Answer the following based on the above information: (Mainly need help with Cash Flow statements and the memorandum)
- Prepare the following financial exhibits for 2013 through 2016:
- Ratio table
- Vertical analysis of income statements and balance sheets
- Horizontal analysis (index numbers) of income statements and balance sheets
- Cash flow statements
- 5-way analysis of ROE
- Assuming the role of William Wyler, CPA, prepare a 2-page memorandum that analyzes the financial condition of PGI and makes recommendations relating to the companys financial performance and proposed new product introduction. The memo should be divided into sections describing liquidity, asset management, long-term debt paying ability, profitability, and recommendations.
Power Green Industries In early January 2017, William Wyler, CPA, a senior manager at Myers Norris Penny LLP in Regina, Saskatchewan, was assigned the task of reviewing the financial performance of Power Green Industries (PGI) Ltd., a Canadian-based manufacturer of alternative electrical generating equipment. Before proceeding with the introduction of a revolutionary new product, PGI's board of director thought it prudent to retain an independent consultant to review the company's performance. Despite its rapid sales growth, the board was worried about PGI's financial ability to execute this expansion. Having taken two years of engineering before changing to accounting at university, Wyler feels he has the technical knowledge to understand the company's products, which will aid him in analyzing its financial performance. If this review goes smoothly, Wyler believes he will finally make partner after 10 years at the firm. Company Formation PGI was formed in 2005 by Dr. Maggi McGruder, P.Eng. who had taken a buyout from Natural Resources Canada, a department of the federal government of Canada, after becoming frustrated with the slow rate of implementation of her many ideas. McGruder completed her PhD in electrical engineering in 1997 at the University of Manitoba where her dissertation dealt with home and farm-based energy alternatives such as wind turbines, water turbines, solar panels, geothermal, and biogas. In the new start-up, she decided to focus on wind and water turbines and solar panels because of her background in electrical engineering. Also, in her opinion, the geothermal and biogas segments of the alternative energy industry were not cost effective in the long term. McGruder's knowledge of manufacturing and marketing was limited so she recruited two partners, Matthew Wiggins, P.Eng. and Nancy Cranston, CSP. Wiggins had over 30 years of experience supervising manufacturing facilities for companies such as Caterpillar, General Electric, and Nortel while Cranston had been a vice-president of marketing and sales for several equipment producers with her most recent position being with Stanley Tools. Each contributed CAD 200,000 for a 25.0% share of the company and the remainder of the seed capital was provided by Wilson Mclvor, a retired Fortune 500 CEO, who had been an "angel" to several other tech start-ups in Canada. After three rounds of funding from CanDo Venture Capital, each of the three founders' holdings had been reduced to 15.0%. In 2007, the angel and venture capitalists took PGI public in an initial public offering in order to exit the investment. The partners bought enough of the shares to maintain control. Company Expansion The period from 2005 to 2007 was a troublesome one for PGI. Products took much longer than planned to develop and production processes where difficult to master. Venture capital financing was also difficult to acquire, and the owners had to relinquish a much larger portion of the business than hoped to secure the needed funding. By 2008, the products and manufacturing facilities were in place. Despite initial hesitancy, several key distributors were recruited. In Canada, both Canadian Tire and Home Hardware agreed to carry PGI's products. Canadian Tire also featured them in one of their advertising campaigns where they stressed their new focus on environmentally friendly products. The Co-op, a farmer cooperative organization and major agricultural supply chain agreed to sell the products and allowed PGI to promote them at all their membership meetings. In the U.S. Eagle Hardware and several regional farmer cooperatives also signed distribution agreements. Sales of PGI's products increased dramatically from 2008 to 2016. Farmers welcomed them to reduce costs in a competitive industry and to avoid frequent power outages that can be problematic especially for dairy and poultry producers. People living in remote areas found them to be a cheaper alternative to burning fossil fuels, while