The Financial Detective

National College of Business and Arts Fairview, Quezon City

The Financial Detective (A Case Study in Financial Management) Submitted By: De Castro, Kenneth Michael Acaso, Marilou Almonte, Poneve Cantor, Rachelle Salmorin, Princess Submitted To: Ms. Adalia Bringas October 19, 2009

I.

Brief Background: The financial statements of no two companies are alike. External factors that affect such differences are the nature of the industry in which the company belongs, and the financial norms and standards that govern in each industry. In addition, the internal factors are also considered such as the management’s philosophy and operating style and its attitude towards achieving certain goals. Moreover, business strategies are also a key factor in analyzing such financial, as well as non-financial differences between companies. Lastly, the social perspective should not be taken for granted. The presence of good customer relations and a sense of social responsibility add up in building company goodwill which will in turn contribute to the operations of the entity as a whole.

II. Case Objective: Given the common sized financial statements of each company in each industry, the objective is to match the financial data with the company descriptions. Exhibit 1 shows the financial statements, as well as the financial ratio analysis of each company. The professor will be given a copy of the case study to provide her with the company descriptions which will be serve as a basis for the analysis of financial data.

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Exhibit 1 – Common Sized Financial Statements (Financial Position) Health Products "A" "B"

Appliances "C" "D"

Computers "E" "F"

Retailing "G" "H"

Percentage of Total Assets Current Assets: Cash and Cash Equivalents Receivables Inventory Other Current Assets Total Current Assets

11.3% 14.6% 17.8% 6.3% 50.0%

0.7% 16.7% 16.7% 2.0% 36.1%

1.8% 23.9% 30.5% 4.9% 61.1%

3.7% 13.4% 25.8% 2.8% 45.7%

15.4% 18.7% 22.7% 9.1% 65.9%

19.3% 10.7% 21.4% 0.6% 52.0%

0.2% 1.9% 51.7% 2.8% 56.6%

15.6% 34.7% 5.5% 0.0% 55.8%

Noncurrent Assets: Net Property, Plant and Eqpt. Other Assets Total Noncurrent Assets

34.4% 15.6% 50.0%

23.3% 40.6% 63.9%

31.0% 7.9% 38.9%

32.3% 22.0% 54.3%

23.1% 11.0% 34.1%

42.2% 5.8% 48.0%

41.8% 1.6% 43.4%

6.4% 37.8% 44.2%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

14.1% 12.8% 26.9%

15.1% 9.5% 24.6%

11.3% 16.3% 27.6%

12.1% 21.2% 33.3%

9.5% 31.0% 40.5%

2.1% 16.5% 18.6%

21.4% 12.6% 34.0%

8.6% 31.1% 39.7%

11.2% 8.7%

21.5% 5.3%

16.5% 7.3%

6.8% 3.3%

14.6% 4.4%

12.0% 1.7%

3.6% 18.4%

12.8% 29.4%

19.9%

26.8%

23.8%

10.1%

19.0%

13.7%

22.0%

42.2%

46.8%

51.4%

51.4%

43.4%

59.5%

32.3%

56.0%

81.9%

0.0% 53.2% 53.2%

0.0% 48.6% 48.6%

0.0% 48.6% 48.6%

2.7% 53.9% 56.6%

0.8% 39.7% 40.5%

0.0% 67.7% 67.7%

0.0% 44.0% 44.0%

0.0% 18.1% 18.1%

Total Assets Current Liabilities: Accounts Payable Other Current Liabilities Total Current Liabilities Noncurrent Liabilities: Long-term debt Other Liabilities Total Noncurrent Liabilities Total Liabilities Equity : Minority Interest Equity Total Equity

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Total Liabilities and Equity

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

Exhibit 1 – Common Sized Financial Statements (Financial Position) Electronics "I" "J"

Hotel "K"

"L"

Newspapers "M" "N"

Transportation "O" "P"

Percentage of Total Assets Current Assets:

Cash and Cash Equivalents Receivables Inventory Other Current Assets Total Current Assets

5.8% 20.7% 17.1% 7.3% 50.9%

15.6% 19.9% 17.4% 7.3% 60.2%

15.2% 7.9% N/A N/A 23.1%

0.3% 9.2% 3.5% 4.1% 17.1%

8.5% 8.7% 4.5% 2.6% 24.3%

4.4% 9.0% 2.1% 3.1% 18.6%

1.8% 6.5% 1.5% 0.9% 10.7%

0.9% 18.7% 3.9% 1.3% 24.8%

Noncurrent Assets: Net Property, Plant and Eqpt. Other Assets Total Noncurrent Assets

