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 medium- sized 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.

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.

Your analysis and report should include:

1. Statements of cash flows for the years ending June 30 of 2019, 2020 and 2021.

2. Vertical (common-size) income statements and balance sheet for the three years.

3. Horizontal (trend) analysis for the three-year period.

4. Financial ratios for two or three years.

5. Your evaluation of the performance of the company.

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

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

Notes: Assume beginning balances for all accounts are 0 on July 1, 2018. Please use the indirect method for preparing the operating activities section of the statements of cash flows.

EXHIBIT 1: INCOME STATEMENT, July 1 to June 30 (IN THOUSANDS)

	2018-2019	2019-2020	2020-2021
Sales - Cash	100,000	150,000	200,000
Sales - Credit	200,000	600,000	1,000,000
Total sales	300,000	750,000	1,200,000
Cost of goods sold	180,000	450,000	720,000
Gross profit	120,000	300,000	480,000
Selling, general, and administrative expenses	40,000	100,000	200,000
Depreciation	15,000	40,000	75,000
Operating income	65,000	160,000	205,000
Interest expense	12,000	40,000	72,000
Income before tax	53,000	120,000	133,000
Tax@30%	15,900	36,000	39,900
Net income	37,100	84,000	93,100

EXHIBIT 2: BALANCE SHEET (IN THOUSANDS)

	June 30, 2019	June 30, 2020	June 30, 2021
Assets
Cash and cash equivalents	132,100	191,100	154,200
Accounts receivable	40,000	150,000	300,000
Inventories	45,000	120,000	260,000
Current assets	217,500	461,100	714,200
Property, Plant and Equipment (net of accumulated depreciation)	150,000	400,000	750,000
Total assets	367,100	861,100	1,464,200
Liabilities and Shareholders equity
Account payable	30,000	90,000	200,000
Current portion of LT debt	50,000	100,000	200,000
Current liabilities	80,000	190,000	400,000
Long-term debt	100,000	400,000	700,000
Total liabilities	180,000	590,000	1,100,000
Share capital common	150,000	150,000	150,000
Retained earnings	37,100	121,100	214,200
Total shareholders equity	187,100	271,100	364,200
Total liabilities and equity	367,100	861,100	1,464,200

EXHIBIT 3: INDUSTRY AVERAGES

Current ratio	2:1
Quick ratio	1.5:1
Accounts receivable turnover ratio	6 times
Average collection period	60.8 days
Inventory turnover ratio	7 times
Days in inventory	50.7 days
Financial debt to equity ratio	120%
Operating liabilities to equity ratio	30%
Gross profit ratio	40%
Net profit ratio	12%
Return on equity	40%
Return on total assets	24%
Total asset turnover ratio	2.0
Fixed asset turnover ratio	3
Times interest earned ratio	5