environmentally conscious consumers felt they greatly reduced their ecological footprint. New Product Introduction To expand its product line further, PGI is currently developing an advanced power management system. This includes high-capacity batteries that store electricity to balance differences in generation and consumption as well as a monitoring system that automatically resells power to the local grid when user's needs are met, and prices offered by the local public utility are at their highest. The monitoring system also detects faulty storage batteries so they can be quickly replaced. PGI will produce its own batteries using technology licensed from a well-known research firm, but the remainder of this new system is being developed in-house and is considered "leading-edge" by the industry. Financial Data PGI provided Wyler with financial statements for the last five years, which are contained in Exhibit 1 and 2. A detailed breakdown of unit prices and costs and sales quantities for the last five years was also provided in Exhibit 3. Exhibit 1 Income Statements (CAD) 2012 2013 2014 711,100,000 850.762.000 1,625,324,200 421,650,000 516,212,000 1,021,419,200 289,450,000 334,550,000 603.905,000 2015 2.211.360,600 1,469,340,150 743.020,450 2016 2.651,882.800 1,791, 102,960 860,779,840 Sales Cost of sales Gross profit Operating costs Selling and distribution Research and development Administration Amortization Operating profit Interest Earnings before taxes Taxes Net income 74,500,300 45,890,340 24350 300 49,557,087 95, 151.973 14,189,065 80.962.908 28,337,018 52.625.890 85.984,000 55,689,500 32,534,000 56.830.350 103.512 150 17,386,710 86 125,440 30143,904 55,981.536 200.450.300 101,230,000 95,608,890 141,468,842 65,146,968 46,694,825 18,462, 143 6.461.750 12.000,393 231.530,000 185,640,000 124,890,000 142.920,000 58.040,450 51,226,136 6.814314 2.385,010 4,429,304 267,300 200 239,560,000 137,450,300 152.885,800 63.583.540 56,015,189 7.568,351 2,648,923 4,919,428 Cash Accounts receivable Parts inventory WIP inventory Finished goods inventory Total current assets Land, plant, and equipment, net Intangibles Total assets Exhibit 2 Balance Sheets (CAD) 2012 2013 2014 75,340,000 76,800,300 95,630,000 31.650.000 45,320,000 65,340,000 96,670,000 150,320,000 245,320,600 46,789,180 65,354,460 86,650,675 145,300,530 210,360,300 271,530,200 395,749,710 549.155.000 764,471,475 445 230.840 489,300.500 1,317,388,220 50 340.030 79,003.000 97,300,200 891,320,580 1,116,458,560 2,179,159,895 2015 55,320,100 75.800,300 339.760,200 124,532,030 314,580,400 909,993,030 1318,350,000 110,850,000 2,339,193,030 2016 15,430,300 95,300,000 423,340,000 145,673,800 389,640,200 1.069,394,300 1,402,870,000 125.998,000 2,598,242,300 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 68.700,400 23.453,000 92,153,400 234.530,000 564,637,180 891,320.580 95.620,000 26,790,000 122,410,000 267.900.000 726,148,560 1,116,458,560 167.500,300 69.575,000 237,075,300 695.750,000 1 246.334.595 2.179.159.895 240,650,430 73.453,020 314,103,450 734,530,200 1.290,559,380 2,339,193,030 320.640,430 79.567.030 400,207,460 795.670,300 1,402,364,540 2,599,242,300 Exhibit 3 Sales Analysis (CAD) 2012 2013 2014 2015 2016 9,500 5.750 15,000 9.500 5.932 21,000 9,500 6.010 55,560 9,500 6.230 62.500 9.500 6,500 85,600 Wind turbines Unit price Unit cost Quantity Water turbines Unit price Unit cost Quantity Solar panels Unit price Unit cost Quantity 5,400 3.900 2.500 5,400 4100 3.100 5,400 4,200 4,560 5,400 4,350 6.509 5,400 4.450 7.848 8,540 5.010 65,000 8,540 5,100 74,300 8,540 5,320 125,630 8,540 5,670 185,300 8,540 5,704 210340 Financial Benchmarks Exhibit 4 contains industry average information secured from Statistics Canada. Exhibit 4 Industry Averages Financial Ratios Current ratio Cash ratio Parts inventory turnover in days WIP inventory turnover in days FG inventory turnover in days Accounts receivable turnover in days Industry Averages 2016 4.90x 11x 33.71 days 15.93 days 51.98 days 30.44 days Accounts payable turnover in days Cash conversion scle Fixed assets turnover Total assets turnover Debt ratio Long-term debt total capitalization Times interest earned Cash flow coverage Gross profit margin Operating profit margin Net profit margin Retum on assets Retum on equity 1913 days 112.93 days 2.42x 1.22x 3296 29% 9.47x 2.66x 40.66% 14.04% 8.16% 6.4696 14.51% Vertical Analysis (96) Income Statement 2016 Sales 100.00 Cost of sales 59.34 Gross profit 40.66 Operating costs Selling and distribution 9.32 Research and development 7.02 Administration 4.83 Depreciation 5.45 Operating profit 14.04 Interest 1.48 Earnings before taxes 12.56 Taxes 4.40 Net income 9.16 Vertical Analysis (96) Balance Sheet 2016 Cash Accounts receivable