INTRODUCTION

Silver River manufacturing company is a US based large regional producer of firm and utility
trailers, specializes livestock carriers, mobile home chassis owned by Greg white. More than 85%
of SRM’s sales come from the southeastern part of the Unites States. Several major boat companies
in Florida work closely with SRM in designing trailers for their new offerings. SRM is major client
of Marion Country National Bank (MCNB). Due to the recession that had been plaguing the
nation’s farm economy since 2010s caused problem for agriculture for the SRM who depends on
farmers roughly 45 to 50% of total sales .SRM whose products are totally based on latest
technology and SRM hold several patents with which it can partially offset some of the risks.

The banks has to calculate keys ratios for each customers, charts trends and compare the calculated
ratios with industry average. If any ratio is significantly worse than the industry average, reflects
a market adverse trend, or fails to meet contractual requirements. But SRM currents, quick, debt
ratios in 2015 seems that it doesn’t meet contractual limits of 2.0, 1.0, and 55% respectively .The
long and short term loans should be repaid within 10 days if not bank can take legal right to force
company into bankruptcy .SRM had been a good client of MCNB for many years, had never
missed a payment when it was due, and had a reputation of a unquestioned integrity in its business
dealing. Lesa nix who looked upon the threat of accelerating the loan repayment primarily as a
,mean to get Greg white’s undivided attention and to force him to think about corrective actions
that must be taken once to reverse the deterioration and to correct SRM’s near-term problems.
SRM in designing trailers for their new offerings, and this boat-trailer package are sold through
the nationwide dealers networks of boat companies. With few exceptions, the product
manufactured by SRM not subjected to technological obsolescence or to deterioration, and in those
instances where technology is factor to be consider.

In the decade prior to 2013, SRM had experienced high and relatively steady growth in sales,
assets, and profits. Toward the end of 2013, the demand for new field trailers in the citrus and
vegetable industries started to fall off. Consequently, in the light of the softening demand, white
aggressively reduced prices to stimulate further sales. He had full confidence that national
economic policies would revive the ailing farm sector, so the downturn in demand would only be
a short-term problem .To maintain the previously high growth of sales and to reduce the ever-
expanding inventory, SRM not only reduce prices, but also, as part of an “integrated market

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penetration plan”, offered more favorable credit terms and relaxed credit standards. Sales growth
remains high through the third quarter of 2015, but investors also increased steadily and,
particularly in 2015, accounts receivables shot up dramatically. To finance these increases in
assets, SRM turn to MCNB for a long-term loan in 2014 and increases in its short-term credit lines
in both 2014 and 2015.

SRM’s Altman Z factor (2.88) for 2015 was below (2.99) which indicated that SRM was likely to
get bankrupt in two years. Because of this deficiency, MCNB was under increased pressure from
the regulators to reclassify SRM’s loan as ‘problem category’ and take whatever steps needed to
collect the money due and reduce the bank’s exposure as quickly as practicable. In order to avoid
reclassification, SRM required strong and convincing evidence to prove that its problems were
temporary in nature and it had good chance of reversing the trend. The current financial problems
were not the only problem Mr. White faced. He had recently signed a contract for a plant expansion
that would require another $7012500 of the capital during the first quarter of 2016. He had planned
to obtain this money by a short term loan from MCNB to be repaid from the profit generated in
the first half of 2016. He believed that new facilities would enhance the production capabilities in
a very lucrative area of custom horse van. According to Mr. White’s analysis, the financial
position of the company could improve significantly over the next two years if the bank maintained
or even increase the credit lines. Once the new facility is goes online, the company would be able
to increase output in rapidly growing(and particularly profitable) horse van and home chassis
segment of the market and also reduce the dependency on farm and light utility trailer sales to 35%
or less. He also projected that the sales growth would be 6% and 9.5% in an average for 2016 and
2017 respectively, assuming there is no significant improvement in either national or farm
economy. He also assumed that SRM would change its policy of aggressive marketing and sales
promotion and return to full margin prices, standard industry credit term and tighter credit
standards. These changes would reduce cost of goods sold to 85% in 2015 and 82.5% in 2016 and
80 % in 2017.

Similarly administrative and selling expenses are likely to decrease from 9% to 8% in 2016
and7.5% in 2017. Also, the miscellaneous expense would reduce to 1.75% and 1.25% of sales in
2016 and 2017 respectively. Average collection period and inventory turnover will be maintained
at average industry level. Regarding the financial data provided in the case and the projected

2
income statement and balance sheet, we have to analyze whether SRM is eligible to obtain the
bank loan. Now, the question is whether the bank should extend the existing short and long-term
loans or should rather demand immediate repayment of both existing loans. Also we have to
propose alternatives available to SRM if the bank were to decide to withdraw the entire line of
credit and to demand immediate repayment of the two existing loans.

Question 1
(a) Prepare a statement of changes in financial position for 2015 (sources and uses of funds
statement) or complete Table 6.

Solution:

Table 6: Silver River Manufacturing Company

Statement of Changes in Financial Position Year Ended December 31st(thousands of dollars)
Particulars 2014 2015

Sources of funds
Net income after taxes 6,987 831
Depreciation 1283 2244

Funds from operation 8810 3075

Long term loan 3506 0

Net decrease in working capital 471

Total sources 12316 3546

Application of funds
Mortgage change 295 287
Fixed assets change 2574 3051
Dividends on stock 1747 208
Net increase in working capital 7702 -

Total uses 12316 3546

Analysis of changes in working capital

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Increase (decrease) in current assets
Cash change (1260) (107)
AR change 1500 11985
INV change 15505 14992

CA change 15745 26870

Increase(decrease) in current liabilities

AP change 2104 10441
NP change 4116 14446
ACC change 1823 2454
CL change 8043 27341

Net increase(decrease) in working capital 7702 (471)

Particulars 2014 Calculated 2015 Difference

Sources of funds
Net income after taxes 6,987 831 Given
Depreciation 1283 2244 Given

