Question

1. The Clothes Clutch, a retail clothier, has had average sales of $400,000 for the last five years, 2008-2012. The firm's total assets at the end of 2010 were $400,000.

An internal staff cost analyst has prepared the following financial data from the annual reports. You have been hired as a consultant to help analyze the financial position.

	2012	2011	2010	2009	2008
Current Ratio	2.80	2.43	2.36	2.10	2.00
Acid Test Ratio	2.03	1.93	1.82	1.61	1.47
Days' Sales in Receivables	61	58	54	42	35
Merchandise Inventory Turnover	4.20	4.10	4.10	3.90	3.70
Debt Ratio	0.48	0.50	0.49	0.47	0.47
Times Interest Earned	4.60	4.80	5.90	5.70	6.00
Sales as a Percent of 1996 Sales	1.46	1.23	1.12	1.06	1.00
Net Income as a Percent of 1996
Income	1.31	1.20	1.10	1.06	1.00
Gross Profit Margin	38.5%	38.8%	38.9%	40.0%	39.7%
Operating Expenses to Net Sales	11.4%	11.3%	11.5%	11.4%	11.7%
Net Profit Margin	7.6%	8.6%	8.9%	9.4%	9.3%
Return on Total Assets	9.4%	9.6%	9.6%	10.0%	10.7%

Required:

a.	Explain the trend in liquidity. Make specific reference to the effect of receivables and inventory on this trend.
b.	Briefly describe the trend in the long-term, debt-paying ability of The Clothes Clutch. Explain the cause(s) of this trend.
c.	The net profit margin has declined substantially. Cite and discuss specific causes of this.
d.	Has the firm utilized its total assets effectively? Discuss the ability of the firm to generate sales based on total assets. (Use DuPont analysis.)
e.	Specifically cite and briefly describe two additional types of information that would aid in your analysis.

Answer 1

a. The Current ratio has improved over the last 5 years, ensuring the high liquidity position of the firm. The effect of inventory and receivables with reference to the data given will be:

Inventory - We see that the inventory turnover has improved and hence the inventory stock held will be minimal compared to the previous years. So this is converted to cash much quicker, increasing the current assets.

Receivables - The days' receivable has increased over the period resulting in increasing account receivables and thereby increase in current assets.

Increase in numerator of Current ratio results in higher ratio.

b. There is no much variation in the debt ratio. This will be due to no much increase/decrease in the debt financing. This is also evident in the times interest earned ratio.

c. The net profit margin has declined. This is attributed to the decline in gross profit margin, when the operating expenses has improved (decreased) slightly. Even when the sales has improved over the years, the reason for decline in gross profit will be the increase in Cost of Goods Sold.

d. DuPont model of ROA is Net profit margin * Asset turnover ratio = (Net income/Sales) * (Sales/Avg total assets)

It is evident that the Net profit margin has declined substantially over the 5 years and thereby resulting in the decline in Return on Asset.

e. The effect of Receivables is also evident in the quick ratio which implies the high liquidity position of the firm.

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