Parts inventory WIP inventory Finished goods inventory Total current assets Land, plant and equipment, net Other assets Total assets 10.95 10.15 6.67 3.15 10.28 41.21 50.31 8.49 100.00 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 3.78 4.62 8.41 23.12 69.47 100.00 Operations In order to expand sales, PGI has kept its prices constant over the last five years despite increases by competitors. It also offers its distributors terms of 2/15, net 30, which vary from the industry standard of net 30. PGI designs and assembles its products in Canada but sources its components globally. As a precautionary measure, to guard against supply interruptions caused by strikes, material shortages, and transportation delays, it stockpiles many of its key parts. Its accounts payable relate primarily to inventory purchases. Industry standard credit terms are 3/15, net 60 and most suppliers charge interest of 10.0% per annum on any overdue accounts. In order to remain competitive with low-wage countries, PGI invested heavily in factory automation, but has had difficulties with many of the complex systems. Breakdowns and software "bugs" are commonplace as most of the equipment was bought from a low-cost supplier, which has since gone bankrupt. Low educational standards also made training difficult and lowered production efficiency. It was thought automation would allow the company to reduce finished goods inventory though just-in-time production, but the frequent breakdowns made it necessary to carry more stock. To accommodate company growth, PGI built a new corporate headquarters, R&D facility and distribution centre in 20014. Several existing buildings were considered, but a new facility in an expensive area of Toronto was constructed to increase the profile of the company. Retained earnings were insufficient to fund PGI' rapid growth, so large amounts of capital had to be raised externally - the company has yet to pay a dividend. Terms loans and mortgages were negotiated with five different banks to diversify its funding sources. PGI is listed on the Toronto and New York Stock Exchanges and has gone to the market in each of the past five years to sell equity. To avoid losing control, the three founding shareholders agreed to issue only non- voting common shares but is appears the market has lost its appetite for this type of security. PGI maintains a CAD 1,500,000 line of credit with Western Canadian Bank to finance seasonal variations in net working capital. The loan must be 200.0% secured by inventory and accounts receivable. Also, to comply with the different loan agreements, the current ratio must be kept above 2.5, the long-term debt to total capitalization below 30.0%, and the cash flow coverage ratio above 2.0 Power Green Industries In early January 2017, William Wyler, CPA, a senior manager at Myers Norris Penny LLP in Regina, Saskatchewan, was assigned the task of reviewing the financial performance of Power Green Industries (PGI) Ltd., a Canadian-based manufacturer of alternative electrical generating equipment. Before proceeding with the introduction of a revolutionary new product, PGI's board of director thought it prudent to retain an independent consultant to review the company's performance. Despite its rapid sales growth, the board was worried about PGI's financial ability to execute this expansion. Having taken two years of engineering before changing to accounting at university, Wyler feels he has the technical knowledge to understand the company's products, which will aid him in analyzing its financial performance. If this review goes smoothly, Wyler believes he will finally make partner after 10 years at the firm. Company Formation PGI was formed in 2005 by Dr. Maggi McGruder, P.Eng. who had taken a buyout from Natural Resources Canada, a department of the federal government of Canada, after becoming frustrated with the slow rate of implementation of her many ideas. McGruder completed her PhD in electrical engineering in 1997 at the University of Manitoba where her dissertation dealt with home and farm-based energy alternatives such as wind turbines, water turbines, solar panels, geothermal, and biogas. In the new start-up, she decided to focus on wind and water turbines and solar panels because of her background in electrical engineering. Also, in her opinion, the geothermal and biogas segments of the alternative energy industry were not cost effective in the long term. McGruder's knowledge of manufacturing and marketing was limited so she recruited two partners, Matthew Wiggins, P.Eng. and Nancy Cranston, CSP. Wiggins had over 30 years of experience supervising manufacturing facilities for companies such as Caterpillar, General Electric, and Nortel while