NewEraUniversity

CASESTUDY
EVERELITETECHNOLOGYCO.,LTD.
FinancialManagement
DeanIsaganiSabado

ChristianAngelBuyson
JamilaDeLaCruz
HyraPearlPorbasas
JericoGalvez
4BSA1

INTEGRATED CASE
FINANCIAL STATEMENT ANALAYSIS
Everelite Technology Co., Ltd had increased service capacity and undertaken a
major marketing campaign in an attempt to go global. Thus far, sales have not
reached the forecasted level, the company incurred higher than projected costs,
and the company recorded a huge loss for 2008 instead of projected profits. As a
result, its managers, directors, and investors are concerned about the firms
survival.
Robert Su, an MBA graduate from the Business School of Hong Kong University of
Sciance and Technology, received a request to join Everelite, from his uncle- Frank
Su, chairman of Everelites board of directors. Roberts mission is to get Everelite
beck into a sound financial position. Everelites 2007 and 2008 balance sheets and
income statements, together with projections for 2009, are given in Tables IC 3-1
and IC 3-2. In addition, Table IC 3-3 gives the companys 2007 and 2008 financial
ratios, together with industry average data. The 2009 projected fincancial
statement data represent Roberts abd Franks best guess for 2009 resuts, assuming
that some new financing is arranged to get the company over the hump.
Robert must prepare an analysis of where the company is now, what it must do to
regain its financial health, and what actions should be taken. Your assignment is to
help him answer the following questions. Provide clear explanations, not yes or no
answers.
a.) Why are ratios useful? What are the five major categories of ratios?
b.) Calculate Everelites 2009 current and quick ratios based on the projected
balance sheet and income statement data. What can you say about the
companys liquidity positions in 2007, in 2008, and as projected for 2009? We
often think of ratios as being useful (1) to managers help run the business.
(2) to bankers for credit analysis and (3) to stockholders for stock valuation.
Would these different types of analysts have an equal interest in the

companys liquidity ratios?

c.) Calculate the 2009 inventory turnover, days sales outstanding (DSO), fixed
assets turnover, and total assets turnover. How does Everelites utilization of
assets stack up against other firms in the industry?
d.) Calculate the 2009 debt and times-interest-earned ratios. How does Everelite
compare with the industry with respect to financial leverage? What can you
conclude from these ratios?
e.) Calculate the 2009 operating margin, profit margin, basic earning power
(BEP), return on assets (ROA), and return on equity (ROE). What can you say
about these ratios?
f.) Calculate the 2009 price/earnings ratio and market/book ratio. Do these
ratios indicate that investors are expected to have a high or low opinion of
the company?
g.) Use the DuPont equation to provide a summary and overview of Everelites
financial condition as projected for 2009. What are the firms major strengths
and weaknesses?
h.) Use the following simplified 2009 balance sheet to show, in general terms,
how an improvement in the DSO would tend to affect the stock price. For
example, if the company could improve its collection procedures and thereby
lower its DSO without affecting sales, how would that change ripple through
the financial statements (shown in thousands below) and influence the stock
price?
Accounts receivable $877

Debt

$1,730

Other current
assets

1109

Net fixed assets

313

Equity

569

$2,299

Liabilities plus

$2,299

Total assets

equity
i.) Does it appear that inventories could be adjusted? If so, how should that
adjustment affect Everelite's profitability and stock price?
j.) In 2008, the company paid its suppliers much later than the due dates; also,
it was not maintaining financial ratios at levels called for in its bank loan
agreements. Therefore, suppliers could cut the company off, and its bank

could refuse to renew the loan when it comes due in 90 days. On the basis of
data provided, would you, as a credit manager, continue to sell to Everelite
on credit? (You could demand cash on delivery that is, sell on terms of COD
but that might cause Everelite to stop buying from your company.) Similarly,
if you were the bank loan officer, would you recommend renewing the loan or
demand its repayment?
k.) What are some potential problems and limitations of financial ratio analysis?
l.) What are some qualitative factors that analysts should consider when
evaluating a company's likely future financial performance?

