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Zach Industries

P3-24 Financial statement analysis The financial statements of Zach Industries for the year ended December 31, 2015, follow.

Solution:

a.   Ratio Industry averageActual 2014Actual 2015
Current Ratio1.801.841.04
Quick ratio0.700.780.38
Inventory turnover2.502.592.33
Average Collection period37.5036.5057.03
times interest earned ratio3.804.002.79
Gross profit margin38%40%34%
Net profit margin3.5%3.6%4.1%
Return on total assets4.0%4.0%4.4%
Return on common equity9.5%8.0%11.3%
Market/book ratio1.11.21.3

b.

1-Liquidity

Industry and 2014 has higher liquidity position than Zack has in 2015. The current ratio in 2014 was above industry average but in 2015 it fell down from both the 2014 and industry average. Similarly, the current ratio has also fallen below both the industry average and of 2014. This means the liquidity of the company has moved towards adverse position. The inventories are 63.19% of the total current assets (Inventory*100/Total current assets) which means the company has either invested excessively in the inventories or failed to maintain adequate cash and other liquid current assets. This is the reason the quick ratio has shown a remarkably low result as compared to both 2014 and industry average. Right now company has $1.04 in current assets and $0.38 in quick assets to pay off the current liability of $1 which is considerably lower than the market average.

2-Activity

Inventory turnover is 2.33 times in 2015 which has fallen from 2.59 times as was in 2014. The industry average is 2.5 times which the company was meeting in 2014 but for 2015 it dropped below that level. One of the obvious reason could be the excessive investment in the inventories or the increase in the cost of goods sold due to possibly increasing labor and overhead rates but from the liquidity position the inventory has been excessively piled up by the company therefore the inventory turnover has dropped below the industry average. The average collection period has also fallen below the industry average which in 2014 was better than the industry average. This means company has been facing money tied up in the receivables far more than the average of the industry businesses does.

3-Debt

Right now the debt ratio is 61.3 percent (Total debt/Total Assets) which means more than half of the Zack Industries’ financing is coming from parties other than common stockholders. This poses the company to a high financial risk. The company’s previous debt ratio and the industry average would give a clearer picture though but decline in the times interest earned ratio also suggests that the company is either experiencing lower profitability or it has to pay interests heavily. From the calculations above the net profit margin is nearly equal to market but return on equity is higher than the industry which means the average of industry company is not using this much amount of debt in its capital structure.

4-Profitability

Again the Gross profit margin for 2015 is lower than both of 2014 and industry average. The reason may be the decline in the selling price, change in sales mix or the increase in the cost of goods sold. Zack industries did well in the net profit margin which suggests that it has cut down some considerable operating expenses to achieve higher net profit margin than it had in 2014 and the industry average. Further, the return on equity in 2015 is also higher than both the industry and 2014’s. The reason may be the higher profits or the increased debts. But increased debts may also increase the interest payment i.e. lower net profit. Overall, Zack Industries has improved in the profitability area.

5-Market

            Zack Industries has shown a great improvement in this area. The market/book ratio is very useful ratio for an investor as is shows what positive expectations market has from the company which has been increased so far. The market over book value reveals the value of goodwill or other expectations attached with company’s operations. Therefore, greater than one means the company has unrecognized goodwill or some other intangible assets which is not recognized in the books. Thus, from 2014 to 2015 company has increased its market/book ratio and for both 2014 and 2015 this ratio remained above the average of the industry.

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