Cranston had been a vice-president of marketing and sales for several equipment producers with her most recent position being with Stanley Tools. Each contributed CAD 200,000 for a 25.0% share of the company and the remainder of the seed capital was provided by Wilson Mclvor, a retired Fortune 500 CEO, who had been an "angel" to several other tech start-ups in Canada. After three rounds of funding from CanDo Venture Capital, each of the three founders' holdings had been reduced to 15.0%. In 2007, the angel and venture capitalists took PGI public in an initial public offering in order to exit the investment. The partners bought enough of the shares to maintain control. Company Expansion The period from 2005 to 2007 was a troublesome one for PGI. Products took much longer than planned to develop and production processes where difficult to master. Venture capital financing was also difficult to acquire, and the owners had to relinquish a much larger portion of the business than hoped to secure the needed funding. By 2008, the products and manufacturing facilities were in place. Despite initial hesitancy, several key distributors were recruited. In Canada, both Canadian Tire and Home Hardware agreed to carry PGI's products. Canadian Tire also featured them in one of their advertising campaigns where they stressed their new focus on environmentally friendly products. The Co-op, a farmer cooperative organization and major agricultural supply chain agreed to sell the products and allowed PGI to promote them at all their membership meetings. In the U.S. Eagle Hardware and several regional farmer cooperatives also signed distribution agreements. Sales of PGI's products increased dramatically from 2008 to 2016. Farmers welcomed them to reduce costs in a competitive industry and to avoid frequent power outages that can be problematic especially for dairy and poultry producers. People living in remote areas found them to be a cheaper alternative to burning fossil fuels, while environmentally conscious consumers felt they greatly reduced their ecological footprint. New Product Introduction To expand its product line further, PGI is currently developing an advanced power management system. This includes high-capacity batteries that store electricity to balance differences in generation and consumption as well as a monitoring system that automatically resells power to the local grid when user's needs are met, and prices offered by the local public utility are at their highest. The monitoring system also detects faulty storage batteries so they can be quickly replaced. PGI will produce its own batteries using technology licensed from a well-known research firm, but the remainder of this new system is being developed in-house and is considered "leading-edge" by the industry. Financial Data PGI provided Wyler with financial statements for the last five years, which are contained in Exhibit 1 and 2. A detailed breakdown of unit prices and costs and sales quantities for the last five years was also provided in Exhibit 3. Exhibit 1 Income Statements (CAD) 2012 2013 2014 711,100,000 850.762.000 1,625,324,200 421,650,000 516,212,000 1,021,419,200 289,450,000 334,550,000 603.905,000 2015 2.211.360,600 1,469,340,150 743.020,450 2016 2.651,882.800 1,791, 102,960 860,779,840 Sales Cost of sales Gross profit Operating costs Selling and distribution Research and development Administration Amortization Operating profit Interest Earnings before taxes Taxes Net income 74,500,300 45,890,340 24350 300 49,557,087 95, 151.973 14,189,065 80.962.908 28,337,018 52.625.890 85.984,000 55,689,500 32,534,000 56.830.350 103.512 150 17,386,710 86 125,440 30143,904 55,981.536 200.450.300 101,230,000 95,608,890 141,468,842 65,146,968 46,694,825 18,462, 143 6.461.750 12.000,393 231.530,000 185,640,000 124,890,000 142.920,000 58.040,450 51,226,136 6.814314 2.385,010 4,429,304 267,300 200 239,560,000 137,450,300 152.885,800 63.583.540 56,015,189 7.568,351 2,648,923 4,919,428 Cash Accounts receivable Parts inventory WIP inventory Finished goods inventory Total current assets Land, plant, and equipment, net Intangibles Total assets Exhibit 2 Balance Sheets (CAD) 2012 2013 2014 75,340,000 76,800,300 95,630,000 31.650.000 45,320,000 65,340,000 96,670,000 150,320,000 245,320,600 46,789,180 65,354,460 86,650,675 145,300,530 210,360,300 271,530,200 395,749,710 549.155.000 764,471,475 445 230.840 489,300.500 1,317,388,220 50 340.030 79,003.000 97,300,200 891,320,580 1,116,458,560 2,179,159,895 2015 55,320,100 75.800,300 339.760,200 124,532,030 314,580,400 909,993,030 1318,350,000 110,850,000 2,339,193,030 2016 15,430,300 95,300,000 423,340,000 145,673,800 389,640,200 1.069,394,300 1,402,870,000 125.998,000 2,598,242,300 