Funds from operation 8810 3075 831+2244

Long term loan 3506 0 10519-10519

38266-37795
Net decrease in working capital 471 or Change in WC
Total sources 12316 3546
Application of funds
Mortgage change 295 287 2574-2861
Fixed assets change 2574 3051 25161-22110
Dividends on stock 1747 208 Given
Net increase in working capital 7702 0

287+3051+208+471
Total uses 12316 3546

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 Analysis of changes in working capital
Increase (decrease) in current assets
Cash change (1260) (107) 4296-4403
AR change 1500 11985 32293-20308
INV change 15505 14992 51324-36332

CA change 15745 26870 -107+26870+14992

Increase(decrease) in current liabilities

AP change 2104 10441 21998-11557
NP change 4116 14446 20056-5610
ACC change 1823 2454 8064-5610
CL change 8043 27341 10441+14446+2454

Net increase(decrease) in working capital 7702 (471) 26870-27341

The above table shows the sources and uses of fund of Silver Manufacturing Company. The major
sources of fund are net income after tax, depreciation, long term loan and net decrease in working
capital. The major applications of fund are changes in fixed assets, mortgages, dividend on stock
and net increase in working capital.

As long as there are more short term assets than liabilities, the firm is said to be in a relatively
liquid position. From the analysis of change in working capital, the company is in a relatively
liquid position in 2014 but the current assets are less than current liabilities in the year 2015
showing that it is not relatively liquid. Hence the company cannot pay off all of its short term
obligations without having to liquidate any long term assets in 2015.

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b) Calculate SRM’s key financial ratios for 2015 and compare them with those of 2013, 2014,
industry average, and contract requirement or complete Table 7.

Solution.

Table 7: Silver River Manufacturing Company

Ratio Analysis Year Ended December 31

Industry
Particulars 2013 2014 2015 Average
Liquidity ratios
Current ratio 3.07 2.68 1.75 2.50
Quick ratio 1.66 1.08 0.73 1.00
Leverage ratios
Debt ratio (%) 40.46 46.33 59.796 50.00
Times interest earned 15.89 7.97 1.49 7.70
Asset management ratios
Inventory turnover(cost) 7.14 4.55 3.57 5.70
Inventory turnover(selling) 9.03 5.59 4.20 7.00
Fixed assets turnover 11.58 11.95 12.10 12.00
Total asset turnover 3.06 2.60 2.04 3.00
Average collection period 36.00 35.99 53.97 32.00
Profitability ratios
Profit margin (%) 5.50 3.44 0.39 2.90
Gross profit margin (%) 20.89 18.70 14.86 18.00
Return on total assets 16.83 8.95 0.79 8.80
Return on owner's equity 28.26 16.68 1.96 17.50
Potential failure
indicator
Altman Z factor 6.689 4.7485 2.77 1.89/2.99

Notes:

a) Uses cost of goods sold as the numerator.

b) Uses net sales as the numerator.

c) The Altman Z factor range of 1.81-2.99 represents the so-called “zone of ignorance".

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 d) Year-end balance sheet values were used throughout in the computation of rations
embodying balance sheet items

e) Assume constant industry-average ratios throughout the period 2013-2017.

Ratio analysis is one of the techniques of financial analysis. In other word, Ratio
analysis is the process of establishing meaningful relationship between two figures or
set of figures of financial statement with a view to present the financial instability form.
Ratios are calculated Following are the key financial ratio.

1. Liquidity Ratio

Liquidity reflects the short term of financial strength of organization. In other

word, it is the ability of a firm to meet the short term obligation. Thus, Liquidity
ratio shows the relationship of firm’s current assets and current liabilities and
ability to maturing debt. Liquidity of SRM has been analyzed by
computing following liquidity ratio.

a. Current Ratio

Current Ratio
3.5
3 3.07
2.68
2.5
Ratios

2
1.75
1.5
1
0.5
0
2013 2014 2015
Year

current ratio industry average

Fig 1.1
The above figure shows that the current ratio has decreased in 2015 as compared to 2013, 2014
and industry average that means company’s ability to fulfill short term obligations with current
assets has decreased.

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b. Quick Ratio

Quick Ratio
1.8 1.66
1.6
1.4
1.2 1.08
Ratios

1 1
0.8 1 1
0.6 0.73
0.4
0.2
0
2013 2014 2015
Year

quick ratio industry Average

Fig 1.2
The above figures shows that quick ratios in the year 2013 and 2014 are higher than industry
average and in the year 2015 is lower than industry average. Quick ratios are in the declining trend.
It means the company is showing less liquidity in 2015 as compared to the previous years and
industry average.

2. Leverage Ratios

Solvency ratios, also called leverage ratios, measure a company’s ability to sustain operations
indefinitely by comparing debt levels with equity, assets, and earnings. In other words, solvency
ratios identify going concern issues and a firm’s ability to pay its bills in the long term. Leverage
ratio are computed using following ratio.

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 a. Debt ratios

Debt Ratios
70 59.796
60 50 50
50 50
Ratios

40 46.33
30 40.46

20
10
0
2013 2014 2015
Years

Debt Ratio industry average

Fig 1.3
The debt ratio of the company is in increasing trend showing that it is becoming riskier. The
company has been able to finance about more than half of its assets by borrowing in 2015. In 2015,
its debt ratio surpassed the industry average by 9.796%.

b. Time Interest Earned

Time Interest Earned Ratio

18 15.89
16
14
12
Ratios

10 7.97
8
6 7.7 7.7
7.7
4 1.49
2
0
2013 2014 2015
year

time interest earned industry Average

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 Fig 1.4
The time interest earned ratio is declined from 2013 to 2015 but is not below 1 so it is still able to
meet its interest obligations. So from this we can easily see the decreasing interest paying capacity
of SRM over the years. And in the year 2015 SRM has failed to maintain the ratio as off industry.

3. Assets Management Ratios

Asset management ratios are the key to analyzing how effectively and efficiency your small
business is managing its assets to produce sales. Asset management ratios are also called turnover
ratios or efficiency ratios. Assets Management Ratios are computed using following ratios.

a Inventory Turnover (cost)

The below figure shows that the inventory turnover ratio (cost) is in decreasing trend. It has
decreased from 7.14 to 3.57. It shows the company is not efficient in managing the inventory.

