Ratio Analysis at S & S Air, Inc.

Chris Guthrie was recently hired by S&S Air, Inc., to assist the company with its financial
planning and to evaluate the company's performance. Chris graduated from college five years
ago with a finance degree. He has been employed in the finance department of a Fortune 500
company since then.

S&S Air was founded 10 years ago by friends Mark Sexton and Todd Story. The company has
manufactured and sold light airplanes over this period, and the company's products have received
high reviews for safety and reliability. The company has a niche market in that it sells primarily
to individuals who own and fly their-own airplanes. The company has two models; the Birdie,
which sells for $53,000, and the Eagle, which sells for $78,000.

Although the company manufactures aircraft, its operations are different from commercial
aircraft companies. S&S Air builds aircraft to order. By using prefabricated parts, the company
can complete the manufacture of an airplane in only five weeks. The company also receives a
deposit on each order, as well as another partial payment before the order is complete. In
contrast, a commercial airplane may take one and one-half to two years to manufacture once the
order is placed.

Mark and Todd have provided the following financial statements. Chris has gathered the industry
ratios for the light airplane manufacturing industry.

Income Statement
Sales $20,077,000
Cost of goods sold $14,985,000
Other expenses $2,399,000
Depreciation $655,000
EBIT $2,038,000
Interest $362,000
Taxable income $1,676,000
Taxes (40%) $670,400
Net income $1,005,600
Dividends $205,000
Add to retained earnings $800,600

S&SAIR,INC.
2006 Balance Sheet
Assets
Current assets
Cash $365,040
Accounts receivable $1,534,680
Inventory $1,238,500
Total current assets $3,138,220
Fixed assets
Net plant and equipment $12,315,680
Total assets $15,453,900

Liabilities and Equity

Current liabilities

Accounts payable $715,680

Notes payable $1,446,400
Total current liabilities $2,162,080

Long-term debt $3,825,000

Shareholder equity
Common stock $150,000
Retained earnings $9,316,820
Total equity $9,466,820
Total liabilities and equity $15,453,900

Light Airplane Industry Ratios

Lower quartile median Upper quartile
Current Ratio .50 1.43 1.89
Quick Ratio .64 .84 1.05
Cash Ratio .08 .21 .39
Total Asset Turnover .68 .85 1.28
Inventory Turnover 4.89 6.15 10.89
Receivables turnover 6.27 9.82 11.51
Total Debt Ratio .31 .52 .61
Debt-Equity Ratio .58 1.08 1.56
Equity Multiplier 1.58 2.08 2.56
Times Interest 5.18 8.06 9.83
Earned
Cash Coverage Ratio 5.84 8.43 10.27
Profit Margin 4.05% 5.15% 6.47%
Return on Assets 6.05% 10.53% 13.21%
Return on Equity 9.93% 16.54% 26.15%

Questions:
1. Calculate the ratios for S &S Air that are shown for the industry.

Solution:
Ratios of S & S Air
Current ratio = Current assets/ Current liabilities

= 3,138,220/2,162,080

= 1.451

Quick Ratio = (Current assets – Inventory)/ Current liabilities

= (3,138,220 – 1,238,500)/ 2,162,080

= 0.878

Cash ratio = Cash/ Current liabilities

= 365,040/2,162,080

= 0.1688

Total assets turnover = Sales/ Total assets

= 20,077,000/15,453,900

= 1.67

Inventory turnover = Costs of goods sold/ Inventory

= 14,985,000/1,238,500

=12.099

Receivables turnover = Sales/ Receivables

= 20,077,000/1,534,680

=13.082

Total debt ratio = Total debt/ Total Assets

= 3,825,000/ 15,453,900

= 0.247

Debt-equity ratio = Debt/ Equity

= 3,825,000/9,466,820

= 0.404

Equity multiplier = 1+ Debt-equity

= 1 + 0.404
 = 1.404

Times Interest earned = EBIT/ Interest

= 2,038,000/ 362,000

= 5.62

Cash coverage =(EBIT + Depreciation)/ Interest

= (2,038,000 + 655,000)/ 362,000

= 7.43

Profit Margin = Net Income/ Sales

= 1,005,600/20,077,000

= 0.05

Return on assets = Net Income/Total assets

= 1,005,600/$15,453,900

= 0.06

Return on equity = Net Income/ Total equity

= 1,005,600/$9,466,820

=0.10

2. Mark and Todd agree that a ratio analysis can provide a measure of a company’s
performance. They have chosen Boeing as an aspirant company. Would you choose
Boeing as an aspirant company? Why or Why not?

Solution:
Boeing is probably not a good aspirant company. Even if both companies manufacture
airplanes, S&S Air manufactures small airplanes while Boeing manufactures large like
commercial aircraft. There are two different markets for small and large aircraft. In addition,
Boeing is mainly involved in defense industry as well as Boeing capital which finances
airplanes.

3. Compare the performance of S & S Air to the industry. For each Ratio comment why it
might be viewed as positive or negative relative to the industry. Suppose you create an
inventory ratio calculated as inventory divided by current liabilities. How do you think S
& S Air’s ratio would compare to the industry average.
Solution:

S&S Air is above median industry for cash and current ratios. This tells that the company
has more liquidity than industry. However, both these are ratios are above 3 rd quartile, so
thereare companies which have higher liquidity than S&S Air.

It is possible that the company may have more predictable cash flows or they are more
access to short term borrowing. If an inventory is created to current liabilities ratio, S&S Air
would have ratio which is lower than that of the industry median. Current ratio is above
industry median while the quick ratio is above industry median. This shows that S&S Air has
same inventory to current liabilities as industry median.

S&S Airhas same inventory as industry median, so inventory to current liabilities has same
median as that for the industry. The turnover rations are higher than the industry median,
all the three turnovers are above upper quartile which means that S&S Air is more efficient
than industry.

The financial leverage ratios are all less than the industry median, ROA and ROE are both
less than industry median but higher than lower quartile. It has debt less than comparable
companies but lies within the normal range.

Overall S&S Air’s performance appears to be good, the liquidity ratios indicate closer look
that may be required here.

Ratio Positive Negative

Current Ratio Better in managing accounts
Quick Ratio Better in managing accounts
Cash Ratio Better in managing accounts
Assets may depreciate, require
Total assets turnover Better at utilizing assets
Better in managing inventory
Inventory turnover
due to better procedures.
Better at collecting
Receivables turnover
receivables.
Debt less than industry mean
Total debt ratio company is less likely to face
credit problems.
Debt less than industry mean
Debt-equity ratio company is less likely to face
credit problems.
Debt less than industry mean
Equity multiplier company is less likely to face
credit problems.
Debt less than industry mean
TIE company is less likely to face
credit problems.
May have liquidity problems.
May have liquidity problems.
May have liquidity problems.
extensive investment.
Experienced shortage in
inventory.
Increase in amount debt
increases shareholders
returns.
Increase in amount debt
increases shareholders
returns.
Increase in amount debt
increases shareholders
returns.
Increase in amount debt
increases shareholders
returns.
 Debt less than industry mean Increase in amount debt
Cash coverage company is less likely to face increases shareholders
credit problems. returns.
Company’s controlling costs
Profit margin Costs may be very high.
may be better than industry.
Assets may be sold and
Company is performing above
ROA depreciated relative to
its peers.
industry.
Profit margin and EM could be
Company is performing above
ROE increases, which could
its peers.
increase ROE.

4. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do
these numbers mean?’

Solution: