# Ratio Analysis, Balance Sheet and Income Statement-Finance Homework Solution

QUESTION

Combine the following three parts into one document.

Part 1. Ratio Analysis (1–2 pages)

Using the XYZ Balance Sheet and Income Statement linked in the Resources and the table provided below, complete the following for XYZ Inc.:

1. Calculate the indicated ratios for XYZ.
2. Construct the DuPont equation for both XYZ and the industry.
3. Use your analysis to outline XYZ’s strengths and weaknesses.
4. Say XYZ had doubled its sales as well as its inventories and common equity during 2013. Do you think this would this affect the validity of your ratio analysis? No calculations are necessary.

 Ratio XYZ Inc. Industry Average Current 2.0x Quick 1.3x Days sales outstanding 35 days Inventory turnover 6.7x Total assets turnover 3.0x Profit margin 1.2% ROA 3.6% ROE 9.0%

Part 2. Investment Analysis (1–2 pages)

For this part of the assessment, imagine that you are looking into investing in a manufacturing company, such as a car company or a steel company. Your goal is to create a plan for determining the potential strength of an investment in the company (investment analysis) and determining how the company might perform over a selected period of years (forecast).

After considering a potential investment in this manufacturing company, address the following:

• What are some of the qualitative factors that must be considered when selecting a company in which to invest?
• What financial ratios would you examine, and why?
• What non-financial factors would you examine, and why?

Use research from at least two references to support your ideas.

Part 3. Forecast (1–2 pages)

Using the same hypothetical manufacturing company described above, address the following questions related to forecasting the performance of the company:

• How would you forecast revenue, profitability, and asset management, such as inventory control and accounts receivable, for a hypothetical manufacturing company?
• What ratios would you analyze?
• What techniques would you use? Why?
• What non-financial factors would be important in your analysis?

Use research from at least two references to support your ideas.

Additional Requirements

• Length: Your document should include 3–6 typed, double-spaced pages to cover all of the parts of the assessment. In addition, include a title page and references page.
• Written communication: Written communication should be free of errors that detract from the overall message.
• Style and Formatting: Apply APA style and formatting to cite your references.
• Resources: You must use at least four references, at least two references supporting Part 2 and two references supporting Part 3.
• Font and font size: Times New Roman, 12 point.

ANSWER

Part 1. Ratio Analysis (1–2 pages)

Using the XYZ Balance Sheet and Income Statement linked in the Resources and the table provided below, complete the following for XYZ Inc.:

1. Calculate the indicated ratios for XYZ.
2. Construct the DuPont equation for both XYZ and the industry.
3. Use your analysis to outline XYZ’s strengths and weaknesses.
4. Say XYZ had doubled its sales as well as its inventories and common equity during 2013. Do you think this would this affect the validity of your ratio analysis? No calculations are necessary.

 Ratio XYZ Inc. Industry Average Current 1.43 2.0x Quick 1.07 1.3x Days sales outstanding 68 35 days Inventory turnover 11.14 6.7x Total assets turnover 1.61 3.0x Profit margin 1.7% 1.2% ROA 2.7% 3.6% ROE 6.8% 9.0%

DU Pont equation, ROE= Net Profit Margin x Return on Assets X Financial Leverage

For Industry 9% = 1.2% x 3.6% x Financial Leverage

Financial Leverage= 0.5%

For XYZ inc, 6.8% = 1.7% x 2.7% x Financial Leverage

Financial Leverage= 0.7%

As Per analysis, XYZ is less attractive than market when it comes to liquidity and receivable management, however the profit margin is higher than the market which shows efficiency in operations. But since return on equity and return on asset is lower than market, it does not seem to be invest in.

Weakness

• Less liquidity
• Inefficient debtor management
• High investment and low return

Strengths

• Efficient operation giving higher profit margin

Part 2. Investment Analysis (1–2 pages)

For this part of the assessment, imagine that you are looking into investing in a manufacturing company, such as a car company or a steel company. Your goal is to create a plan for determining the potential strength of an investment in the company (investment analysis) and determining how the company might perform over a selected period of years (forecast).

After considering a potential investment in this manufacturing company, address the following:

I’ve selected a company which is making cars which run on solar power

• What are some of the qualitative factors that must be considered when selecting a company in which to invest?