Inventory turnover (cost)

8 7.14
7
5.7 5.7 5.7
6
5
Ratios

3.57
4
4.55
3
2
1
0
2013 2014 2015
Year

inventory turnover Industry Average

Fig 1.5

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b. Inventory turnover (selling)

Inventory turnover (selling)

10 9.03
9
8 7 7 7
7
5.59
6
Ratios

5 4.2
4
3
2
1
0
2013 2014 2015
year

inventory turnover (seling) Industry Average

Fig 1.6
Above figure shows that the inventory turnover ratio (selling) is in decreasing trend. It has
decreased from 9.03 to 4.2. It shows the company is not efficient in managing the
inventory.

b. Fixed Assets Turnover

Fixed Assets Turnover
12.2 12.1
12.1 12 12 12
12
11.9
11.95
Ratios

11.8
11.7 11.58
11.6
11.5
11.4
11.3
2013 2014 2015
year

fixed assets turnover industry average

Fig 1.7

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 As the turnover generated from fixed asset are in increasing trend i.e. from 11.58 to 12.1
in 2013 to 2015. The industry average is 12 is less than turnover ratio in the year 2015 it
means the company has used its fixed assets effectively.

c. Total Assets Turnover

Total Assets Turnover

3.5 3.06 3 3
3
3
2.5 2.04
2.6
Ratios

2
1.5
1
0.5
0
2013 2014 2015
Years

Total Assets Turnover Industry Average

Fig 1.8
In 2015, the total asset turnover is $ 2.04 which is less in contrast with 2013 (i.e. $ 3.06).this
indicates the company is not capable to utilize its total asset. As the industry average is $3,
which means SRM is not using its asset effectively to increase the productivity of the
company.

d. Average Collection Period

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 Average collection period
60 53.97

50
36 35.99
Ratios 40

30
32 32 32
20

10

0
2013 2014 2015
years

Average Collection Period industry average

Fig. 1.9

The number of days tied up in accounts receivables has increased in 2015. The collection
period is less in 2013 and 2014. Also, the industry average is lower. The company is not
able to appraise accounts receivables in a timely manner.

4. Profitability Ratios
Profitability ratio is the key factor which measure how effective the firm is operating. Profitability
is an indication of efficiency with which the operating of business is carried. Profit is regarded as
the engine that drives the business and indicates economic progress of the firm. Profitability ratio
is related with the profit which measures the earning capacity. Profitability Ratios are computed
using following ratios.

a. Profit Margin (%)

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 Profit Margin %
6 5.5

4 3.44
2.9 2.9 2.9
Ratios
3

1 0.39

0
2013 2014 2015
Year

Profit Margin % Industry Average

Fig. 1.10

The profit margin ratio of SRM Company in 2013 is 5.5 and in 2015 is 0.39, which shows the
rapid decrease in profit margin ratio. The industry average is found to be 2.9, which indicate SRM
possess lesser profit margin compared with competitors.

b. Gross Profit Margin %

Gross Profit Margin %

25
20.89
18.7 18
20

15 18 18
Ratios

10 14.86

0
2013 2014 2015
Year

Gross Profit Margin Industry Average

Fig. 1.11

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The gross profit margin are 20.89% in 2013 to 14.86% in 2015, it shows decreasing trend. The
industry average in term of gross profit margin is 18%, which is more compared to SRM. Company
is unable to make profit by using raw materials, labor and manufacturing with compared to its
competitors.

c. Return on Total assets

Return on Total Assets

16.83
18
16
14
12 8.95
8.8 8.8
Ratios

10
8
6 8.8
4
2 0.79
0
2013 2014 2015
Year

Return on total Assets Industry Average

Fig. 1.11

The return on assets of SRM has been declining from 16.83% to 0.786% from 2013 to 2015.
Compared to industry average of 8.8% other companies are more efficient in generating profit
using its assets

SRM’s return on asset has drastically declined from 2013 to 2015 (ie.16.83% to 0.79%) as
compared to industry average i.e. 8.8%. ROA indicate the efficiency in generating profit using its
asset. Therefore SRM is less effective in generating profit by using its asset, as compared to
competitors.

d. Return on owners’ equity

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 Return on owner's Equity
28.26
30

25
17.5
20 17.5 17.5

Ratios 15
16.68
10

5 1.96

0
2013 2014 2015
year

Return on owner's equity Industry Average

Fig. 1.12

Return on equity for SRM is rapidly declining from 2013 to 2015, (i.e. 28.26 to 1.95%), industry
average is found to be 17.5%. which indicate SRM is less capable of generating profit from
shareholder money compared to competitors.

Question-2
Based on the case data and results of your analysis in question 1, what are the SRM’s
strengths and weaknesses? What are the causes thereof? (Use of the DU Pont system and
Altman Z factor would facilitate analysis and strengthen your answer.)

Solution:
Du Pont System:
Du Pont system decomposes ROE into its component parts. This decomposition helps us to find
out exactly where the strengths and weaknesses lie. Management can use this system to analyze
ways of improving the firm’s performance.
If ROE goes up due to an increase in net profit margin or asset turnover, it is beneficial for the
company because it shows the operating efficiency and asset use efficiency. But if the equity
multiplier is the source, it means that company is taking excessive debt and making it very risky.

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 Du Pont system
Particulars Return on = Net Profit × Asset Turnover × Equity
Equity margin Multiplier
(ROE)
= Net Income × Sales______ × Asset
Sales Total Assets Equity
2013 28.27 = 5.50 × 3.06 × 1.68
2014 16.65 = 3.44 × 2.603 × 1.86
2015 1.98 = 0.39 × 2.04 × 2.49
Industry 17.50 = 2.90 × 3.00 × 2.00
Average

Altman Z factor
The Z-Score Bankruptcy-Predictor combines several of the most significant variables in a
statistically derived combination.

