Avery Products, Inc.
1. Calculate the key financial ratios for Avery Products, Inc., for each year and ratio suggested in the case’s industry averages. Analyze the trends for each ratio.
2. What strengths and weaknesses are revealed by the ratio analysis? • Quick Ratio: The ratio is declining which reflects higher liabilities and cash flow problems of the company • Current Ratio: The ratio is declining which means that Avery is having problems with liquidity. • Inventory Turnover: The ratio is increasing which shows that Avery has liquidity problems since their inventories are not moving fast enough. • Average Collection Period: The ratio is increasing which shows that Avery has problems with collecting on accounts receivables. • Fixed …show more content…
Asset Turnover: The industry average is 13 and so Avery is almost on par with the industry average. • Total Asset Turnover: Here the ratio is declining which reflects lower sales and hence lower receivables. • Return on Total Asset: The ratio is declining which means higher cost of goods sold. • Return on Net Worth: The ratio is declining which shows net income is much lower than the liabilities. • Debt Ratio: The ratio is increasing but is still below industry average. • Profit Margin on Sales: The ratio is declining which reflects lower profit margin on sales.
3. What amount of internal 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, 1997, to June 30, 1997, would the company be able to retire the loan on June 30, 1997?
Ans)
Additional revenue generated from matching industry for inventory turnover
Sales/Inventory= Inventory Turnover
2900000/Inventory= 7 (industry inventory turnover avg)
Inventory= $ 414,286
Previous Inventory= $ 826,200
Hence savings generated from reducing ending inventory will lead to freeing up of cash as mentioned below-
Savings= Previous Inventory- New Ending Inventory = $826,200-$414,286 = $411,914
Savings generated from matching industry average collection period
Avg. Collection Period= 365/(Sales/Accounts Receivable)
32 days (Industry Average)=365/(2900000/Accounts Receivables)
Accounts Receivables= $254,246.00
Previous Accounts Receivables= $388,000
Hence savings generated = $388,000- $254,246 = $133,754
Looking at the savings above, Avery can save around $ 414,914+ $133,754= $548,668 by just matching their inventory turnover ratio and average collection period to that of the industry average.
4. 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 30,1997?
Ans.) If Avery products successfully follows industry standards and is able to improve its liquidity situation, then the bank should grant the additional loan and extend the line of credit to June 30, 1997. i.e. If Avery products are able to bring down their ending inventory down and at the same time reduce their expenses (COGS and others) and thus increasing the net profit margin, then only the bank should grant the additional loan and extend the line of credit. If they are not able to follow this, then bank should consider of not giving them additional loan.
5. If the credit extension is not made, what alternatives are open to Avery Products?
Ans.) If the bank decides against the credit extension, the alternatives open for Avery products are: • Collect account receivable: This can be done by offering discounts or other
benefits. • Reduce inventory turnover period: Control the purchase inventory by following the JIT technique. In this way there will not be a difference of many days between the accounts payable and accounts receivable making the finance requirement minimum. • Increase profit margin: We can see that the profit margin has reduced from 5% to 1.85% in 2 years. The main reason for this is the increase in general and miscellaneous expenses. It is very important to control this in order to increase profitability. • Reduce COGS
6. Under what circumstances is the validity of comparative ratio analysis questionable?
Ans.) Below are a few circumstances in which the ratio analysis will be questionable: • Technological advancement of competitor: There is a possibility that the competitor has better technology for production, that allows them to manufacture faster, with less inventory turnover ratio and better average collection period • Size of the company: If Avery is relatively small in size than its competitors, it will have a higher COGS and a higher avg. collection period. • Entry level and industry size: If there are many competitors in the industry and Avery is a late entrant its ratios are bound to differ from the industry. • Political and legal environment.
-----------------------
[pic]
2. What strengths and weaknesses are revealed by the ratio analysis? • Quick Ratio: The ratio is declining which reflects higher liabilities and cash flow problems of the company • Current Ratio: The ratio is declining which means that Avery is having problems with liquidity. • Inventory Turnover: The ratio is increasing which shows that Avery has liquidity problems since their inventories are not moving fast enough. • Average Collection Period: The ratio is increasing which shows that Avery has problems with collecting on accounts receivables. • Fixed …show more content…
Asset Turnover: The industry average is 13 and so Avery is almost on par with the industry average. • Total Asset Turnover: Here the ratio is declining which reflects lower sales and hence lower receivables. • Return on Total Asset: The ratio is declining which means higher cost of goods sold. • Return on Net Worth: The ratio is declining which shows net income is much lower than the liabilities. • Debt Ratio: The ratio is increasing but is still below industry average. • Profit Margin on Sales: The ratio is declining which reflects lower profit margin on sales.
3. What amount of internal 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, 1997, to June 30, 1997, would the company be able to retire the loan on June 30, 1997?
Ans)
Additional revenue generated from matching industry for inventory turnover
Sales/Inventory= Inventory Turnover
2900000/Inventory= 7 (industry inventory turnover avg)
Inventory= $ 414,286
Previous Inventory= $ 826,200
Hence savings generated from reducing ending inventory will lead to freeing up of cash as mentioned below-
Savings= Previous Inventory- New Ending Inventory = $826,200-$414,286 = $411,914
Savings generated from matching industry average collection period
Avg. Collection Period= 365/(Sales/Accounts Receivable)
32 days (Industry Average)=365/(2900000/Accounts Receivables)
Accounts Receivables= $254,246.00
Previous Accounts Receivables= $388,000
Hence savings generated = $388,000- $254,246 = $133,754
Looking at the savings above, Avery can save around $ 414,914+ $133,754= $548,668 by just matching their inventory turnover ratio and average collection period to that of the industry average.
4. 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 30,1997?
Ans.) If Avery products successfully follows industry standards and is able to improve its liquidity situation, then the bank should grant the additional loan and extend the line of credit to June 30, 1997. i.e. If Avery products are able to bring down their ending inventory down and at the same time reduce their expenses (COGS and others) and thus increasing the net profit margin, then only the bank should grant the additional loan and extend the line of credit. If they are not able to follow this, then bank should consider of not giving them additional loan.
5. If the credit extension is not made, what alternatives are open to Avery Products?
Ans.) If the bank decides against the credit extension, the alternatives open for Avery products are: • Collect account receivable: This can be done by offering discounts or other
benefits. • Reduce inventory turnover period: Control the purchase inventory by following the JIT technique. In this way there will not be a difference of many days between the accounts payable and accounts receivable making the finance requirement minimum. • Increase profit margin: We can see that the profit margin has reduced from 5% to 1.85% in 2 years. The main reason for this is the increase in general and miscellaneous expenses. It is very important to control this in order to increase profitability. • Reduce COGS
6. Under what circumstances is the validity of comparative ratio analysis questionable?
Ans.) Below are a few circumstances in which the ratio analysis will be questionable: • Technological advancement of competitor: There is a possibility that the competitor has better technology for production, that allows them to manufacture faster, with less inventory turnover ratio and better average collection period • Size of the company: If Avery is relatively small in size than its competitors, it will have a higher COGS and a higher avg. collection period. • Entry level and industry size: If there are many competitors in the industry and Avery is a late entrant its ratios are bound to differ from the industry. • Political and legal environment.
-----------------------
[pic]