Background

American Construction, Inc. (American) begins operations on April 1, 2004 as a general corporation. (Fiscal period for the company ends March 31.) The company operates as a general contractor engaged in commercial and institutional building construction. The company provides construction services to construct structures such as schools, low-rise office buildings, restaurants, malls and retail stores, and office-warehousing facilities. In addition, the company actively seeks work for remodel and restoration of commercial and institutional facilities as noted above. The company self-performs concrete, steel, masonry, and carpentry work. All other work is subcontracted.

During the first three years of operation, the company experiences rapid growth thanks to strong markets that reduced the effects of price competition. The growth is supported by sound financial backing from the sale of stock to the principal owners, retained earnings and the acquisition of long term debt. Strong financial statements coupled with seemingly good management expertise allow the companys bonding capacity to peak at $20,000,000 annual revenue as of March 31, 2007.

The fiscal period April 1, 2007 to March 31, 2008 shows a slow down in construction in the local Midwest region where American operates. Company revenue declines from $14,000,000 to $10,000,000. American lowers its price on bid work (mostly new construction) in order to be competitive. In response to Americans poor profit showing for the period ending March 31, 2008, the surety company reduces Americans bonding capacity to $8,000,000 annual revenue.

Currently Americans management is concerned about Americans poor profit showing. The team needs to determine the financial state of the company and wants to track this financial state over the last four years. The balance sheets for the last four years are shown in Table 3.9 and the income statements are shown in Table 3.10. Among other issues, management needs to determine how bad the current financial condition of the company might be and what can be done to turn the company around.

Once the management decides courses of action that need to be taken, the company can prepare a budgeted income statement for the coming fiscal year. The budget will be used to develop overhead and profit mark-up rates for bid work as well as time and material work. The budget will be used to control company operating expense, as well as prepare the company cash flow projection.

Table 3.9. Balance sheets for American Construction, Inc.

Account	3/31/2005	3/31/2006	3/31/2007	3/31/2008
Cash	200,000	280,000	390,000	160,000
Accounts Receivable	650,000	1,104,000	3,400,000	2,000,000
Retainage Receivable	50,000	96,000	300,000	205,200
Material Inventory	80,000	140,000	170,000	70,000
Under-billings	200,000	420,000	500,000	250,000
Other Current Assets	20,000	30,000	40,000	40,000
Total Current Assets	1,200,000	2,070,000	4,800,000	2,725,200
Equipment (Gross)	120,000	216,000	360,000	360,000
Less: Acc. Dep.	24,000	67,200	139,200	211,200
Equipment (Net)	96,000	148,800	220,800	148,800
Building (Gross)	60,000	60,000	60,000	60,000
Less: Acc. Dep.	3,000	6,000	9,000	12,000
Building (Net)	57,000	54,000	51,000	48,000
Land	47,000	47,000	47,000	47,000
Total Non-Current Assets	200,000	249,800	318,800	243,800
Total Assets	1,400,000	2,319,800	5,118,800	2,969,000
Equities
Liabilities
Account Payable	100,000	200,000	560,000	475,000
Subcontracts Payable	200,000	430,000	1,270,000	400,000
Retainage Payable	20,000	50,000	170,000	75,000
Over-billings	100,000	200,000	600,000	700,000
Note Payable (current)	100,000	150,000	300,000	150,000
Income Tax Payable	28,000	40,000	58,000	<14,000>
Current Portion (L/T/D)	40,000	64,000	200,000	100,000
Other Current Liability	12,000	16,000	42,000	14,000
Total Current Liability	600,000	1,150,000	3,200,000	1,900,000
Long Term Debt	100,000	389,800	818,800	145,000
Total Liability	700,000	1,539,800	4,018,800	2,045,000
Net Worth
Capital Stock	650,000	650,000	840,000	700,000
Retained Earnings	50,000	130,000	260,000	224,000
Total Net Worth	700,000	780,000	1,100,000	924,000
Total Equities	1,400,000	2,319,800	5,118,800	2,969,000

Table 3.10. Income statements for American Construction, Inc.