Z = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.999X5

Where,
X1 = working capital / total assets (working capital = current assets - current liabilities)
X2 = retained earnings / total assets
X3 = earnings before interest and taxes / total assets
X4 = market value of equity / book value of total debt (market value of equity includes both
preferred and common shares, and debt includes current and long-term liabilities)
X5 = sales / total assets

Z = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.999X5

For the year 2013,

Working capital = Current assets – Current liabilities

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 = $ (45298 – 14733) = $ 30565
Total Assets = $ 61539
Retained Earnings = $ 11041
EBIT = $ 21251
Market value of equity = $ 68481.57
Book value of debt (Total Liability) = $ 24901
Sales = $ 188097

Altman Z factor = 0.012×Working capital + 0.014×Retained earnings + 0.033×EBIT

Total Assets Total Assets Total Assets
+ 0.006×Market value of equity + 0.999×Sales
Book Value of debt Total Assets
= 0.012 × 30565 + 0.014× 11041 + 0.033 × 21251 +
61539 61539 61539
0. 006 × 68481.57 + 0.999 × 188097
24901 61539
= 0.012 × 49.67 + 0.014 × 17.94 + 0.033× 34.53+ 0.006 × 275
+ 0.999 × 3.05
= 6.69

SRM’s Altman Z Score = 6.69

Industry Average = (1.81 - 2.99)

For the year 2014,

Working capital = Current assets – Current liabilities
= $ (61043 - 22777) = $ 38266
Total Assets = $ 78034
Retained Earnings = $ 16282

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EBIT = $ 15364
Market value of equity = $ 37405.54
Book value of debt (Total Liability) = $ 36156
Sales = $ 203124
Altman Z factor = 0.012×Working capital + 0.014×Retained earnings + 0.033×EBIT
Total Assets Total Assets Total Assets
+ 0.006×Market value of equity + 0.999×Sales
Book Value of debt Total Assets
= 0.012 × 38266 + 0.014× 16282 + 0.033 × 15364+
78034 78034 78034
0. 006 × 37405.54 + 0.999 × 203124
36156 78034
= 0.012 × 49.04 + 0.014 × 20.87 + 0.033× 19.69+ 0.006 × 103.46
+ 0.999 × 2.6
= 4.75

For the year 2015,

Working capital = Current assets – Current liabilities
= $ (87913 - 50118) = $ 37795
Total Assets = $ 105711
Retained Earnings = $ 16904
EBIT = $ 1597
Market value of equity = $ 3852.815
Book value of debt (Total Liability) = $ 63211
Sales = $ 215305
Altman Z factor = 0.012×Working capital + 0.014×Retained earnings + 0.033×EBIT
Total Assets Total Assets Total Assets
+ 0.006×Market value of equity + 0.999×Sales

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 Book Value of debt Total Assets
= 0.012 × 37795 + 0.014× 16904 + 0.033 × 1597+
105711 105711 105711
0. 006 × 3852.815 + 0.999 × 215305
63211 105711
= 0.012 × 35.75 + 0.014 × 15.99 + 0.033× 1.51+ 0.006 × 6.09
+ 0.999 × 2.034
= 2.77

The Interpretation of Altman Z-Score:

Altman provides multivariate analysis of bankruptcy utilizing financial ratios. It allows combining
several financial ratios into a single predictive equation.

Z score below 1.8: High probability of failure

Z score above 3.0: High probability of no failure

Z score between 1.8 and 3.00: hard to predict with confidence whether the firm will or will not
fail. This range is also known as gray zone

Strengths

1. Favorable fixed asset turnover ratio: The fixed asset turnover ratio is increasing in 2015.
The number of times that SRM has been able to turn its fixed assets is high. This shows
that the fixed assets are used effectively.

2. Altman Z score: SRM’s Altman Z score is decreased but compatible with the industry
average (i.e. 2.77 against the industry average of 1.81/2.99) for year 2015. Even though,
the factor is compatible with the industry average, it is not a good sign for the company.
The company falls under gray zone and needs to be more careful about going bankrupt.

Weaknesses

1. Liquidity position: The Company is not in a relatively liquid position. The company has
fewer current ratio and quick ratio than industry average thereby showing less liquid
position of SRM.

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 2. Declining profitability ratios: All the profitability ratios are in declining trend in 2015.
The net profit margin and return on total assets has drastically reduced from 2013 to 2015
and is less than the industry average in 2015. From Du Pont analysis, it can be seen that
the net profit margin of 0.39 is below the industry average of 2.90 reflecting the operating
inefficiency in 2015.

3. Inefficiency in major asset management ratios: The major asset management ratios are
showing declining trend from 2013 to 2015. The Du Pont analysis also shows that the asset
turnover ratio has decreased from 3.06 in 2013 to 1.98 in 2015 which becomes less than
the industry average that is 3. The assets have not been efficiently utilized to generate sales.

Deteriorating financial leverage:

The Company has financed about more than half of its assets by borrowing as can be seen from
the debt ratio in 2015. Time interest earned ratio has drastically decreased from 2013 to 2015and
has becomes less than industry average. This indicates SRM interest paying capacity has
decreased. The Du Pont analysis also show that the equity multiplier is higher in 2015 as compared
to 2013 and 2014 and industry average. This reflects that SRM is using more debt to finance its
assets than its competitors. This indicates that the company has high chances of being bankrupt
Question 3.

If the bank were to maintain the present credit lines and grant an additional $6,375,000
short-term loan at a 16 percent rate of interest effective from January 1, 2006, would the
company be able to retire all short-term loans existing on December 31, 2006? (Assume that
all of White’s plans and predictions concerning sales and expenses materialize. In these
calculations cash is the residual balancing figure, and SRM’s tax rate is 48%. Assume that
SRM pays no cash dividends during the year.) Complete tables 9 and 10 included as
worksheets to facilitate analysis.

