Question

Burchetts Green had enjoyed the bank training course, but it was good to be starting his first real job in the corporate lending group. Earlier that morning the boss had handed him a set of financial statements for The Hobby Horse Company Inc. (HH). “Hobby Horse,” she said, “has a $45 million loan from us due at the end of September, and it is likely to ask us to roll it over. The company seems to have run into some rough weather recently, and I have asked Furze Platt to go down there this afternoon and see what is happening. It might do you good to go along with her. Before you go, take a look at these financial statements and see what you think the problems are. Here’s a chance for you to use some of that stuff they taught you in the training course.”

Mr. Green was familiar with the HH story. Founded in 1990, it had rapidly built up a chain of discount stores selling materials for crafts and hobbies. However, last year a number of new store openings coinciding with a poor Christmas season had pushed the company into loss. Management had halted all new construction and put 15 of its existing stores up for sale.

Mr. Green decided to start with the 6-year summary of HH’s balance sheet and income statement (Table 4.10). Then he turned to examine in more detail the latest position (Tables 4.11 and 4.12).

What appear to be the problem areas in HH? Do the financial ratios suggest questions that Ms. Platt and Mr. Green need to address?

TABLE 4.10 Financial highlights for The Hobby Horse Company Inc., year ending March 31

TABLE 4.11 Income statement for The Hobby Horse Company Inc., year ending March 31, 2016 (figures in $ millions)

TABLE 4.12 Consolidated balance sheet for The Hobby Horse Company Inc. (figures in $ millions)

Note: Column sums subject to rounding error.

Answer 1

Introduction:

Ratio analysis is an important tool to measure the performance of the firm. It helps in the inter-firm and intra firm comparison. The comparison analysis prepared with the help of ratios enables the firm to take corrective action. Hence, ratio analysis is an important tool for the management.

Analysis of statement:

The analysis of different ratios can be made with the help of excel as follows:

Following are the formulas entered in excel to compute different ratios:

Following are the results of above entered formula in excel:

Following conclusions and problem areas can be withdrawn from the above computations:

• The current ratio is declining. It shows that the current assets are not sufficient to meet the current liabilities. The current ratio should be improved with the increase in current assets. The current assets can be increased with the help of better credit collection policies.

• The debt equity ratio is declining. It shows that the debt has been lowered in the capital structure. The decline in debt will reduce the tax shield on net profit. The tax liability will increase.

• The fixed asset turnover is declining. It shows that the fixed assets are not sufficient to generate sales. The fixed assets should be improved by purchasing efficient assets.

• Return on equity is declining and it has reached to negative level in the year 2016. It shows that the company is not able to utilise the funds properly and it has incurred losses. The management should focus on the measures of reducing cost, increasing sales and profit.

Notes:

Current ratio:

Current ratio is the ratio of current assets and current liabilities. The current ratio is calculated by dividing current assets with current liabilities:

Fixed Asset turnover:

The fixed asset turnover ratio is the ratio of sales to fixed assets. This ratio is calculated to determine the efficiency of fixed assets to generate sales.

Return on equity:

Return on equity is the profitability ratio measured in terms of relationship between net profits and investments made by stockholders. The return on assets is calculated by dividing earnings after taxes with equity.

Debt equity ratio: Debt equity ratio is the relationship between borrowed fund and owners’ capital. It is calculated by long term debt with equity.