Track Software, Inc.

Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as manager of cost systems for Davis, Cohen, and OBrien Public Accountants and started Track Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and OBrien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Tracks 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 operation2009 and 2010its profit has increased steadily from 2011 to the present (2015). The firms 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 (2009), 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 firms stock was valued at $4.50 per share in 2014 and at $5.28 per share in 2015.

Table 1

Track Software, Inc., Profit, Dividends, and Retained Earnings, 20092015

Year Net profits after taxes (1)Dividends paid (2) Contribution to retained earnings [(1) (2)] (3) 2009 ($50,000) $ 0 ($50,000) 2010 (20,000) 0 (20,000) 2011 15,000 0 15,000 2012 35,000 0 35,000 2013 40,000 1,000 39,000 2014 43,000 3,000 40,000 2015 48,000 5,000 43,000

Stanley has just prepared the firms 2015 income statement, balance sheet, and statement of retained earnings, shown in Tables 2, 3, and 4, along with the 2014 balance sheet. In addition, he has compiled the 2014 ratio values and industry average ratio values for 2015, which are applicable to both 2014 and 2015 and are summarized in Table 5. He is quite pleased to have achieved record earnings of $48,000 in 2015, but he is concerned about the firms cash flows. Specifically, he is finding it more and more difficult to pay the firms 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 firms 2015 operating cash flow (OCF) and free cash flow (FCF). Stanley is further frustrated by the firms 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 firms growing complexity has forced him to devote more of his time to administrative duties, thereby halting the development of this product. Stanleys 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 firms earnings per share (EPS) over the next couple of years. Although the projects success is in no way guaranteed, Stanley believes that if the money were spent to hire the software developer, the firms sales and earnings would significantly rise once the 2- to 3-year development, production, and marketing process was completed. With all these concerns in mind, Stanley set out to review the various data to develop strategies that would help ensure a bright future for Track Software. Stanley believed that as part of this process, a thorough ratio analysis of the firms 2015 results would provide important additional insights.

Table 2

Track Software, Inc., Income Statement ($000) for the Year Ended December 31, 2015

Sales revenue $ 1,550 Less: Cost of goods sold $ 1,030 Gross profits $ 520 Less: Operating expenses Selling expense $ 150 General and administrative expenses 270 Depreciation expense 11 Total operating expense 431 Operating profits (EBIT) $ 89 Less: Interest expense 29 Net profits before taxes $ 60 Less: Taxes (20%) 12 Net profits after taxes $ 48

Table 3

Track Software, Inc., Balance Sheet ($000)

December 31

Assets 2015 2014

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

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

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 $490

Table 4

Track Software, Inc., Statement of Retained Earnings ($000) for the Year Ended December 31, 2015

Retained earnings balance (January 1, 2015) $ 59

Plus: Net profits after taxes (for 2015) 48

Less: Cash dividends on common stock (paid during 2015) 5

Retained earnings balance (December 31, 2015) $102

Table 5

Ratio

Actual

2014

Industry average

2015

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

TO DO:

(D) Evaluate the firm on both a cross-sectional and a time-series basis.