Solution:

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 Table 9: Silver River Manufacturing Company
Pro Forma Income Statements (Projected)
Worksheet for Year End 2017 (Thousands of Dollars)

Particulars 2015 2016 2017

projected Projected

Net sales 215,305 228,223.5 2,49,904.51

Cost of goods sold 183,305 1,88,284.38 1,99,923.608
Gross profit 31,998 39,939.08 49,980.902
Administrative And selling 18,569 18,257.88 18,742.838
Depreciation 2,244 2,665 2,006
Miscellaneous expenses 6,397 3,993.911 3,123.81

Total operating expenses 27,110 24,916.79 23,872.65

EBIT 4,888 15,022.32 26,108.252

Interest on short-term loans 2,006 4,331 4,331

Interest on long-term loans 1,052 1052 1,052

Interest on mortgage 233 210 189

Net income before tax 1,597 9429.32 20536.252

Taxes 767 4526.07 9857.4

Net income 831 4,903.25 10678.85

Dividends on stock 208 - -

Additions to retained earnings 623 4,903.25 10678.85

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 Table 10: Silver River Manufacturing Company
Pro Forma Balance sheets (Projected)
Worksheet for Year End 2017 (Thousands of Dollars)

Particulars 2015 2016 2017

projected Projected
Assets
Cash 4296 39666.16 49527.95
Accounts receivable 32,293 20286.52 22,213.73
Inventory 51,324 33032.32 35074.32
Current assets 87,913 92985 106816
Land, buildings, plant, and equipment 25,161 32,173 33,139
Accumulated Depreciation (7,363) (10,028) (10,929)
Net fixed assets 17,798 22,145 22,199
Total Assets 105,711 115130 129015
Liabilities and equities
Short-term bank loans 20.056 27,068 27,068
Accounts payable 21,998 17,594 18,474
Accruals 8,064 10,231 12,789
Current liabilities 50,118 54,894 58,221
Long-term bank loans 10,519 10,519 10,519
Mortgage 2,574 2,314 2,083
Long-term debt 13,092 12,833 12,602
Total liabilities 63,211 67,727 70,933
Common stock 25,596 25,596 25,596
Retained earnings 16,904 21,807 32,486
Owners' equity 42,500 47403 58082
Total capital 105,711 115130 129015

Working of Table 10
Particular 2016 2017
215,305 *106 % 228,223.5 228,223.5*9.50 2,49,904.51
Projected sales
228,223.5*82.5% 1,88,284.38 2,49,904.51*80% 1,99,923.608
Cost of goods sold
Administrative and selling 228,223.5*8% 18,257.88 1,99,923.608*7.5 18,742.838
expenses
228,223.5*1.75 3,993.911 2,49,904.51*1.25 3,123.81
Miscellaneous expenses
9429.32*48% 4526.07 20536.252*48% 9857.4
Taxes

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Working Table 10
1. Retained Earnings.
Retained earnings of 2015 + Projected Additions to retaining earning of 2015
For 2016
(16,904+4903.25) = 21,807.25
For 2017
(21807.25+10678.85) =32,486
2. Accounts Receivables.

Average Collection Period = 360/sales/Account Receivable

For 2016

i.e. 32 = 360/228223.3/Account Receivable

Therefore, receivables = 20286.5
For 2017
32= 360/2,49,904.51/Account Receivable
Therefore, receivables = 22213.734
3. Inventory
Inventory turnover Cost = COGS/ Average Inventory
For 2016
I.e. 5.7 = 188284.22/ Average inventory
Therefore, Inventory = 33032.32/
For 2017
i.e. 5.7= 199923.608/35074.31
Therefore, Inventory = 35074.32

Notes:
1. Cash is the balancing figure.
2. Accounts receivables and inventory has been calculated by using the industry average
ratios.

In 2016, the company has total cash balance of 39,666.16 thousands and during the same year the
short-term bank loan to be retired is 27,068.

24
 = $(39666.16 – 27,068)
= $12598.16
The company should maintain cash balance of 5% of sales.
Minimum cash balance = $ (228,223.5 * 0.05)
= $ 11,411.175
From the calculation we can see that the company is able to maintain the minimum cash
balance. Hence, it has enough cash balance to retire the short-term bank loans.

Question no: 4

Compute projected financial ratios for 2016 and 2017 (or complete Table 11). Compare these
ratios with 2015 along with industry averages and analyze improvement or deterioration in
financial condition.

25
 Table 11: Silver River Manufacturing Company

Ratio Analysis Year Ended December 31, 2017 (Projected)

2016 2017 Comment

Particulars 2015 projected projected Ind. Avg.

Liquidity ratios

Current ratio 1.75 1.18 1.19 2.5 Poor

Quick ratio 0.73 1.09 1.22 1 Good

Leverage ratios

Debt ratio (%) 59.80 58.82 54.98 50 Risky

Times interest earned 1.49 2.69 4.69 7.7 Poor

Asset management ratios

Inventory turnover (Cost) 3.57 5.69 5.69 5.7 Ok

Inventory turnover Ok
(selling) 4.20 6.90 7.12 7

Fixed asset turnover 12.10 10.3 11.26 12 Ok

Total asset turnover 2.04 1.98 1.94 3 Poor

Average collection period 53.97 32 32 32

Profitability ratios

Profit margin (%) 0.39% 2.15% 4.27% 2.9 Good

Gross profit margin (%) 14.86% 17.50% 20% 18 Good

Return on total assets 0.79% 4.26% 8.27% 8.8 Ok

Return on owners' equity 1.96% 10.34% 18.38% 17.5 Ok

Working Notes for Ratio Analysis (Table 11) (2016) 2017)

26
 Ratios Formula Calculation for 2016 Calculation for 2017

Current Ratio CA/CL 6473/54894=1.18 69783.28/58331 =

1.19
Quick Ratio Cash+Account (39666.16+20286.52 (49527.8+22213.73)
receivable/CL )/54894 = 1.09 /58331= 1.22
Debt Ratio TD/TA (54894+12833)/1151 (58331+12602)/1290
30 = 58.82% 14.85 = 54.98%
Times Interest EBIT/Interest 15022.32/5593 = 26108.252/5572 =
Earned Expenses 2.69 4.69
Inventory Turnover COGS/INV 188284.22/33032.32 199923.608/35074.3
Ratio (Cost) = 5.69 2 = 5.69
Inventory Turnover COGS/INV 228223.3/233032.32 249904.51/35074.32
Ratio (Selling) =6.90 =7
Fixed Assets Net Sales/F.A 228223.3/22145 = 249904.51/22199 =
Turnover Ratio 10.30 11.26
Total Assets Net Sales/T.A 228223.3/115130 = 249904.51/129014.8
Turnover Ratio 1.98 5 = 1.94
Average Coll. 360*A.R/Net 360*20286.52/22822 360*2213.73/249904
Period Sales 3.3= 32days .51 = 32days