Table IC 3-1 Balance

Sheets
2009 (E)

2008

2007

$ 199,551

$208,323

$102,024

Accounts Receivable

876,897

690,294

824,979

Inventories

909,379

942,374

715,414

$1,985,827

$1,840,991

$1,642,417

Gross fixed asstes

380,510

317,503

232,179

Less accumulated

67,413

54,045

34,187

$313,097

$263,458

$197,992

$2,298,924

$2,104,449

$1,840,409

$312,500

$288,798

$296,149

Accounts payable

650,535

636,318

414,611

Accruals

110,157

106,748

103,362

$1,073,192

$1,031,864

$814,122

656,600

410,769

372,931

Assets
Cash

Total Current assets

depreciation
Net fixed assets
Total assets

Liabilities and Equity

Short-term borrowings

Total current liabilities

Long-term debt

Commin stock (100,000

shares)
Retained earnings
Total Equity
Total liabilities and equity

550,000

550,000

550,000

19,132

111,816

103,356

$569,132

$661,816

$653,356

$2,298,924

$2,104,449

$1,840,409

Table IC 3-2 Income

Statements
2009 (E)

2008

2007

$2,069,032

$2,325,967

$2,220,607

1,647,925

1,869,326

1,655,827

241,490

287,663

273,870

$1,889,415

$2,156,989

$1,929,697

17,891

25,363

26,341

$161,726

$143,615

$264,569

27,434

31,422

13,802

$134,292

$112,193

$250,767

53,717

44,877

100,307

$80,575

$67,316

$150,460

EPS

$0.81

$0.67

$1.50

DPS

$1.00

$1.00

$1.42

Sales
Cost of good sold
Other expenses
Total operating costs
excluding depreciation
and amortization
Depreciation and
amortization
EBIT
Interest Expense
EBT
Taxes (40%)
Net Income

Book value per share

$5.69

$6.62

$6.53

Stock price

$19.2

$15.60

$21.8

100,000

100,000

100,000

40%

40%

40%

Shares outstanding
Tax rate

Table IC 3-3 Ratio

Analysis
2009E

2008

2007

Industry

Current

1.78x

2.02x

Average
2.05x

Quick

0.87x

1.14x

1x

Inventory Turnover

2.47x

3.10x

6.1x

108.32 days

135.60 days

56 days

Fixed Asset Turnover

8.83x

11.22x

9.3x

Total Assets

1.11x

1.21x

2.1x

68.55%

64.50%

50.00%

4.57x

19.17x

6.2x

Operating Margin

6.17%

11.91%

13%

Profit Margin

2.89%

6.78%

9.00%

Basic Earning Power

6.82%

14.38%

15.00%

ROA

3.20%

8.18%

6.50%

ROE

10.17%

23.03%

12.00%

23.17x

14.49x

10.00x

DSO

Turnover
Debt Ratio
TIE

Price/ Earnings

Market/ Book

2.36x

3.34x

3.00x

Book Value per

$6.62

$6.53

NA

share

SOLUTIONS:
a.) Why are ratios useful? What are the five major categories of ratios?
Ratios are important because it enables the business owner and managers to
detect trends in the company and to compare its performance and condition with
the average performance of similar businesses in the same industry. Ratios also
helps us identify and quantify a companys strengths and weaknesses, evaluate its
financial position, and understand the risks involved in the company. Ratio can help
managers implement plans that improve a companys profitability, liquidity and
financial structure.
The five major categories of ratios are; Liquidity Ratios, Asset Management
Ratios, Debt Management Ratios, Profitability Ratios and Market Value Ratios.
b.) Calculate Everelites 2009 current and quick ratios based on the projected
balance sheet and income statement data. What can you say about the
companys liquidity positions in 2007, in 2008, and as projected for 2009? We
often think of ratios as being useful (1) to managers help run the business.
(2) to bankers for credit analysis and (3) to stockholders for stock valuation.

Would these different types of analysts have an equal interest in the

companys liquidity ratios?

Current Ratio =

Quick Ratio=

Current Assets
1,985,827
=
=1.85 x
Current Liabilites 1,073,192

Current AssetsInventories 1,985,827909,379

=
=1.00 x
Current Liabilites
1,073,192

In 2007, Everelites current ratio is slightly below the industry average.

