risk that D’Leon could default on its
loan. If the repayment was demanded under these current conditions, it could nudge the
firm straight into bankruptcy. In this scenario, renewal of the loan would be a safer option
given proof that the financial condition of the firm is stabilizing. However, if D’Leon
could prove that it is raising its turnover rate, reducing its debt ratio, and increasing its
BEP and ROA, I, as a creditor, would renew its loan.
k. In hindsight, D’Leon should have reevaluated its management functions and conducted
an extensive ratio analysis to ensure the financial stability of the firm before going under
expansion. Due to the financial instability of the firm before the expansion, it ultimately
hurt the company drastically in in the subsequent year.
l. Potential problems and limitations of financial ratio analysis include:
1. It is difficult to develop an industry average since some firms have divisions that
operate in more than one industry. Thus, ratio analysis is more useful for firms
that have a narrow focus.
2. The industry average is merely an average, therefore basing the ratio analysis off
the industry average creates limitations to the potential of the firm. Instead, the
ratio analysis of firm should be compared to that of leading firms in the industry.
4. Serina Robnett
Finance 370
Case Study of D’Leon
3. Inflation can distort the firms book values, market values, asset values, profits,
and much more. Therefore, when analyzing the ratio analysis of a firm, the year in
which the analysis takes place must be considered.
4. Seasonal factors can distort ratios.
5. “Window dressing” techniques can make firm’s financial statements appear to be
better than actuality. Thus, distorting the financial ratio analysis.
6. Generalizations of a firm can be made from focusing on particular ratios when, in
reality, all ratios must be considered before passing judgement on particular ratios
or the financial condition of the firm overall.
7. Different accounting practices can distort comparisons.
8. Within the ratio analysis of a firm, at first glance, some firms have weak ratios
and strong ratios. Thus, it can be hard to tell whether the firm is in balance,
strong, or weak.
m. Qualitative factors that analysists should consider when evaluating a company’s likely
future financial performance include:
1. Diversification of the firm or, in other terms, how many products the firm makes
2. How many suppliers the firm has
3. The percentage of the company’s business that is generated overseas
4. The necessary amount of research and development required for the future of the
firm’s products and/or services
5. Amount of competition the firm faces
6. Changes in laws and regulations that could impact the firm