Answer

To select a company to invest in one has to drill down every possible aspect, on of which is Qualititavive factors. Qualitative benchmarks defers from industry to industry and investor to investor, but still there are certain common qualitative factors which shall be considered before investing hard earned money, they are as under:

• Business Model: It is all about the answer to question “ How a company makes money”. I my case the selected company manufactures cars and sell them through dealers. It is a simple business model.
• Competitive advantage: It is important to look for the competitors who might cause a loss to your company, or the market in which your company is operating. My selected company is a monopoly as of now, hence it has no competition.
• Management: The management of the company shall be decentralized, more open and transparent. Company which I selected is having a transparent management culture, meetings are held on daily basis on calls and con calls. It has a designated cell for idea sharing and customer query resolution
• Corporate Governance: Compliance with laws, transparency to shareholders, filing of returns and compliance with listing requirements.
• What financial ratios would you examine, and why?

Answer

• Debt to Equity Ratio- How much debt is involved in financing a company, if company is unable to earn more than the interest rate to be paid to debt providers, shareholders will lose the value of shares.
• P/E ratio- It is the ratio of price of the share to earning per share of the company, high PE ratio is a signal of overvaluation of company, High or low PE ratio can be determined by comparing PE ratio of a company to the PE ratio of its competitors
• ROE- It helps a shareholder to compare profitability of a company with others, it is the return provided by the company to shareholders. Investment is done for returns hence it is one of the prime factors.
• Interest Coverage Ratio- It depicts that how many time the company is able to pay its fixed interest from the profits
• Current ratio, Quick Ratio are some of other ratios which are to be looked on to determine the liquidity of a comapny
• What non-financial factors would you examine, and why?

Answer

• Pending Suits against Company- If some suit is pending against company, it might not involve any financial outflow today but it can make a company non existing tomorrow
• Compliance with laws- If a company is failing to comply with laws, it won’t be able to survive for long
• Employee Turnover- If a company is unable to retain its employees, it will be lacking growth in long run
• Relationship with suppliers and customers- If a company is able to maintain good relationship with its suppliers and customer it will lead to permanent support for the company.

(SEC, n.d.)

(Caldbeck, 2014)

Part 3. Forecast (1–2 pages)

Using the same hypothetical manufacturing company described above, address the following questions related to forecasting the performance of the company:

• How would you forecast revenue, profitability, and asset management, such as inventory control and accounts receivable, for a hypothetical manufacturing company?

Answer

• Revenue can be forecasted by using the average growth rate of the company of past years or forecasted growth rate of the industry
• Profitability can be forecasted by drafting an income statement by using the ratios of various costs to revenue, and subtracting cost from revenue
• Asset Management can be forecasted from the projected income statement, by using cost of goods sold, sales and making out a ratio with the increased assets of the company, computed using the growth rates.
• What ratios would you analyze?

Answer

• Debt Ratios
• Profitability ratio
• Current ratio
• Gross Profit Ratio
• Interest Coverage ratio

• What techniques would you use? Why?

Answer

There are mainly 4 techniques used in forecasting:

• Straight Line- Using a constant growth
• Moving Average- making repeated forecasts
• Simple linear regression-Compare one independent variable with one dependent variable
• Multiple linear regression- Compare many independent variable with many dependent variable

I would be using Straight line method as it requires only historical data of the company, to decide trend.

• What non-financial factors would be important in your analysis?

Answer

• State of economy
• Competitive Environment
• Seasonal Factor
• Demographic changes
• Technological Changes
• Legal and regulatory changes

(Donner, 2017)

(Wallstreet, n.d.

References

Caldbeck, R., 2014. https://www.forbes.com/sites/ryancaldbeck/2014/03/03/10-things-an-investor-must-do-before-investing/. [Online].

Donner, D., 2017. https://bizfluent.com/how-7791703-forecast-financial-statements.html. [Online].

SEC, n.d. https://www.sec.gov/investor/pubs/tenthingstoconsider.htm. [Online].

Wallstreet, n.d. https://www.wallstreetprep.com/knowledge/income-statement-forecasting/. [Online].

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