Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as Manager of Cost Systems for Davis, Cohen, and O'Brien Public Accountants and started Track Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Stanley had spent nights and weekends developing a sophisticated cost accounting software program that became Track's initial product offering. As the firm grew, Stanley planned to develop and expand the software product offerings?all of which would be related to streamlining the accounting processes of medium- to large-sized manufacturers.

Although Track experienced losses during its first 2 years of operation?1997 and 1998?its profit has increased steadily from 1999 to the present (2003). The firm's profit history, including dividend payments and contributions to retained earnings, is summarized in Table 1. Stanley started the firm with a $100,000 investment?his savings of $50,000 as equity and a $50,000 long-term loan from the bank. He had hoped to maintain his initial 100 percent ownership in the corporation, but after experiencing a $50,000 loss during the first year of operation (1997), he sold 60 percent of the stock to a group of investors to obtain needed funds. Since then, no other stock transactions have taken place. Although he owns only 40 percent of the firm, Stanley actively manages all aspects of its activities; the other stockholders are not active in management of the firm. The firm's stock closed at $4.50 per share in 2002 and at $5.28 per share in 2003.

Stanley has just prepared the firm's 2003 income statement, balance sheet, and statement of retained earnings, shown in Tables 2, 3, and 4, along with the 2002 balance sheet. In addition, he has compiled the 2002 ratio values and industry average ratio values for 2003, which are applicable to both 2002 and 2003 and are summarized in Table 5 He is quite pleased to have achieved record earnings of $48,000 in 2003, but he is concerned about the firm's cash flows.

Specifically, he is finding it more and more difficult to pay the firm's bills in a timely manner and generate cash flows to investors?both creditors and owners. To gain insight into these cash flow problems, Stanley is planning to determine the firm's 2003 operating cash flow (OCF) and free cash flow (FCF).

Stanley is further frustrated by the firm's inability to afford to hire a software developer to complete development of a cost estimation package that is believed to have "blockbuster" sales potential. Stanley began development of this package 2 years ago, but the firm's growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Stanley's reluctance to fill this position stems from his concern that the added $80,000 per year in salary and benefits for the position would certainly lower the firm's earnings per share (EPS) over the next couple of years. Although the project's success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firm's sales and earnings would significantly rise once the 2- to 3-year development, production, and marketing process was completed. With all of these concerns in mind, Stanley set out to review the various data to develop strategies that would help to ensure a bright future for

Track Software. Stanley believed that as part of this process, a thorough ratio analysis of the firm's 2003 results would provide important additional insights.

Table 1 Track Software, Inc. Profit, Dividends, and Retained Earnings, 1997-2003 Contribution to Net profits after taxes Dividends paid retained carnings [(1) - (2)] Year (1) (2) (3) 1997 ($50,000) V ($50,000) 1998 ( 20,000) ( 20,000) 1999 15,000 15,000 2000 35,000 35,000 2001 40,000 1.000 39,000 2002 43,000 3,000 40,000 2003 48,000 5,000 43,000Table 2 Track Software, Inc. Income Statement ($000) for the Year Ended December 31, 2003 Sales revenue $1,550 Less: Cost of goods sold 1,030 Gross profits $ 520 Less: Operating expenses Selling expense $150 General and administrative expense 270 Depreciation expense 11 Total operating expense 431 Operating profits (EBIT) S 89 Less: Interest expense 29 Net profits before taxes 5 60 Less: Taxes (20%) 12 Net profits after taxes S 48Table 3 Track Software, Inc. Balance Sheets ($000) December 31 Assets 2003 2002 Current assets Cash $ 12 $ 31 Marketable securities 66 82 Accounts receivable 152 104 Inventories 191 145 Total current assets $421 $362 Gross fixed assets $195 $180 Less: Accumulated depreciation 63 52 Net fixed assets $132 $128 Total assets $553 $490 Liabilities and Stockholders' Equity Current liabilities Accounts payable $136 $126 Notes payable 200 190 Accruals 27 25 Total current liabilities $363 $341 Long-term debt $ 38 $ 40 Total liabilities $401 $381 Stockholders' equity Common stock (50,000 shares outstanding at $0.40 par value) $ 20 $ 20 Paid-in capital in excess of par 30 30 Retained earnings 102 59 Total stockholders' equity $152 $109 Total liabilities and stockholders' equity $553 $490Table 4 Track Software, Inc. Statement of Retained Earnings ($000) for the Year Ended December 31, 2003 Retained earnings balance (January 1, 2003) $ 59 Plus: Net profits after taxes (for 2003) 48 Less: Cash dividends on common stock (paid during 2003) 5 Retained earnings balance (December 31, 2003) $102Table 5 Actual Industry average Ratio 2002 2003 Current ratio 1.06 1.82 Quick ratio 0.63 1.10 Inventory turnover 10.40 12.45 Average collection period 29.6 days 20.2 days Total asset turnover 2.66 3.92 Debt ratio 0.78 0.55 Times interest earned ratio 3.0 5.6 Gross profit margin 32.1% 42.3% Operating profit margin 5.5% 12.4% Net profit margin 3.0% 4.0% Return on total assets (ROA) 8.0% 15.6% Return on common equity (ROE) 36.4% 34.7% Price/earnings (P/E) ratio 5.2 7.1 Market/book (M/B) ratio 2.1 2.2