	2005	2006	2007	2008
Account	$	$	$	$
Earnings	4,000,000	7,000,000	14,000,000	10,000,000
Cost of Construction
Labor	640,000	1,120,000	2.240,000	1,600,000
Material	1,600,000	2,800,000	5,600,000	4,000,000
Subcontracts	960,000	1,890,000	4,480,000	3,200,000
Other Direct Cost (JOH)	80,000	140,000	280,000	200,000
Total Direct Cost	3,280,000	5,950,000	12,600,000	9,000,000
Gross Profit	720,000	1,050,000	1,400,000	1,000,000
Operating Expense
Variable Operating Expense
Auto and Truck	60,000	105,000	210,000	150,000
Communications	24,000	42,000	84,000	60,000
Interest (Work in progress)	40,000	70,000	140,000	100,000
Insurance (Work in progress)	136,000	196,000	204,200	237,000
Other Variable Expense	8,000	14,000	28,000	20,000
Total Variable Expense	268,000	427,000	666,200	567,000
Fixed Operating Expense
Contributions	9,000	7,000	5,000	5,000
Depreciation (Equipment)	24,000	43,200	72,000	72,000
Depreciation (Building)	3,000	3,000	3,000	3,000
Insurance (Equipment)	8,000	18,000	27,000	29,000
Interest (Equipment)	8,000	14,000	28,000	20,000
Rent	36,000	40,000	44,000	44,000
Salaries	246,000	334,800	334,800	300,000
Other Fixed Expense	18,000	20,000	10,000	10,000
Total Fixed Operating Exp.	352,000	480,000	523,800	483,000
Total Operating Expense	620,000	907,000	1,190,000	1,050,000
Net Profit (before tax)	100,000	143,000	210,000	<50,000>
Tax (28%)	28,000	40,040	58,800	<14,000>
Net Profit (after tax)	72,000	102,960	151,200	<36,000>
Dividends	22,000	22,960	21,200	0
Retained earnings	50,000	80,000	130,000	<36,000>

Requirements

As a member of Americans management team, and the only one who knows anything about analyzing company financial statements (not an uncommon occurrence), it is your responsibility to determine the financial strengths and weakness of the company. Most importantly, the owners of the company are concerned about the risk of their investment. You may perform the following analyses using Excel spreadsheets.

1. Perform a horizontal analysis of the balance sheet for the period ending March 31, 2007 by comparing the ending balance to the beginning balance for this fiscal period with the spreadsheet shown below (Hint: Please refer to Pages 3-9, 3-10, and 3-11):

	3/31/2007	3/31/2006	Change	Change
Account	$	$	$	%

2. Perform a vertical analysis on the income statement for the period ending March 31, 2008. (Hint: Please refer to Pages 3-15 and 3-16)

3. Use the completed vertical analysis for the period ending March 31, 2008 and the cost-volume-profit analysis to answer the following questions. (Hint: Please refer to Pages between 3-16 and 3-21)

a. What is the actual cost structure for American in 2008? (Hint: Please refer to Page 3-6)

b. Given the cost structure as shown on the income statement, what volume in dollars must be generated for the company to break even? (Hint: Please refer to the example on Pages 3-20 and 3-21)

c. Given the cost structure as shown on the income statement, what volume in dollars must be generated to yield $150,000 net profit before tax?

d. Given the cost structure as shown on the income statement, what volume in dollars must be generated to yield a 1% profit after tax?

4. Perform a trend on the ratios shown in the following table. For aging ratios such as the average age of accounts receivable, the trend will include results from the last three years. For all other ratios, the trend will include all four years. The ratios must appear in a spreadsheet as follows (Hint: Please refer to Pages between 3-23 and 3-33):

Ratio	2005	2006	2007	2008	*Range	**U/F	***Interpretation
CR = CA/CL
QR=(Cash+AR)/CL
WC = CA-CL
AAAR = AAR/R x 365 Days
AAAP = AAP/M x 365 days
D to E = D/E
DFAN = NFA/GFA (equipment)

* Range give range as stated in the text, if available

**U/F indicated whether the trend is unfavorable or favorable

*** Interpretation Defend your selection of favorable or unfavorable. Apply industry norms, if available, for those ratios where a range is not given.