However, its quick ratio is higher compared to the industry average. Thus, the firm
can pay their current liabilities if they will not rely on the sale of their inventories.
In 2008, as shown in its liquidity ratios, both below the industry average,
Everelite, could not be able to meet its short term debts.
In 2009, both current and quick ratios increased relative to last years.
However, current ratio is lower than the industry average by .2 while its quick ratio
levels the industry average. This means that basing solely from the current and
quick ratios, improvement is expected but it is safe to say that the liquidity position
of the firm is weak.
No, they don't have an equal interest in the liquidity ratio. The following are the
specific reasons:
MANAGER:
Some of the most basic financial ratios show how much a business or investment
will return compared to how much it will cost. When managers are planning new
projects, these financial ratios provide the support they need to receive funding
from executives to move forward. Executives like to see a high return on
investment, or ROI, based on analysis of costs and projected revenues. After
projects are completed, the same type of analysis can show the returns actually
delivered, and how the investment lived up to expectations, which is useful for
future strategy.
CREDIT ANALYST:
Credit analysts will be particularly interested in the applicant's liquidity and ability
to pay bills on time. Such ratios as the quick ratio, receivables, inventory turnovers,

the average payable period and debt-to-equity ratio are particularly relevant. In
addition to analyzing financial statements, the credit analyst will consider the
character of the company and its management, the financial strength of the firm,
and various other matters.
STOCKHOLDERS:
Interested only in Return On Equity (ROE), Dividend Rate, Gross Margin, Net Income
Margin and Quarterly and Annual Growth Ratios.
In general, Financial Statement Analysis is used by: a) managers to evaluate and
improve performance, b) lenders (banks and bondholders) and bond rating analysts
(SP and Moody's) to evaluate the creditworthiness of a company, and c)
stockholders (current or prospective) and stock analysts, to forecast earnings, DIV
and stock price." The five types of ratios are liquidity, asset management, debt
management, profitability, and market value ratios.

c.) Calculate the 2009 inventory turnover, days sales outstanding (DSO), fixed
assets turnover, and total assets turnover. How does Everelites utilization of
assets stack up against other firms in the industry?

Inventory Turnover=

DSO=

Sales
2,069,032
=
Inventory 909,379

= 2.28x

Receivable
Receivables
876,897
876,897
=
=
=
=154.69 days
Average sales per day Annual Sales/365
2,069,032
5,668.58
(
)
365

Net
Sales
2,069,032
Assets Turnover= Assets =
=6.61 x
313,097

Total Assets Turnover=

Sales
2,069,032
=
=0.90 x
Total Assets 2,298,924

Inventory turnover is below the industry average and is getting worse, maybe
because they have old inventories or its control might be poor. No improvement is
currently forecasted (In fact, the opposite). The firm collects its receivables too
slowly (2007: 135.60 days, 2008: 108.32 days. 2009: 154. 69 days) as compared to
the 56 days norm. This suggests the managements poor credit policy. The
companys fixed assets turnover declines with time, and is expected to go way
lower than the industry average. This shows that it does not use its long term assets
effectively so as to generate higher sales. Total assets turnover is not in line with
other companies in the same industry. As time passes by, it continues to turn down.
This is caused by excessive current assets (Accounts Receivable/Inventory) To sum
up; Everelite is inefficiently using its assets.
d.) Calculate the 2009 debt and times-interest-earned ratios. How does Everelite
compare with the industry with respect to financial leverage? What can you
conclude from these ratios?

Debt Ratio=

Total Debt 1,729,792

=
=75.24
Total Assets 2,298,924

Time interest earned ratio=

EBIT
161,726
=
=5.90 x
Interest 27,434

As compared to the industry average, Everelite's financial leverage is

relatively higher which means that a large fraction of their assets are primarily
financed by the creditors. Since the company uses great financial leverage, it is
subject to higher risks.
e.) Calculate the 2009 operating margin, profit margin, basic earning power
(BEP), return on assets (ROA), and return on equity (ROE). What can you say
about these ratios?

