Question

Balance Sheets                                 2006                 2005      

Assets

Cash                                             $     52,000         $     57,600

Accounts receivable                           402,000              351,200

Inventories                                         836,000              715,200

   Total current assets                    $1,290,000         $1,124,000

Gross fixed assets                              527,000              491,000

Less accumulated depreciation           166,200            146,200

   Net fixed assets                          $   360,800         $   344,800

   Total assets                               $1,650,800         $1,468,800

Liabilities and Equity

Accounts payable                          $   175,200         $   145,600

Notes payable                                    225,000              200,000

Accruals                                             140,000              136,000

   Total current liabilities                 $   540,200         $   481,600

Long-term debt                                  424,612              323,432

Common stock (100,000 shares)         460,000              460,000

Retained earnings                              225,988              203,768

   Total equity                                $   685,988         $   663,768

   Total liabilities and equity            $1,650,800         $1,468,800

Income Statements                            2006                 2005      

Sales                                            $3,850,000         $3,432,000

Cost of goods sold                         (3,250,000)         (2,864,000)

Other expenses                             (   430,300)         (   340,000)

Depreciation                                  (     20,000)          (     18,900)

Total operating costs                     $3,700,300         $3,222,900

EBIT                                             $   149,700         $   209,100

Interest expense                            (     76,000)          (     62,500)

EBT                                              $     73,700         $   146,600

Taxes (40%)                                  (     29,480)          (     58,640)

Net income                                    $    44,220          $    87,960

EPS                                                    $0.442                $0.880

Statement of Cash Flows (2006)                                             

Operating Activities

Net income                                    $   44,220

Other additions (sources o f cash)

   Depreciation                                    20,000

   Increase in accounts payable            29,600

   Increase in accruals                            4,000                          

Subtractions (uses of cash)

   Increases in accounts receivable    ( 50,800)                         

   Increase in inventories                   (120,800)                         

         Net cash flow from operations                            $( 73,780)       

Long-Term Investing Activities

Investment in fixed assets                                           $( 36,000)

Financing Activities

Increase in notes payable               $   25,000

Increase in long-term debt                 101,180

Payment of cash dividends               ( 22,000)

   Net cash flow from financing                                    $104,180

Net reduction in cash account                                      $( 5,600)

Cash at beginning of year                                               57,600

Cash at end of year                                                     $ 52,000

Other Data                                         2006                 2005         

December 31 stock price                        $6.00                  $8.50

Number of shares                              100,000              100,000

Dividends per share                              $ 0.22                  $0.22

Lease payments                                 $40,000              $40,000

Ratio                                                                 Industry Average 2006

Current                                                                         2.7x

Quick                                                                           1.0x

Inventory turnover                                                         6.0x

Days sales outstanding (DSO)                                     32.0 days

Fixed assets turnover                                                  10.7x

Total assets turnover                                                     2.6x

Debt ratio                                                                   50.0%

TIE                                                                              2.5x

Fixed charge coverage                                                  2.1x

Net profit margin                                                           3.5%

ROA                                                                            9.1 %

ROE                                                                          18.2%

Price/earnings                                                            14.2x

Market/book                                                                 1.4x

1.Begin by reviewing briefly what balance sheets and income statements are. Then give an overview of the statement of cash flows. Explain that some data (net income, depreciation, and dividends) come fro m the income statement, while the other items reflect differences between balance sheet accounts and thus show changes in those accounts between the two dates.

2. Compute HHCs current and quick ratios , and then compare them with industry (cross - sectional analysis) and its past (Trend analysis). You must interpret results.

3. Compute all the ratios to evaluate its asset management, and then compare them with industry (cross - sectional analysis) and its past (Trend analysis). You must interpret results.

4. Compute all the ra tios to evaluate its debt management, and then compare them with industry (cross - sectional analysis) and its past (Trend analysis). You must interpret results.

Compute all the ratios to evaluate its profitability, and then compare them with indus try (cross - sectional analysis) and its past (Trend analysis). You must interpret results.

Answer 1

Review of Cash flow statement

Few important aspects of company’s financial condition can be highlighted from the cash flow statement. The net operating cash flow is ( $ 73,780) i.e. the operating cash flow is negative even though the company has net income in its income statement and then due to this negative operating cash flow the company need to borrow funds as long term or short term debts to pay for additions to fixed assets and dividends. Even after the borrowing the cash balance reduced to $ 5,600

Computation of current ratio and quick ratio

Current ratio = Current assets / current liabilities = $ 1,290 / $ 540.2 = 2.40

Quick ratio = (current assets – Inventories) / Current liabilities = (1,290 - $ 836) / $ 540.2 = 0.84

The company’s current and quick ratio are steady in both the years but they are below the industry average with slight difference. In 2006 the current ratio is 2.4 which means the entity the can liquidate assets to 1/2.4 x 100 = 42% of book value and can pay creditors in full. Inventories are the assets where there is chance of loss in case of forced sale. The company’s liquid ratio indicates than if receivables are collected in full also it is required to raise funds from sale of inventories to pay its current claims

Comparison of asset management ratios

Fixed Assets turnover = Sales / Net fixed assets = $ 3,850 / $ 360.8 = 10.67

Total assets turnover= Sales / Total assets = $ 3,850 / $ 1,650.8 = 2.33

The fixed assets ratio has improved in 2006 compared to 2005 and is equals to industry average. But the total assets turnover remained constant at a level below the industry average. These ratios comparison depicts that the company is succeed in utilizing its fixed assets but not in case of total assets to its industry average.

Evaluation of debt management ratios

Debt ratio = Total debt / Total assets = (540.2 + 424.6) / 4650.8 = 58.4%

TIE = EBIT / interest expense = 149.7 / 76 = 1.97

Fixed charge coverage = (149.7 + 40) / (76 + 40) = 1.6

The debt ratio is above the industry average rate and it is in upward trend. It would be difficult to borrow at reasonable cost additional funds without raising equity.

The TIE ratio focus in entity’s ability to cover interest payments. In 2006 the company’s TIE is below the industry average and it is in reducing trend and this indicates excessive usage of debt funds

FCC ratio of the company is again below the industry average just like TIE and is in falling trend. This means the company has a difficulty in obtaining lease financing and additional debt.