Profit Margin Net income/ Net 4903.24/228223.3= 10678.85/249904.51

Sales 2.15% = 4.27%
Gross Profit Margin GP/ Net Sales 39939.08/228223.3 = 49980.902/249904.5
17.5% 1= 20%
Return on Total NI/TA 4903.25/115130 = 10678.85/129014.85
Assets 4.26% = 8.27%
Return on Equity NI/ Share Holder 4903.25/47403=10.3 10678.85/58081.85 =
Equity 4% 18.38%
Note: figures for 2015 have been taken from table 7

Current ratio

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 Figure 4.1: current ratio comparison

The projected current ratio of SRM is lower than the industry average. This shows the firm’s
ability to meet the short term obligation has improved but still poor in comparison to industry
average.

Quick ratio

Figure 4.2: Quick ratio analysis

The quick ratio of the organization is above the industry average thus the company has the ability
to meet its short term obligation.

Debt ratio

28
The projected debt ratio is higher than the industry average. The debt ratio has decreased
comparatively to previous year. The debt ratio indicates that the company has minimized its risk
level.

Figure 4.3: Debt ratio

Times interest earned (TIE)

Figure 4.4: TIE ratio

The TIE ratio earned ratio is significantly lower than the industry average. In 2017 the TIE ratio
has significantly improved than the past year.

Inventory Turnover

29
 Figure 4.5: Inventory turnover (cost)

Inventory turnover ratio is slightly lower than the industry average. It doesn’t change in year
2017.

Inventory Turnover (selling)

Figure 4.6: Inventory turnover (selling)

In above figure, Inventory turnover selling is equal to the industry average in year 2016 and
2017.

Fixed asset Turnover

30
 Figure 4.7: Fixed asset turnover

The fixed asset turnover in 2016 is low compared to 2015 and the industry average. There is
some progress in utilization of fixed assets.

Total asset Turnover

Figure 4.8: Total asset turnover

Total Assets Turnover ratio is lower than industry average and it is constant in the year 2016 as
well as in year 2017.

31
 Average Collection Period

Figure 4.9: Average collection period

In above figure, Average collection period is equals to the industry average in 2016 and 2017.

Profit Margin

Figure 4.10: Profit margin

In above figure, Profit margin is lower than industry average in 2016 and is higher than industry
average in 2017.

32
 Return on total asset

Figure 4.11: Return on total asset

In above figure, Return on total Assets is drastically lower than industry average in 2016 and is slightly
lower than industry average in 2017.

Return on owners’ equity

Figure 4.12: Return on owners’ equity

There has been great improvement in the ROE in compared to 2015 but is still below the industry
average. In 2017 it is above the industry average showing improvement in both operating and
financial decisions of the company.

33
Question 5.

If all short-term bank loans are repaid towards the end of the first half of 2016, do you think
that company is still able to pay regular dividends and maintain minimum cash balance?
Revise the tables 9, 10, 11 (or complete the tables 12, 13 and 14). Do you find any situations
developing that may indicate poor financial policy? What should be the impact of such
situations on the ratios for the company, and are such impacts necessarily either good or
bad? Why?

Solutions:

Table 12: Silver River Manufacturing Company

Pro Forma Income Statements (Revised)

Worksheet for Year End 2017 (Thousands of Dollars)
Particulars 2015 2016 Revised 2017 Revised
Net Sales 215,305 228,223.3 249,904.51
Cost of Goods Sold 183,307 188,284.22 199,923.61
Gross Profit 31,998 39,939.08 49,980.90
Administrative and Selling 18,569 18,257.86 18,742.84
Depreciation 2,244 2,667 2,006
Miscellaneous expenses 6,297 3,993.9 3,123.81
Total operating expenses 27,110 24,916.76 23,872.65
EBIT 4,888 15,022.32 26,108.25
Interest on short-term loans 2,006 2,165 0
Interest on long-term loans 1,052 1,052 1,052
Interest on mortgage 233 210 189
Net income before tax 1,597 11,595.32 24,867.25
Taxes 767 5,565.75 11,936.28
Net income 831 6,029.57 12,930.97
Dividends on stock 208 1,507.39 3,232.74
Additions to retained earnings 623 4,522.18 9,698.22

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 Table 13: Silver River Manufacturing Company

Pro Forma Balance Sheets (Revised)

Worksheet for Year End 2017 (Thousands of Dollars)
Particulars 2015 2016 Revised 2017 Revised
Assets
Cash 4,296 12,216.34 22,192.35
Accounts Receivable 32,293 20,286.52 22,213.73
Inventory 51,324 33,032.32 35,074.32
Current Assets 87,913 65,535.18 79,480.39
Land, Buildings, Plant and Equipment 25,161 32,173 33,139
Accumulated Depreciation -7,363 -10,028 -12,033
Net Fixed Assets 17,798 22,145 21,105
Total Assets 105,711 87,680.18 100,585.4
Liabilities and Equities
Short-term bank loans 20,056 0.00 0.00
Account payable 21,998 17,594 18,474
Accruals 8,064 10,231 12,789
Current liabilities 50,118 27,286 31,263
Long-term bank loans 10,519 10,519 10,519
Mortgage 2,574 2,314 2,083
Long-term debt 13,092 12,833 12,602
Total liabilities 63,211 40,658 43,865
Common stock 25,596 25,596 25,596
Retained earnings 16,904 21,426.18 31,124.4
Owners' equity 42,500 47,022.18 56,720.4
Total Capital 105,711 87,680.18 100,585.4

35
 Table 14: Silver River Manufacturing Company

Ratio Analysis Year Ended December 31 (Revised)