Operating margin=

Profit margin=

EBIT
161,726
=
=7.82
Sales 2,069,032

Net Income
80,575
=
=3.89
Sales
2,069,032

Basic Earning Power=

EBIT
161,726
=
=7.03
Total Assets 2,298,924

Return on Assets(ROA)=

Net Income
80,575
=
=3.50
Total Assets 2,298,924

Return on Equity ( ROE ) =

Net Income
80,575
=
=14.16
Common Equity 569.132

It may be recalled that the profitability ratios bring together the asset and
debt management ratios and show their effects on ROE. Though Everelites
operating margin, profit margin, basic earning power and return on assets have
shown improvements compared to last years, still, they are way lower than the
industry average. This implies the firms poor utilization of assets. However, its ROE
is above the industry norm. This may be attributed to the use of too much leverage
which exposes the firm to a higher risk. Using leverage does not guarantee the
firms good results of operations. In Everelites case, the use of leverage leaves the
firm in a near-to-bankruptcy position.
f.) Calculate the 2009 price/earnings ratio and market/book ratio. Do these
ratios indicate that investors are expected to have a high or low opinion of
the company?

Price/ Earnings Ratio=

Market /book ratio=

Price per share

19.20
=
=23.82 x
Earnings per share 0.80575

Market price per share 19.20

=
=3.37 x
Book value per share
5.69

Both the P/E and M/B ratio are above the industry norm.

A stock with a high

P/E ratio suggests that investors are expecting higher earnings growth in the future
compared to the overall market, as investors are paying more for today's earnings
in anticipation of future earnings growth. Hence, as a generalization, stocks with
this characteristic are considered to be growth stocks. The growth investor views high P/E
ratio stocks as attractive buys and low P/E stocks as flawed, unattractive prospects
On the other hand, the firms high P/B ratio is often a sign that a business has
rosier future prospects than past performance. Share price is high relative to book
value because investors have bid up the share price based on expectations of better
earnings and/or cash flow ahead.

g.) Use the DuPont equation to provide a summary and overview of Everelites
financial condition as projected for 2009. What are the firms major strengths
and weaknesses?

Return on Equity ( DuPont Equation )=Profit Margin x Total asset turnover x Equity Multiplier
Returnon Equity ( DuPont Equation )=

Returnon Equity ( DuPont Equation )=

Net Income
Sales
Total assets
x
x
Sales
Total assets Total common equity

80,575
2,069,032 2,298,924
x
x
2,069,032 2,298,924 569,132

Ret urn on Equity ( DuPont Equation )=14.16

Strengths: The firms ROE shows a great increase. This indicates that managers did
an effective utilization of the resources given by stockholder by generating profits
that will result to an accretion of the investors equity.
Weaknesses: The firms liquidity position is weak; all its asset management ratios
are poor); its debt management ratios are poor and most of its profitability ratios
are low (except return on equity). The company is currently achieving low
productivity from its inventory and fixed assets. It is also not collecting from its
customers as quickly as the industry. It needs to improve its sales and/or reduce
inventories and fixed assets to better match its competitors.

h.) Use the following simplified 2009 balance sheet to show, in general terms,
how an improvement in the DSO would tend to affect the stock price. For
example, if the company could improve its collection procedures and thereby
lower its DSO without affecting sales, how would that change ripple through
the financial statements (shown in thousands below) and influence the stock
price?

Accounts
receivable

$877

Other current
assets

1109

Net fixed assets

313

Debt
$1,730

Total assets $2,299

Equity

569

Liabilities plus

$2,299

equity

Sales / day = $2, 069, 032 / 365 = $5, 668. 58

Reducing Accounts Receivable will have no effect on sales.
Old Accounts Receivable

= $877, 000

New Accounts Receivable = $5, 668.58 x 56 days

= $317, 440

Cash freed up: $ 559, 560

Initially shows up as addition to cash.
Effect of reducing receivables on balance sheet and stock price
Added Cash
$560
Accounts receivable 317