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 68.700,400 23.453,000 92,153,400 234.530,000 564,637,180 891,320.580 95.620,000 26,790,000 122,410,000 267.900.000 726,148,560 1,116,458,560 167.500,300 69.575,000 237,075,300 695.750,000 1 246.334.595 2.179.159.895 240,650,430 73.453,020 314,103,450 734,530,200 1.290,559,380 2,339,193,030 320.640,430 79.567.030 400,207,460 795.670,300 1,402,364,540 2,599,242,300 Exhibit 3 Sales Analysis (CAD) 2012 2013 2014 2015 2016 9,500 5.750 15,000 9.500 5.932 21,000 9,500 6.010 55,560 9,500 6.230 62.500 9.500 6,500 85,600 Wind turbines Unit price Unit cost Quantity Water turbines Unit price Unit cost Quantity Solar panels Unit price Unit cost Quantity 5,400 3.900 2.500 5,400 4100 3.100 5,400 4,200 4,560 5,400 4,350 6.509 5,400 4.450 7.848 8,540 5.010 65,000 8,540 5,100 74,300 8,540 5,320 125,630 8,540 5,670 185,300 8,540 5,704 210340 Financial Benchmarks Exhibit 4 contains industry average information secured from Statistics Canada. Exhibit 4 Industry Averages Financial Ratios Current ratio Cash ratio Parts inventory turnover in days WIP inventory turnover in days FG inventory turnover in days Accounts receivable turnover in days Industry Averages 2016 4.90x 11x 33.71 days 15.93 days 51.98 days 30.44 days Accounts payable turnover in days Cash conversion scle Fixed assets turnover Total assets turnover Debt ratio Long-term debt total capitalization Times interest earned Cash flow coverage Gross profit margin Operating profit margin Net profit margin Retum on assets Retum on equity 1913 days 112.93 days 2.42x 1.22x 3296 29% 9.47x 2.66x 40.66% 14.04% 8.16% 6.4696 14.51% Vertical Analysis (96) Income Statement 2016 Sales 100.00 Cost of sales 59.34 Gross profit 40.66 Operating costs Selling and distribution 9.32 Research and development 7.02 Administration 4.83 Depreciation 5.45 Operating profit 14.04 Interest 1.48 Earnings before taxes 12.56 Taxes 4.40 Net income 9.16 Vertical Analysis (96) Balance Sheet 2016 Cash Accounts receivable Parts inventory WIP inventory Finished goods inventory Total current assets Land, plant and equipment, net Other assets Total assets 10.95 10.15 6.67 3.15 10.28 41.21 50.31 8.49 100.00 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 3.78 4.62 8.41 23.12 69.47 100.00 Operations In order to expand sales, PGI has kept its prices constant over the last five years despite increases by competitors. It also offers its distributors terms of 2/15, net 30, which vary from the industry standard of net 30. PGI designs and assembles its products in Canada but sources its components globally. As a precautionary measure, to guard against supply interruptions caused by strikes, material shortages, and transportation delays, it stockpiles many of its key parts. Its accounts payable relate primarily to inventory purchases. Industry standard credit terms are 3/15, net 60 and most suppliers charge interest of 10.0% per annum on any overdue accounts. In order to remain competitive with low-wage countries, PGI invested heavily in factory automation, but has had difficulties with many of the complex systems. Breakdowns and software "bugs" are commonplace as most of the equipment was bought from a low-cost supplier, which has since gone bankrupt. Low educational standards also made training difficult and lowered production efficiency. It was thought automation would allow the company to reduce finished goods inventory though just-in-time production, but the frequent breakdowns made it necessary to carry more stock. To accommodate company growth, PGI built a new corporate headquarters, R&D facility and distribution centre in 20014. Several existing buildings were considered, but a new facility in an expensive area of Toronto was constructed to increase the profile of the company. Retained earnings were insufficient to fund PGI' rapid growth, so large amounts of capital had to be raised externally - the company has yet to pay a dividend. Terms loans and mortgages were negotiated with five different banks to diversify its funding sources. PGI is listed on the Toronto and New York Stock Exchanges and has gone to the market in each of the past five years to sell equity. To avoid losing control, the three founding shareholders agreed to issue only non- voting common shares but is appears the market has lost its appetite for this type of security. PGI maintains a CAD 1,500,000 line of credit with Western Canadian Bank to finance seasonal variations in net working capital. The loan must be 200.0% secured by inventory and accounts receivable. Also, to comply with the different loan agreements, the current ratio must be kept above 2.5, the long-term debt to total capitalization below 30.0%, and the cash flow coverage ratio above 2.0