45.9% 3.2% 49.1%

35.7% 4.1% 39.8%

49.5% 27.4% 76.9%

48.0% 34.9% 82.9%

14.0% 61.7% 75.7%

56.2% 25.2% 81.4%

82.3% 7.0% 89.3%

73.3% 1.9% 75.2%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

Current Liabilities: Accounts Payable Other Current Liabilities Total Current Liabilities

10.3% 21.0% 31.3%

25.0% 4.3% 29.3%

8.9% 0.9% 9.8%

9.5% 11.4% 20.9%

5.4% 9.7% 15.1%

6.2% 11.9% 18.1%

12.0% 1.4% 13.4%

5.1% 21.0% 26.1%

Noncurrent Liabilities: Long-term debt Other Liabilities Total Noncurrent Liabilities

6.5% 5.7% 12.2%

11.4% 6.5% 17.9%

21.6% 14.3% 35.9%

46.5% 17.5% 64.0%

25.6% 7.9% 33.5%

19.6% 14.1% 33.7%

14.5% 27.4% 41.9%

13.7% 17.7% 31.4%

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

0.4%

0.0%

Total Assets

Total Liabilities Equity : Minority Interest

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Equity Total Equity Total Liabilities and Equity

56.5% 56.5%

52.8% 52.8%

54.3% 54.3%

15.1% 15.1%

51.4% 51.4%

48.2% 48.2%

44.3% 44.7%

42.5% 42.5%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

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Exhibit 1 – Common Sized Financial Statements (Income Statement and Financial Ratios) Health Products "A" "B"

Appliances "C" "D"

Computers "E" "F"

Retailing "G" "H"

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

36.9% 63.1%

64.0% 36.0%

72.8% 27.2%

79.3% 20.7%

69.7% 30.3%

35.7% 64.3%

77.0% 23.0%

N/A 100.0%

40.3%

21.7%

13.3%

14.4%

29.4%

16.3%

16.3%

97.1%

7.7% 1.4% -1.2% 14.9% 4.5% 10.4%

3.2% 3.4% 0.5% 7.2% 1.9% 5.3%

N/A 0.6% -0.4% 13.7% 5.7% 8.0%

N/A 0.6% -0.4% 6.1% 1.5% 4.6%

N/A 1.9% -2.7% 1.7% 1.1% 0.6%

15.8% 1.3% 0.0% 30.9% 9.5% 21.4%

N/A 0.7% -0.7% 6.7% 2.8% 3.9%

N/A N/A -1.1% 4.0% 0.6% 3.4%

122.0% 13 24 96 186 43

82.0% 4 12 71 147 75

223.0% 18 37 93 221 39

173.0% 8 15 51 137 28

128.0% 1 2 84 163 54

76.0% 16 24 162 280 51

311.0% 12 28 6 6 2

65.0% 2 12 127 127 196

8.41 6.88 21.0%

4.87 4.87 44.0%

9.33 7.32 34.0%

12.92 6.69 13.0%

6.81 5.62 37.0%

7.09 3.56 18.0%

166.37 6.02 8.0%

1.86 11.77 70.0%

33.0% 17.9 4.4 1.1

49.0% 22.1 2.1 1.1

50.0% 13.5 5.2 1.1

43.0% 13.5 1.9 1.2

0.0% 32.0 1.2 1.3

0.0% 21.5 5.1 1.4

11.0% 27.7 8.0 1.3

46.0% 11.0 1.1 1.2

Percentage of Sales Revenues Cost of Goods Sold Gross Profit Selling, General & Admin. Exp.

(all Oper. Exp. for Co. H & O) Research and Development Interest Expense Other Expense (Income) Income before taxes Taxes Net Income Operating and Condition Ratios Ratio of Sales to Assets Return on Assets Return on Equity Quick (Acid-Test) Ratio Current Ratio Days Sales Outstanding Receivable Turnover (times) Inventory Turnover (times) Ratio of Long-term debt to Equity

Market Data Dividend Payout Ratio Price-Earnings Ratio Price-Book Ratio Beta

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Exhibit 1 – Common Sized Financial Statements (Income Statement and Financial Ratios) Electronics "I" "J"

"K"

Hotel "L"

Newspapers "M" "N"

Transportation "O" "P"