Debt

$1,730

Other current
assets

1109

Net fixed assets

313

Equity

569

Total assets

$2,299

Liabilities plus equity

$2,299

Improving the companys collection procedures without affecting sales by lowering

its DSO from 154. 69 days to the 56 days industry average would result to an
addition to cash. The freed up cash could be utilized to repurchase stock, expand
the business, and reduce debt. All of these actions would likely improve the stock
price.
i.) Does it appear that inventories could be adjusted? If so, how should that
adjustment affect Everelite's profitability and stock price?
The inventory turnover ratio is low. It appears that the firm either has
excessive inventory or some of the inventory is obsolete. If inventory were reduced,
this would improve the current asset ratio, the inventory and total assets turnover,
and reduce the debt ratio even further, which should improve the firms stock price
and profitability.
j.) In 2008, the company paid its suppliers much later than the due dates; also,
it was not maintaining financial ratios at levels called for in its bank loan
agreements. Therefore, suppliers could cut the company off, and its bank
could refuse to renew the loan when it comes due in 90 days. On the basis of
data provided, would you, as a credit manager, continue to sell to Everelite
on credit? (You could demand cash on delivery that is, sell on terms of COD
but that might cause Everelite to stop buying from your company.) Similarly,
if you were the bank loan officer, would you recommend renewing the loan or
demand its repayment?
With reference to the ratios such as quick, receivable and inventory turnover
which show the company's inability to pay off its' debts when they fall due. As a
credit manager, it is unfavorable to continue providing supplying a portion of its
total funds with its current arrangement. Terms of COD might be a little harsh and
might push the firm into bankruptcy.
Likewise, if the bank demanded repayment this could also force Everelite into
bankruptcy. Therefore, renewing the loan is a preferable option.
k.) What are some potential problems and limitations of financial ratio analysis?

Many ratios are calculated on the basis of the balance-sheet figures. These
figures are as on the balance-sheet date only and may not be indicative of the yearround position. Comparing the ratios with past trends and with competitors may
not give a correct picture as the figures may not be easily comparable due to the
difference in accounting policies, accounting period etc. It gives current and past
trends, but not future trends. Impact of inflation is not properly reflected, as many
figures are taken at historical numbers, several years old. There are differences in
approach among financial analysts on how to treat certain items, how to interpret
ratios etc. The ratios are only as good or bad as the underlying information used to
calculate them.
Although ratio analysis is very important tool to judge the company's performance,
following are the limitations of it. Seasonal factors can distort ratios, Window
dressing techniques
can make statements and ratios look better. Different operating and accounting
practices distort comparisons. Sometimes, it is hard to tell if ratio is good or
bad.

l.) What are some qualitative factors that analysts should consider when
evaluating a company's likely future financial performance?
The following are some qualitative factors that analysts should consider:
1. To what extent are the company's revenues tied to one key customer or to
one key product? To what extent does the company rely on a single supplier?
Reliance on single customers, products, or suppliers increases risk.
2. What percentage of the company company's business is generated overseas?
Companies with a large percentage of overseas business are exposed to risk
of currency exchange volatility and political instability.
3. What are the probable actions of current competitors and the likelihood of
additional new competitors?
4. Do the company's future prospects depend critically on the success of the
products currently in the pipeline or on existing products?
5. How does the legal and regulatory environment affect the company?

Industry
Current
Quick
Inventory turnover
Days sales outstanding

2009E
1.85x
1.00x
2.28x
154.69

2008
1.78x
0.87x
2.47x
108.32

2007
2.02x
1.14x
3.10x
135.60

(DSO)
days
days
days
Fixed assets turnover
6.61x
8.83x
11.22x
Total assets turnover
0.90x
1.11x
1.21x
Debt ratio
75.24%
68.55%
64.50%
TIE
5.90x
4.57x
19.17x
Operating margin
7.82x
6.16%
11.91%
Profit margin
3.89%
2.89%
6.78%
Basic earning power
7.03x
6.82%
14.38%
ROA
3.50%
3.20%
8.18%
ROE
14.16%
10.17%
23.03%
Price/earnings
23.82x
23.17x
14.49x
Market/book
3.37%
2.36x
3.34x
Book value per share
$5.59
$6.62
$6.53
Note: E indicates estimated. The 2009 data are forecasts.
a

Calculation is based on a 365-day year

Average
2.05x
1.00x
6.10x
56 days
9.30x
2.10x
50.00%
6.20x
13.00%
9.00%
15.00%
6.50%
12.00%
10.00x
3.00x
n.a