2016 Industry Comment

Particulars 2015 Revised 2017 Revised average

Liquidity Ratios

Current ratio 1.75 2.36 2.54 2.5 Ok

Quick Ratio 0.73 1.17 1.42 1 Good

Leverage Ratios

Debt ratio (%) 59.80 46 43.61 50 Less risky

Times interest earned 1.49 4.38 21.04 7.7 Excellent

Asset Management
Ratios

Inventory turnover (Cost) 3.57 5.70 5.7 5.7 Ok

Inventory turnover Ok
(Selling) 4.20 6.91 7.13 7

Fixed asset turnover 12.10 10.31 11.84 12 Ok

Total asset turnover 2.04 2.60 2.48 3 Ok

Average collection period 53.97 32 32 32

Profitability Ratios

Profit margin (%) 0.39 2.64 5.17 2.9 Good

36
 Gross profit margin (%) 14.86 17.5 20 18 Good

Return on total assets 0.79 6.88 12.86 8.8 Good

Return on owners' equity 1.96 12.82 22.80 17.5 Good

Working notes of Table 12

Particulars 2016 2017

Projected sales 215,305 * 1.06 228,223.3 228,223.3* 1.095 249,904.51

82.5% of
Cost of goods sold 228,223.3 188,284.22 80% of 228,223.3 199,923.608

Administrative and
selling expenses 8% of 228,223.3 18,257.86 7.5% of 228,223.3 18,742.84

1.75% of 1.25% of
Miscellaneous expenses 228,223.3 3,993.9 228,223.3 3,123.81

48% of
Taxes 11,595.32 5,565.75 48% of 24,867.25 11,936.28

Working notes of Table 13

1. Retained earnings

For 2016: Retained earnings (2015) + Additions to retained earning in 2016

i.e16,904+ 623= 21,426.18

For 2017: Retained earnings (2016) + Additions to retained earning 2017

i.e. 21,426.18 + 9698.22= 31,124.4

2. Accounts receivables

37
 For 2016: Average collection period = 360*Ac Receivable/ Net sales

i.e. 32 = 360* Ac receivable/228,223.3

Therefore, Ac Receivable= 20,286.52

For 2017: Average collection period = 360* Ac Receivable / Net Sales

i.e. 32 =360* Ac Receivables / 249,904.51

Therefore, receivables = 22,213.73

3. Inventory

For 2016: Inventory turnover = Cost of goods sold / Inventory

i.e. 5.7 = 188,284.22/ Inventory

Therefore, inventory = 33,032.32

For 2017: Inventory turnover = Cost of goods sold/ Inventory

i.e. 5.7 = 199,923.608/ Inventory

Therefore, inventory = 35,074.32

Notes:

3. Cash is the balancing figure.

4. Accounts receivables and inventory has been calculated by using the industry average
ratios.

Working notes of Table 14

Particulars Formula 2016 2017

Current assets / current 79,480.39/

Current ratio liabilities 65,535.18/27,826 2.36 31,263 2.54

38
 (Cash+ Ac Receivable) / (12,216.34+20,28 (22,192.35+22,
Quick ratio Current liabilities 6.52)/ 27,826 1.17 213.73)/31,263 1.42

43,865/100,585.
Debt ratio Total debt / Total asset 40,658/87,680.18 46 4 43.60

Times interest
earned EBIT / Interest 15,022.32/3427 4.38 26,108.25/1,241 21.04

Inventory 188,284.22/33,03 199,923.608 /

turnover(cost) COGS / Inventory 2 5.7 35,074.32 5.7

Inventory 228,223.3/ 249,904.51/35,0

turnover(selling) Sales / Inventory 33,032.32 6.91 74.32 7.13

Fixed assets 249,904.51/

turnover Sales / Fixed asset 228,223.3/22,145 10.31 21,105 11.84

Total asset 228,223.3/ 227,185.70 /

turnover Sales / Total asset 87,680.18 2.6 91,441.86 2.48

Average 360* Ac Receivables / 360*20,286.52/22 360*22,213.73/

collection period Net sales 8,223.3 32 249,904 32

Profit (Net income / Sales) * (6,029.57/228,223 (12,930.97/249,

margin(%) 100 .3)*100 2.64 904.97)*100 5.17

Gross profit (Gross profit / Sales) * (39,939.08/228,22 (49,980.90/249,

margin(%) 100 3.3)*100 17.5 904.51)*100 20

Return on total (Net income / Total (6,029.57/87,680. (12,930.97/100,

assets(%) asset) * 100 18)*100 6.88 585.4)*100 12.86

39
Return on
owner's (Net income / Total (6,029.57/47,022. (12,930.97/56,7
equity(%) equity) * 100 18)*100 12.82 20.4)*100 22.80

If all short term loans are repaid by end of first half of 2016, the company would obviously be able
to pay regular dividends in 2016 as well as in 2017. This is because the interest on short term is
being decreased in 2016 and is nil by 2017.

The minimum cash balance required at the end of 2016 is 11,411.165 (5% of 228,223.3). The
company after paying the dividend of 25% during the year 2016 has the cash balance of
Rs.12,216.34. So, the company will be able to maintain the minimum cash balance of
Rs.11,411.165.

The following table shows the changes in the ratios of the company after the payment of short term
bank loans in the first half of year 2016.

40
 Not Not Revised Revised
Revised revised
Ratios 2016 2017
2016 2017

Liquidity ratios

Current ratio 1.18 1.20 2.36 2.54

Quick ratio 1.09 1.23 1.17 1.42

Leverage ratios

Debt ratio (%) 58.82 54.98 46 43.61

Times interest earned 2.69 4.69 4.38 21.04

Asset management ratios

Inventory turnover (Cost)* 5.7 5.7 5.70 5.7

Inventory turnover (Selling)* 6.91 7.12 6.91 7.13

Fixed asset turnover 10.31 11.26 10.31 11.84

Total asset turnover 1.98 1.94 2.60 2.48

Average collection period 32 32 32 32

Profitability ratios

Profit margin (%) 2.15 4.27 2.64 5.17

Gross profit margin (%) 17.5 20 17.5 20

Return on total assets 4.26 8.28 6.88 12.86

Return on owners' equity 10.34 18.39 12.82 22.80

Since, after the payment of short term loan all the ratios of the company are improving we find
that there is no situation that indicates poor financial policy. The impacts on the ratios after the
payment of short term bank loans are as follows:

41
Liquidity ratios

a. Current ratio: The improvement in the current ratios of the company shows better ability
of the company to meet its current obligations.

b. Quick ratio: the increase in quick ratio indicates improvement of the company’s ability to
meet its short term obligations.

