Bigger Isn’t Always Better

Submitted by Sherin KalamRakhi Verma

Lavanya papoluAraish Jamal

Case Overview

• Andre Pires, with over 15 years experience in the automobile industry opened a automobile parts store, in mid-western region of United States.

• Business had picked up significantly well over the years and Andre had more than doubled the store size by the third year of operations.

• Andre’s knowledge of finance and accounting was limited and he decided to recruit Juan Plexo, a second semester MBA student

Case Facts

• Andre had learned the nuances of the fiercely competitive auto mobile servicing business.

• Andre had more than doubled the store size by the third year of operations.

• Most of his available funds were used up in expanding the business.

• For the past two years, the store’s net income figures had been negative and his cash flow situation had gotten pretty weak.

Major Issues

• The net income figures for the past two years was negative.

• Andre needed to raise funds for future growth and was in need of a loan.

• The return on assets and return on equity had become negative in the last two years.

• The Earnings per share(EPS) also is negative in the last two years.

Q1. How does Quick fix’s average compound growth rate in sales compare with its earnings growth rate over the past five years?

CAGR in sales = (1,013,376/600,000^1/5)-1 = 0.1105Average compound growth rate in sale=CAGR/No of years = 0.1105/5 =0.0221 = 2.21%

Earnings growth rate = Net income/Sales

Average earnings growth = Sum of earnings growth rate/5 = 4.64/5 = 0.9%

2000 2001 2002 2003 2004

Net income 16634 22859 2126 -16435 -102

Net Sales 600000 655000 780000 873600 1013376

Earnings growth rate 2.77 3.49 0.27 -1.88 -0.01

Q2. Which statements should Juan refer to and which ones should he construct so as to develop a fair assessment of the

firm’s financial condition? Explain why?

Juan should refer to the Balance Sheet and Income statement of Quickfix Autoparts.

• The Balance Sheet shows a snapshot of a company• It also showcases the financial strength of the company at any point of

time. • an income statement shows how much revenue a company earned over a

specific period of time.• Juan should construct a statement of cash flows to know whether the

company generated cash.. • The statements of cash flows are classified as operating activities,

investing activities and financing activities.

Q4. Juan knows that he should compare Quickfix’s condition with an appropriate benchmark. How should he go about

obtaining the necessary comparison data?

• Juan could also use Time Trend Analysis which compares the past years data to find out the changes i.e. the trends that the company is following.

• The peer group analysis is to identify firms similar in the sense that they compete in the same markets, have similar assets and operate in similar ways.

• Juan could use the Standard Industrial Classification (SIC) codes. These are the four-digit codes established by the U.S government for statistical reporting.

• There are certain smaller peer companies in the same industry that have filled their return with security exchange commission. Juan could download their financial statements; read footnotes and Management Decision Analysis of those companies which would help him in decide where his company stands.

Q6. Comment on Quick fix’s liquidity, asset utilization, long-term solvency, and profitability

ratios. What arguments have to be made to convince the bank that they should grant Quick

fix the loan?

LIQUIDITY

2000 2001 2002 2003 20040

1

2

3

4

5

6

7

Current ratioQuick ratioCash ratio

2000 2001 2002 2003 2004Current ratio

6.4 3.7 3.6 3.6 3.8Quick ratio

2.5 2 0.6 0.6 0.6Cash ratio

2.4 1.9 0.5 0.2 0.1

LONG TERM SOLVENCY

Year 2000 2001 2002 2003 2004

Total debt

0.5

0.5

0.6

0.6

0.6

Debt-equity

0.9

1.2

1.8

1.8

1.8

Interest coverage

1.8

2.1

1.1

0.4

1.0

Cash coverage

1.1

0.7

-1.0

-2.8

-3.3

2000 2001 2002 2003 20040

0.5

1

1.5

2

2.5

debt ratio Debt-equity Interest coverage Series4

PROBITABILITY year 2000 2001 2002 2003 2004

Inventory turnover

1.9 2 1.3 1.4 1.5

Day sales in Inventory

190.1 184 279 256 237

Receivable turnover

60 54.6 39 11.3 11.2

Day sales in Receivable turn over

6.1 6.7 9.4 32.4 32.4

asset turnover

0.9 0.8 0.8 0.9 1

2000 2001 2002 2003 20040

50

100

150

200

250

300

Inventory turnover Daysales in IReceivable turnoverDay sales in RT asset turnover

EFFICIENCY

YEAR2000 2001 2002 2003 2004

Profit Margi 2.77%3.49%0.27%-1.8% -0.01%

ROA 2.60%2.89%0.21%-1.68%-0.01%

ROE 4.94%6.36%0.59%-4.76%-0.03%

2000 2001 2002 2003 2004

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

Profit MarginROAROE

• Quick fix should be granted a loan since their current assets are fair enough.

• They have more current assets than current liabilities

Q7. If you were the commercial loan officer and were approached by Andre for a short-term loan of $25,000, what

would your decision be? Why?

• Yes, Andre can be granted with short term loan of $25,000

• Short-term loans is available in both secured and unsecured forms. To avail secured quick term loan, the borrower has to place a property or so as collateral with the lender. For unsecured short term loan, no collateral is required but the interest rate is higher.

• Since, Andre’s current ratio and quick ratio show a fair picture, it is

advisable to provide him with a short-term loan.

• It may also be suggested that he goes for a short-term secured loan since he owns assets and he could keep it as collateral against the loan.

Q8. What recommendations should Juan make for improvement, if any?

• Need to work on inventory turnover ratio since it is low here which means the company needs more time to deplete its assets.

• This may be due to overstocking of assets, obsolescence, or deficiencies in

the product line or marketing effort. It is recommended that goods not be overstocked.

• The times interest ratio is also low in the last two years. This may be due to a lot of debt that the company has.

• Thus, it is recommended that the debt be reduced.

• A little bit of sensible planning and proper decision making at the right time can definitely help overcome these issues the company is facing at the moment.

Q9. What kind of problems do you think Juan would have to cope with when conducting a comprehensive financial statement analysis of Quickfix

Auto parts? What are the limitations of financial statement analysis in general?

Firstly, Juan would have to prepare a Statement of Cash flows and a Statement of Owner’s Equity.

Limitations• Past performance, good or bad is, not necessarily a good indicator of what will

happen with a customer in the future.• The more, out-of-date a customer’s financial statements are, the less value they

are to the credit department.• Without the notes to the financial statements, credit mangers cannot get a clear

picture of the scope of the credit risk they are considering.• The financial statement analysis is limited by the fact that financial statements are

“window dressed” by creative accountants.• The financial statement analysis just provides a snapshot of a business’ financial

health but not the complete moving picture.• It is also difficult to say whether a company is healthy seeing its financial

statements because that depends on the nature and size of the business.