Question 6.CS.1: Paper products company
Paper products company
| Paper products company | ||||
| 20X0 | 20X1 | 20X2 | 20X3 | |
| Cash | $550,000 | $450,000 | $150,000 | $ 50,000 |
| Receivables | 800,000 | 750,000 | 750,000 | 700,000 |
| Inventory | 900,000 | 850,000 | 850,000 | 800,000 |
| All other | 250,000 | 250,000 | 250,000 | 250,000 |
| Total current | 2,500,000 | 2,300,000 | 2,000,000 | 1,800,000 |
| Fixed | 1,500,000 | 1,450,000 | 1,400,000 | 1,300,000 |
| All other | 500,000 | 500,000 | 400,000 | 300,000 |
| Total assets | $4,500,000 | $4,250,000 | $3,800,000 | $3,400,000 |
| Due banks | $ 400,000 | $ 400,000 | $ 400,000 | $ 400,000 |
| Due trade | 400,000 | 500,000 | 700,000 | 1,050,000 |
| Taxes | 100,000 | -0- | -0- | -0- |
| All other | -0- | -0- | -0- | -0- |
| Total current | 900,000 | 900,000 | 1,100,000 | 1,450,000 |
| Long-term liabilities | 600,000 | 550,000 | 500,000 | 450,000 |
| Total liabilities | 1,500,000 | 1,450,000 | 1,600,000 | 1,900,000 |
| Net worth | 3,000,000 | 2,800,000 | 2,200,000 | 1,500,000 |
| Total | $4,500,000 | $4,250,000 | $3,800,000 | $3,400,000 |
| Net sales | $9,000,000 | $8,500,000 | $8,000,000 | $7,500,000 |
| Net profit | 300,000 | (200,000) | (600,000) | (700,000) |
| Working capital | 1,600,000 | 1,400,000 | 900,000 | 350,000 |
| Paper products company (continued) | |||||
| 20X0 | 20X1 | 20X2 | 20X3 | Industry average | |
| Liquidity measures | |||||
| Current ratio | 2.8× | 2.6× | 1.8× | 1.2× | 2.5× |
| Inventory to working capital | 56% | 61% | 94% | 229% | 68% |
| Receivables to working capital | 50% | 54% | 83% | 200% | 39% |
| Net sales to working capital | 5.6× | 6.1× | 8.9× | 21.4× | 5.9× |
| Leverage and profitability measures | |||||
| Current liabilities to net worth | 30.0 | 32.1% | 50.0% | 96.7% | 29.6% |
| Total liabilities to net worth | 50.0% | 51.8% | 72.7% | 126.7% | 60.3% |
| Net profit to net worth | 10.0% | (7.1%) | (27.3%) | (46.7%) | 8.6% |
| Causal ratios | |||||
| Fixed assets to net worth | 50.0% | 51.8% | 63.6% | 86.7% | 55.9% |
| Net sales to net worth | 3.0× | 3.0× | 3.6× | 5.0× | 2.5× |
| Net profit to net sales | 3.3% | (2.4%) | (7.5%) | (9.3%) | 3.5% |
| Net sales to inventory | 10.0× | 10.0× | 9.4× | 9.4× | 9.2× |
| Collection period | 32 days | 32 days | 34 days | 34 days | 33 days |
| Miscellaneous assets to net worth | 25% | 27% | 29% | 37% | 16% |
Casual ratio summary
- Fixed assets to net worth – With 86.7 percent against an industry average of 55.9 percent, the company appears to have excess investment in fixed assets relative to capital. This ratio is “bad” or at best “doubtful.”
- Net profit to net sales – Loss of 9.3 percent on each dollar of sales, in contrast with the industry average profit of 3.5 percent, certainly reflects an alarming situation and immediately places their performance in the “bad” category.
- Net sales to net worth – With a trading ratio of 5 times per year in contrast to the industry average of 2.5, this measure points to an overtrading situation and should prompt the analyst to mark this ratio, too, as “bad.”
- Miscellaneous assets to net worth – The present investment of 37 percent in this area is more than twice as large as the industry average of 16 percent. Any such major variance requires investigation; thus, a preliminary assessment of this ratio shows it as “bad.”
Four of the six causal ratios are out of normal bounds. The next step should be to reexamine them more closely.
Fixed asset to net worth ratio
- In 20X0 the company was average. Something happened over the next three years to cause a change.
- In 20X0 the company was average. Something happened over the next three years to cause a change.
- The decline in this ratio is caused by the reduction in net worth.
- Fixed asset investment is not this company’s major problem.
The net profit to net sales ratio appears to be a real problem.
- The company has lost money on sales for the last three years.
- The effect of these losses is to distort all of the other ratios.
- Net worth has been cut in half over the period.
- Clearly, corrective steps must be taken immediately: You can develop a discussion of this by using the list of corrective actions that were associated with the net-profit to net-sales ratio in the causal ratio chapter.
The net sales to net worth ratio also appears out of line.
- Sales have actually decreased over this period, but net worth has declined by a greater amount
- Overtrading is not one of this company’s greatest problems.
The miscellaneous assets to net worth ratio is a problem.
- Even in 20X0 it was higher than the industry average.
- However, miscellaneous assets have declined so that the reduction in net worth is still the major culprit.
This company’s basic problems come from (1) a loss on sales and (2) a decline in sales volume. This case shows that it is easy to over interpret ratios. The whole picture must be examined.
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