Leverage ratios:

a. Debt ratio: The decrease in debt ratio of the company shows the less involvement of debt
to finance fixed assets of the company.

b. Times interest earned: The improvement in the TIE ratio shows the increase in the operating
earnings to pay interest.

Asset management ratio:

a. Total asset turnover: The increase in the ratios shows that the company has more efficiently
utilized the overall assets to generate sales revenue.

Profitability ratios:

a. Profit margin: The increase in the profit margin ratio shows the improvement in the
company’s ability to earn of each sale after paying all the necessary expenses.

b. Return on total assets: The improvement in return on total assets ratio indicates the
enhancement in the effectiveness of the operating management of the firm.

c. Return on owner’s equity: the increase in the ratio shows the improvement in both operating
and financial decisions of the company.

Question 6.
On the basis of your analyses, do you think that the bank should
a. Extend the existing short and long-term loans and grant the additional $7,012,500
loans, or
b. Extend the existing short and long-term loans without granting the additional
loan, or

42
 c. Demand immediate repayment of both existing loans?

If you favor (a) or (b) above, what conditions (collateral, guarantees, or other safeguards)
should the bank impose to protect itself on the loans?
Solution.
Solution:
On the basis of our analysis,

Bank should Extend the existing short and long- term loans and grant the additional $7,012,500
loans. SRM was a good client of MCNB as they were prompt in making payments when it was
due, and had a reputation of unquestioned integrity in its business dealings. The current problem
faced by SRM is temporary in nature. The problem occurred due to financial downturn and as it is
not solely due to the operational failure which was not the only problem faced by Mr. White and
there is chance of SRM recovering from it.

Recently, Mr. White had signed a contract for a plant expansion. He believed that new facilities
would enhance the production capabilities in a very lucrative area of custom horse van. According
to Mr. White’s analysis, the financial position of the company could improve significantly over
the next two years. Once the new facility is added, the company would be able to increase output
in rapidly growing segments of market (horse van and home chain) and also reduce the dependency
on farm and light utility sales to 35% or less. He also projected that the sales growth would be 6%
and 9.5% in an average for 2016 and 2017 respectively, assuming there is no significant
improvement in either national or farm economy. He also assumed that SRM would change its
policy of aggressive marketing and sales promotion and return to full margin prices, standard
industry credit term and tighter credit standards. These changes would reduce cost of goods sold
to 82.5% in 2016 and 80% in 2017. Similarly administrative and selling expenses are likely to
decrease from 9% to 8% in 2016 and 7.5% in 2017. Also, the miscellaneous expense would reduce
to 1.75% and 1.25% of sales in 2016 and 2017 respectively.

Hence, on the basis of our analysis we can be assured that if SRM will undertake new facilities
then within two year period SRM will be able to generate enough profit to meet the entire
obligation owed to the bank.

In addition for the purpose of safety, bank should impose collaterals, guarantees and other
safeguards. The collaterals will serve as a value given or pledged as security for payment of
loan. In this case, the bank may charge SRM following collaterals:

43
  Financial collaterals: Stocks, bonds and negotiable paper assuming SRM possess these
securities.
 Merchandise collaterals: Warehouse receipts, trust receipts, rights in real estates, bills of
sale of movable goods such as crops, machineries, furniture, livestock.
The most promising collateral option for the bank to charge SRM would be the new operation
which is going to start. Above mentioned collaterals may also be charged by the bank in securing
itself from default. In case of default, the bank may sell the collateral pledged by SRM and apply
the money thus acquired to payment of the debt.

Question 7

If the bank decides to withdraw the entire line of credit and to demand immediate repayment
of the two existing loans, what alternatives would be open to SRM?

Answer:

In case if the bank decides to withdraw the entire line of credit and demand immediate repayment
of the two existing loans, SRM could use the following alternatives.

1. Increase the minimum cash balance:

The current minimum cash balance is 5% of net sales. SRM has to increase the percentage so that
it has more cash reserve and can utilize it when necessary. SRM can use the mixture of above
policies at once in order to stabilize the financial condition and generate enough fund for the new
project of plant expansion on hand.

2. Sell accounts receivables and liquidate inventory:

It can sell its receivables and liquidate the inventory in order to repay the loan as well as generate
funds for the new project.

3. Make strict collection policies:

SRM could adopt to a more strict collection policies by first reducing the collection period which
would help company generate income faster for repayment of loan

4. Take mortgage loan from bank:

SRM can issue additional number of equity share to generate cash from general public which could
be used to repay long term & Short term loan.

44
Question 8:

Explain some of the lessons learnt from the case.

Answer:

After analyzing the case of SRM, we are able to analyze and interpret the financial ratio of the
company and compare such ratios with industry average which helps to know the financial
position and performance of the company that enables management to make financial decisions.
Following lessons can be learned from the above case:-

 To compute and analyze Du Pont. To identify strength and weakness of the company
with the help of Du Pont System.
 To identify whether the company is likelihood of bankruptcy with the help of
Altman Z-Score.
 To prepare the Balance Sheet of the company to know the financial position of the
company.
 To prepare Income Statement of the company to know the financial performance in a
certain year.
 To compare the ratio’s obtained from Income Statement and Balance Sheet with industry
average.
 To decide whether or not a company is eligible for loan.
 To decide whether or not, a company should distribute cash dividend in a certain year.
 To prepare projected Balance Sheet and Income Statement of the company.
 To immediately repay the bank loan with the help by analyzing various alternatives.
 To know whether the company can maintain minimum cash balance after repaying the
short-term and long-term loan.
 To make complex financial decisions and to identify and solve the problem in policies
such as changing aggressive marketing and sales proportion strategy to full-margin
pricing, standard industry credit terms and tighter credit standards.

45
46