Question
Roger Elliot, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted to the deteriorating financial position of one of
Roger Elliot, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted to the deteriorating financial position of one of his clients, Seal-best, Inc., by his bank's newly instituted computer loan-analysis program. The bank requires quarterly financial statements - balance sheets and income statements - from each of its major loan customers. This information is fed into the computer, which then calculates the key ratios for each customer, charts trends in these ratios, and compares the statistics of each company with the average ratios and trends of other firms in the same industry. If any ratio of any company is significantly poorer than the industry average, the computer output makes note of this fact. If the terms of a loan require that certain ratios be maintained at specified minimum levels and these minimums are not being met by a company, the computer output notes the deficiency.
When an analysis was run on Seal-best three months earlier, Elliot noticed that some of the company's ratios were showing downward trends, dipping below the averages for the dairy products industry. Elliot sent a copy of the computer output, together with a note voicing his concern, to Eric Swenson, president of Seal-best. Although Swenson acknowledged receipt of the material, he took no action to correct the situation.
- 1) Calculate the key financial ratios for Seal-best, Inc., and plot trends in the firm's ratios against the industry averages.
- 2) What strengths and weaknesses are revealed by the ratio analysis?
- 3) What amount of internally-generated funds would be available for the retirement of the loan? If the bank were to grant the additional credit and extend the increased loan from a due date of February 1 to June 30, would the company be able to retire the loan on June 30? (Hint: To answer this question, consider profits and depreciation as well as the amount of inventories and receivables that would be carried if Seal-best's inventory turnover and average collection period (Days Sales Outstanding) were at industry average levels, that is, generating funds by reducing inventories and receivables to industry averages.)
- 4) In 2018, Seal-best's return on equity was 5.38 percent, versus 18 percent for the industry. Use the duPont equation to pinpoint the factors causing Seal-best to fall so far below the industry average.
5) On the basis of your financial analysis, do you believe that the bank should grant the additional loan and extend the entire line of credit to June 30?
YEAR ENDED DECEMBER 31
2015 | 2016 | 2017 | 2018 | ||
Cash | $ 34,000 | $ 51,000 | $ 23,800 | $ 17,000 | |
Accounts Receivable | 136,000 | 204,000 | 231,200 | 323,000 | |
Inventory | 170,000 | 255,000 | 425,000 | 688,500 | |
Total Current Assets | $ 340,000 | $ 510,000 | $ 680,000 | $ 1,028,500 | |
Land and Building | 51,000 | 40,800 | 108,800 | 102,000 | |
Machinery | 68,000 | 125,800 | 98,600 | 85,000 | |
Other Fixed Assets | 40,800 | 23,800 | 6,800 | 5,100 | |
Total Assets | $ 499,800 | $ 700,400 | $ 894,200 | $ 1,220,600 | |
Notes Payable, bank | --- | --- | 85,000 | 238,000 | |
Accounts and Notes Payable | 74,800 | 81,600 | 129,200 | 255,000 | |
Accruals | 34,000 | 40,800 | 47,600 | 64,600 | |
Total Current Liabilities | 108,800 | 122,400 | 261,800 | 557,600 | |
Mortgage | 51,000 | 37,400 | 34,000 | 30,600 | |
Common Stock | 306,000 | 306,000 | 306,000 | 306,000 | |
Retained Earnings | 34,000 | 234,600 | 292,400 | 326,400 | |
Total Liabilities & Equity | $ 499,800 | $ 700,400 | $ 894,200 | $ 1,220,600 |
SEAL-BEST, INC. INCOME STATEMENT
2016 | 2017 | 2018 | |
Net Sales | $ 2,210,000 | $2,295,000 | $2,380,000 |
Cost of Goods Sold | 1,768,000 | 1,836,000 | 1,904,000 |
Gross Operating Profit | 442,000 | 459,000 | 476,000 |
General, Administrative, Selling | 170,000 | 187,000 | 204,000 |
Depreciation | 68,000 | 85,000 | 102,000 |
Miscellaneous | 34,000 | 71,400 | 102,000 |
EBT | 170,000 | 115,600 | 68,000 |
Taxes (50%) | 85,000 | 57,800 | 34,000 |
Net Income | $ 85,000 | $ 57,800 | $ 34,000 |
Quick Ratio Current Ratio Inventory Turnover Average Collection Period Fixed Asset Turnover (b) Total Asset Turnover (b) Return on Total Assets Dairy Products Industry Ratios (2018) (a) 1.0 2.7 7 times 32 days 13.0 times 2.6 times 9% Quick Ratio Current Ratio Inventory Turnover Average Collection Period Fixed Asset Turnover (b) Total Asset Turnover (b) Return on Total Assets Dairy Products Industry Ratios (2018) (a) 1.0 2.7 7 times 32 days 13.0 times 2.6 times 9%
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