Case 1 Financial Ratio Analysis Triple A Office Mart Susan Burke, president of Triple A Office Mart, studied her notes for the ftemoon meeting with the bank's commercial loan committee. The profitable company, organized in 1978, sold a complete lin ofofice equipment, funiture, and supplies. Two stores operated in two adjoining states in the southwestern United States. Budgetary control ofthe two stores was centralized {in te store and office complex which operated in the larger of the two cities. In preparation for the meeting, Burke wondered about the type of information the bank might have with which to ‘make a decision on her loan. She was also concerned about how the bank would view a profitable company that needed to borrow funds. ‘The stores had operated profitably since their inception. Triple A was organized by Burke and a college roommate, Virginie Best, one year after their graduation. Best left the ‘company after only three years fo participate in an oversees venture. Her interest was sold to ‘Burke at that time. ‘With the advent of the personal computer, a major component of company sales, and a general rend in the economy toward specialty stores, Triple A had experienced excellent growth in revenue and earnings. Table | illustrates a portion ofthe firms sales and earnings history Table 2 provides balance sheets for selected years. ‘The firm had issued no common stock or long-term debt in the recent pest. In fact, the second store was opened in 1992 without any additional long-term financing, In the case of the new store, however, there wes an increase in inventory and bank borrowing, The company’s financial staff wondered if this were @ normal state of affirs for an expansion situation. ‘Triple ‘Ahad traditionally handled its credits well, and the stockholders were generally satisfied with the firm's retum on equity. (Stock was offered to the public for the first time in 1980). ‘The primary benefit to the company was the strong local economy. Although it was primarily a service economy, it supported Triple A almost perfectly. A nearby college of ‘business administration, which published an economic report and forecast concerning the local economy, stated that since 1990 the growth of the local GNP hd been in the range of 8-10 percent. Susan Burke had, as a long-range plan, every intention of participating in the region's ‘gzowth and of contributing to it through the efficient operation of her firm, ‘in recent months during early 1996, there had been cause for concem on the part of company management. Prices from suppliers had risen and the firm's financial managers ‘wondered about the eflet of this upon profitability and the general operation ofthe business. ‘The suppliers to the firm were varied, since the firm carried a wide range of office equipment and supplics. As a result, it was not possible to develop a strong and mutually supportive :eltionship with any one supplier. In general, the company had to deal with the vagaries of the ‘economy, LlCase 1 Triple A Office Mart Foremost in Burke's thinking was to maintain a sensible payout ratio for the equity investors, one which reflected the operational reality ofthe company. Firms that were similar in produc ine and sles pattern to Triple A paid a dividend which amounted to 30-60 peroent ‘feamings. Growl in sales volume beyond the nominal growth in the economy usually came bout as ¢ result of market share being taken away from competitors. Triple A's management intended to survive in the region in which they operated. The relatively stable payout ratio ‘which the company had maintained for several years seemed appropriate given revenve growth. Tin preparation for her meeting with the bank, Susan Burke had coneems about the financial condition of her firm and whether there was a trend in the financial statements that right cause the bank to become wary of Triple A as a continuing customer. For example, Susan wondered whether the firm's inventory level had increased ata rate that was harmful to ‘the firm’s liquidity postion. Tt was important to convince the bank that the firm was well run ‘and that all aspects ofits operation indicated managerial consistency and skill TABLE 1 Triple A Office Mart Income Statement (selected years) 1993 1996 Sales 3,800,000 | s4,180,000 | s4s0,000 | 36,000,000 Cot of goods sold (2.60.00, 5. 20000 | [4.182000 Gres peat sstaao.a00 | $1,205,000 650,000 | $1,820,000 Selling, admin. and ‘epreiation expenses ss84o00) | (ss20,000) | cse9s.s08) | (S1.015.467) Imterst 30.780) 5 (42.372) 35313) Profit before tx $525220 $3347220 1093200 $769,220 Taxes gst3e | 06.266) i766) | 030.266) Net income 3007654 S247.954 $496,454 $5385, 12Case 1 Triple A Office Mart TABLE2 Triple A Office Mart Balance Sheet 1993 1994 1995 1996 Cash 295,000 | $326,040 | $378,300 | $468,000 ‘Accounts receivable 1400 | 12,540 | 20,700 | 18,000 Inventory 950,000 | 1028505 | 1,559,407 | 1.735207 Tota current assets 1256400 | 1,367,175 | 1958407 | 2,221,207 ‘Property plant, equip. (net) 450,000 | _ 501,600 503,000 Total assets 81,706,400 | $1,868,775 $2,724207 Accounts payable 152,000 | $167,200 $300,000 ‘Notes payable - bank — 113,326 ‘Accrued wages & taxes 114,000 30,000 Tota current labiltes 266,000 | 292,200 593,326 Long-term debt 342200 | 342,000 342,000 (Common stock (120,000 shares) 600,000 | 600.000 | 600,000 ] 600,000 Retained exenings 4200 | _ 634575 | _s92.731 88,88) ola abilities and equity i,706,400 | si,368,775 | $3,460,007 | $2,724,207 QUESTIONS a Calculate the compound average annual growsh rate in sales and profit after tax for Triple A What are Triple A’s earnings per share and dividends per share for each year shown in Tables I and 2? Calculate some financial ratios forthe company forthe last three years shown. (Include profit margin, receivables collection period, current ratio, quick ratio, inventory ‘tumover.) What has been the compound growth in inventory, and total current assets? Comment on the trend of the financial ratios Is Triple A a good short-term borrowing client forthe bank? If the typical firm in the industry in which Triple A operates has a debt ratio of 52 percent, and a compound annual growth in gross profit of 8 percent, what advice would ‘you give Triple A concerning its debt ratio? 1310, Triple A Office Mart ‘the company’s compound sales growth slowed to half its present rate, what would be the key effect upon extemal financing needs? What is the desired effect upon inventory if such a change occurs? For a company such as Triple A, comment on the importance of inventory control and accounts receivable collection policy. \Why is there a difference betweon the company’s sales growth and its profit growth? Specifically, how isthe dtference likely to influence borrowing needs? To what isthe Giferenoe due? How should Triple A address this difference? Comment upon the firm's payout ratio relative to its sales growth, Is it appropriate? Why or why not? ‘Based upon the information provided inthe case and upon your ratio analysis only, will ‘he bank likely recommend more long-term borrowing forthe firm or provide short-term funding? 14