Morning Star Canoe & Kayak Company: Analysis of Financial Statements

In the fall of 2021, Sue MacIntosh, owner of the Morning Star Canoe & Kayak Company, approached a local bank for additional funding of $1.5 million to meet the growing requirements of her canoe and kayak manufacturing company. Revenue had increased four-fold from $300,000 to $1,200,000 in three years and net income (N/I) had grown from $37,100 to $93,100 during the same period. Sue confidently discussed her future plans and the financial needs of her company with the bank manager.

In her discussion with the bank manager, Sue described the development of her company and the growth opportunities for the canoe and kayak market in Canada and the northern United States. Sue proudly described the performance of her company, which she believed was doing well in a highly competitive industry environment, to the bank manager. The manager looked over the financial records of Morning Star, including an income statement and balance sheet (see Exhibits 1 and 2), and gave them to his loan officer to analyze. He assured Sue that, once the documents were analyzed, he would get back to her with a decision about her loan. He instructed the loan officer to analyze the performance of the company and evaluate the loan application submitted by Sue as soon as possible and to provide a recommendation about the loan.

Canadian Canoe and Kayak Manufacturing

The Canadian Canoe and Kayak manufacturing industry is made up of a number of small and mediumsized companies. Larger companies offer a full line of standard canoes and kayaks that are built using automated manufacturing techniques. These companies sell through retail companies such as Canadian Tire or Costco. Smaller companies consider canoe and kayak building a craft and build a few models that meet more specialized needs of outdoor adventurists. These canoes are often manufactured with wood or specialized light-weight material such as Kevlar. Smaller manufacturers either sell through specialized retailers or directly to customers.

https://madeinca.ca/category/sports/canoeskayaks/

Sales of canoes and kayaks in Canada have grown rapidly during the past few years as there has been a growing interest in paddling, especially in the 30- to 40-year-old age group. The pandemic also contributed to the surge in demand as it did other types of outdoor activities such as cycling. However, sporadic shortages of raw materials limited production. Industry insiders and analysts are optimistic that growth in demand will continue to be robust during the next five years and project a healthy outlook for the industry.

The Morning Star Story

Sue MacIntosh graduated from engineering school in 2010 and spent the first few years of her career with a large multi-product manufacturing company. Sues passion for outdoor adventures led her to spend weekends and holidays canoeing and kayaking. She eventually left her corporate job and joined an Ontario-based company that manufactured lightweight canoes and kayaks. Sue applied her engineering talents and became an expert in designing and building canoes and kayaks. She decided to start her own company in the summer of 2018.

Sue knew that the canoe and kayak market was competitive, but she believed that she could create a blend of high quality and design coupled with a social presence that would enable her company to compete effectively. She sourced all of her materials locally and employed environmentally-friendly manufacturing techniques. Her manufacturing process was labour-intensive and she provided good benefits to her employees who shared her vision.

Sue poured all of her own financial resources into the company and borrowed money using her home and other assets as collateral. As the business grew, she continued to borrow, using her personal assets as security. Initial borrowing of $250,000 grew quickly into loans of $1,000,000. Morning Star was operating at maximum capacity in a rented warehouse that Sue had converted to a manufacturing facility. Sue knew that she would need state-of-the-art equipment and better space if she wanted to continue to grow her company. The company absorbed a lot of cash and Sues personal finances were maxed out.

Sue did not have formal business training and she relied on a friend who she employed on a part-time basis to keep the accounting records and prepare the financial statements. Sue had good relations with her customers, many of whom were also small businesses with limited financial resources. Sue supported her customers by selling on credit. She also tried to build up Morning Stars inventory levels so that she could respond quickly to new orders.

Sue was confident that the loan would help her take her company to the next level.

Required

As the loan officer, prepare a financial analysis for the bank manager and provide your recommendation about making the loan. You should also provide suggestions for actions that would help improve the financial performance of the company.

1. Your evaluation of the performance of the company.

2. Your loan recommendation, including a discussion of the pros and cons of making the loan.

3. Your suggestions for improving the financial performance of the company.

EXHIBIT 1: INCOME STATEMENT, July 1 to June 30 (IN THOUSANDS) 2018-2019 100,000 200,000 300,000 180,000 120,000 40,000 2019-2020 150,000 600,000 750,000 450,000 300,000 100,000 2020-2021 200,000 1,000,000 1,200,000 720,000 480,000 200,000 Sales - Cash Sales - Credit Total sales Cost of goods sold Gross profit Selling, general, and administrative expenses Depreciation Operating income Interest expense Income before tax Tax@30% Net income 15,000 65,000 12,000 53,000 15,900 37,100 40,000 160,000 40,000 120,000 36,000 84,000 75,000 205,000 72,000 133,000 39,900 93,100 EXHIBIT 2: BALANCE SHEET (IN THOUSANDS) June 30, 2019 June 30, 2020 June 30, 2021 Assets Cash and cash equivalents Accounts receivable Inventories Current assets Property, Plant and Equipment (net of accumulated depreciation) Total assets 132, 100 40,000 45,000 217,500 150,000 191,100 150,000 120,000 461,100 400,000 154,200 300,000 260,000 714,200 750,000 367,100 861,100 1,464,200 Liabilities and Shareholder's equity Account payable Current portion of LT debt Current liabilities Long-term debt Total liabilities Share capital - common Retained earnings Total shareholders' equity Total liabilities and equity 30,000 50,000 80,000 100,000 180,000 150,000 37,100 187,100 367,100 90,000 100,000 190,000 400,000 590,000 150,000 121,100 271,100 861,100 200,000 200,000 400,000 700,000 1,100,000 150,000 214,200 364,200 1,464,200 EXHIBIT 3: INDUSTRY AVERAGES Current ratio Quick ratio Accounts receivable turnover ratio Average collection period Inventory turnover ratio Days in inventory Financial debt to equity ratio Operating liabilities to equity ratio Gross profit ratio Net profit ratio Return on equity Return on total assets Total asset turnover ratio Fixed asset turnover ratio Times interest earned ratio 2:1 1.5:1 6 times 60.8 days 7 times 50.7 days 120% 30% 40% 12% 40% 24% 2.0 3 5