Percentage of Sales Revenues Cost of Goods Sold Gross Profit

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

60.5% 39.5%

78.3% 21.7%

41.0% 59.0%

92.1% 7.9%

45.9% 54.1%

54.2% 45.8%

N/A 100.0%

82.4% 17.6%

24.7% N/A 1.2% 7.4% 6.2% 1.6% 4.6%

17.8% N/A 0.4% -3.9% 7.4% 1.9% 5.5%

33.8% N/A 6.5% 0.7% 18.0% 4.4% 13.6%

1.1% N/A 1.4% -0.7% 6.1% 2.7% 3.4%

28.6% N/A 2.3% -11.8% 35.0% 14.4% 20.6%

28.6% N/A 1.4% -0.1% 15.9% 6.4% 9.5%

86.1% N/A 2.5% 0.0% 11.4% 4.5% 6.9%

7.6% N/A 0.5% 5.8% 3.7% 1.4% 2.3%

126.0% 6 10 81 162 60

131.0% 7 18 121 206 55

55.0% 8 14 218 236 49

121.0% 4 28 45 82 28

73.0% 15 29 114 161 43

99.0% 9 19 74 103 33

46.0% 3 7 62 80 52

191.0% 4 11 75 95 36

6.09 7.38 11.0%

6.6 7.57 22.0%

7.52 N/A 40.0%

5.41 13.21 308.0%

8.48 16.24 50.0%

11.01 47.28 41.0%

7.08 30.97 33.0%

10.18 49.22 32.0%

27.0% 22.7 2.15 1.45

24.0% 19.6 2.43 1.4

21.0% 17.8 2.53 0.95

10.0% 21.8 5.13 1.1

33.0% 20.9 4.58 0.9

20.0% 20.7 3.98 1.1

42.0% 20.9 1.52 N/A

43.0% 23.3 2.42 1.3

Selling, General & Admin. Exp.

(all Oper. Exp. for Co. H & O) Research and Development Interest Expense Other Expense (Income) Income before taxes Taxes Net Income Operating and Condition Ratios Ratio of Sales to Assets Return on Assets Return on Equity Quick (Acid-Test) Ratio Current Ratio Days Sales Outstanding Receivable Turnover (times) Inventory Turnover (times) Ratio of Long-term debt to Equity

Market Data Dividend Payout Ratio Price-Earnings Ratio Price-Book Ratio Beta

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III. Analysis of Financial Data: A. Health Products Company A is the manufacturer of a broad line of namebrand toiletries, non-prescription drugs and consumer and baby-care products primarily because of a larger market, which comprises of 165 decentralized subsidiaries; there is a presence of a higher gross margin which accounts for 63.1% of the total revenue. Company B is the manufacturer of pharmaceuticals and a variety of low-margin hospital supplies which were marketed primarily through direct sales to doctors and hospitals because of the presence of a lower gross margin of 36.0%. In addition, its “other assets” comprise a large percentage of its total assets (40.6%) , which can attributed to the goodwill stemming from acquiring a large hospital supply company.

B. Household Appliances Company C is the marketer of high quality washers, dryers, dishwashers and refrigerators under its own name, primarily because of a presence of lower cost of goods sold (72.8%) which infers that manufacturing and selling under one brand name entails a lower cost. In addition, its sales to assets ratio is much higher (223.0%) which says that they are much concentrated in utilizing their assets to generate more sales. Company D is the marketer of the same products, but under 3 different brand names. The presence of a higher cost of goods sold (79.3%) infer that manufacturing and selling under different brand names would require higher cost.

C. Computers Company E is the manufacturer of large mainframe computers which also provides financial and insurance services. Receivables comprise 18.7 percent of total assets which is significant in financing type of business. In addition, when a company offers financial services, it generates other income in the form of 10

interest, which can be seen in their income statement (2.7%). Company F is the manufacturer of supercomputer systems for scientific applications. Its output may be small, but its price tag is the highest in the industry, which is why they have a lower cost of goods sold (35.7%) due to a small number of units produced, but a higher gross margin (64.3%) because of higher selling prices. In addition, since the computers were used for physical research, the company incurs research and development expense (15.8%).

D. Retailing Company G is the firm that operates discount department store and wholesale clubs. Its inventory is large (51.7%) which is typical for a wholesaler. In addition, the presence of a nominal amount of receivable in its assets (1.9%), a very quick receivable turnover (166.37) and a very short days’ receivable outstanding (2 days) reflect that the company is selling largely on cash. Company H is the firm that operates a credit-based department store. Its receivable comprise 34.7% of its total assets. In addition, the presence of a very slow receivable turnover (1.86) and a long days’ receivable outstanding (196 days) reflect that the company is relying largely on credit sales.

E. Electronics Company I is the firm that produces semi-conductors, with the defense industry as its primary market and specializes on small desktop and hand-held computing equipment. Compared with Company J, its total current assets is only 50.9% as against 60.2% of Company K which represents that it is less financially conservative. Company J is the financially-conservative firm that produces semi-conductors, which specializes on radio and television equipment. Its total current assets are 60.2%, 15.6 % of which is on cash & equivalents. This means that the company is financially conservative.

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Aside from semiconductor manufacturing, it is also involved in manufacturing of television and radio equipment, which will explain the other income of 3.9%.

F. Hotels Company K is the firm that operated a worldwide chain of high-quality hotels and motels in addition to a smaller line of casinos. In contrast with Company L, the long-term debt is much lower (21.6%) which can be inferred that it personally finances its operations and does not rely too much on debt financing, or those that are financed by creditors. Company L is the largest food contractor in the country. Its financing is through off-balance sheet limited partnerships. This can be proven by the percentage of long-term debt to its total assets (46.5%). It means that hotel operations rely too much on the finances provided by creditors on a long-term basis.

G. Newspapers Company M is the newspaper company that owns a number of small newspapers throughout the Midwest. Broadcasting, which is its secondary line of business accounts for the total other income of 11.8%. In addition, the presence of a higher “other assets” (61.7&) results from the goodwill stemming from acquisitions. Company N is the large flagship newspaper that sells around the country and around the world. As compared to Company M, its other assets is lower (25.2%), but since it operates worldwide, its assets should comprise mostly of property, plant and equipment which corresponds to Company N’s net PPE of 56.2%.

H. Transportation Company O is the large national trucking and freight forwarding company. Since this is a service type of business, it does not incur cost of goods sold, which can be clearly seen in its income statement. Majority

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of its expenses are operating, which can be inferred as the “cost of service” which is typical for a freight-forwarding company. Company P is the railroad company. 20% of revenues was said to be derived from real estate business which will reflect on the company’s receivables which comprises 18.7% of the total assets. Its sales to assets ratio (191%) reflects that it has diverse and high selling products like real estate.

IV. Recommendation: A. Health Products Company A should continue to penetrate its market in order to sustain the margin percentage. However, costbenefit considerations should also be considered such that if maintaining its market would entail more cost and will provide less benefits, it would be advisable to reduce the number of its subsidiaries. Company B should expand its market. It can be achieved by having advertising projects aimed to mass market their products in an effort to attract more consumers and generate larger revenue.

B. Household Appliances Company C should maintain its strategy to operate under a single brand name. In addition, if the company’s sales to assets ratio can still be improved, much better. Company D, since selling under 3 different brand names entail more cost, they should make an effort to reduce brand names. However, qualitative factors should also be considered such as the market demand for that particular brand, its impact on consumers and its contribution to the company’s total income.

C. Computers Company E, which also engages in financial insurance services, should take a closer look

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emphasize on credit management; that is, efficient management of receivables, credit granting, and taking precautions with regards to uncollectible accounts. In addition, it should generate larger income in the form of interest. Company F should provide a balance of all sorts. A company may have a larger margin but with its high selling prices, it would not be attractive on the consumers’ point of view. The company should expand on its production and maintain reasonable level of R & D costs.

D. Retailing Company G should sell more on credit. A healthy business enterprise allows for selling goods on credit because it will generate more revenue and would be attractive from the consumers’ viewpoint. However, focus is still on the possibility of uncollectible accounts, but nonetheless, it is still a necessary cost of credit sales. Company H should improve its financial ratios. They may be selling on credit, but the realization of receivables to cash is still very slow. They should improve the collection methods which in turn will improve receivable turnover, and days’ receivables outstanding. Note that selling on credit only postpones the collection of cash, and not to make it uncollectible.

E. Electronics Company I should be more financially conservative. Note that having sufficient cash is the ultimate requirement of being liquid. Cash is still what every business wants. Company J should maintain its being financially conservative. They should continue to provide sufficient cash balance, enough to maintain working capital necessary for operations.

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F. Hotels Company K should maintain its reliance on equity financing, while also taking into consideration the advantages of tapping debt in some situations. Company L should consider the advantages and disadvantages of relying on debt financing. It is advisable to rely on debt if the firm is liquid enough to pay its obligation upon maturity, however, there are disadvantages of debt financing the entity should consider such as: (1) Since debt requires a fixed charge, there is a risk of not meeting this obligation if the earnings of the firm fluctuate; (2) Debt adds risk to the firm; (3) Certain managerial prerogatives are usually given up in the contractual relationship outlined in the contract (Example: specific ratios must be kept above certain level during the term of the loan, restrictions in paying dividends).

G. Newspapers Company M should improve on its broadcasting operations, since it provides benefit on the firm’s operations. It would be a great mix if the firm could find the balance between the print media and visual media operations. Company N should maintain its international operations. Aside from the non-financial benefits of operating on a global market, the worldwide operation would attract more market, and would be a cause of larger revenue. In addition, they should utilize more their property, plant and equipment in their operations.

H. Transportation Company O should reduce the cost of service at a reasonable level. Note that incurring more costs would decrease net income. Company P should improve on its real estate business, since, like Company M in the Newspaper industry, it provides additional benefits on the company.

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