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Exceptional Service Grading Company: A Case Study on Employing

Financial Ratio Analysis as a Basis for Business Expansion

[Student’s Name]

University of the People

BUS 5111: Financial Management

Dr. Anthony Schmidt

February 3, 2021
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Exceptional Service Grading Company: A Case Study on Employing

Financial Ratio Analysis as a Basis for Business Expansion

As the number of comic-book based movies and TV shows increases (i.e., directly proportional to

the number of collectors and enthusiasts sending their books for grading, certification, and encapsulation),

Exceptional Service Grading Company (ESGC) seeks to expand its services and cater to assessing other

publication formats (e.g., certifying large magazines and movie posters). To execute this, a thorough

analysis of the company’s financial position is necessary towards veering off from unforeseen losses.

In this case study, calculations and explanations required for ESGC are provisioned to better

understand its current financial position through a financial ratio analysis – employing gross profit

margin, current ratio, debt ratio, quick ratio, and debt-to-equity ratio. A simple trend analysis is also

provided for significant lines from ESGC’s financial statements to further deep-dive in its accounts.

Moreover, a recommendation as to whether the planned business expansion is feasible or not is provided.

Literature Review

Per Heisinger & Hoyle (2012), financial ratios are categorized into four measures with varying

foci, namely: profitability measures (focus is on the income statement), short-term liquidity (focus is on

short-term liabilities), long-term solvency (focus is on long-term liabilities), and market valuation (focus

is on the market value of the company). Below are the three required (i.e., gross profit margin, current

ratio, and debt ratio) and two additional ratios (i.e., quick and D/E ratios) alongside their respective

definitions to be calculated in this case study:

 Gross Profit Margin – shows the amount of profit made before deducting SG&A costs, which is

the firm's net profit margin (Bloomenthal, 2020).

 Current Ratio – indicates whether a company has sufficient current assets to cover current

liabilities.

 Debt Ratio - measures the amount of leverage used by a company in terms of total debt to total

assets (Hayes, 2020).

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 Quick Ratio – (also called acid-test ratio) indicates whether a company has sufficient quick, or

highly liquid, assets to cover current liabilities.

 Debt to Equity (D/E) Ratio – measures the balance of liabilities and shareholders’ equity used to

fund assets.

Calculations and Analyses

Now that we already have an understanding of the essential financial ratios for ESGC, we can

proceed with our calculations. Table 1 outlines the necessary financial metrics, alongside their respective

formulas, and calculated values (i.e., from 2017 to 2018) which altogether paint a clearer picture of

ESGC’s financial health.

Table 1

Financial Ratio Analysis for Exceptional Service Grading Company (ESGC)

Two-Year Trend
Financial Metric Formula
Solution 2018 Solution 2017
(Net Sales - Cost of Sales) (9,200,000 - 6,503,100) (6,595,400 - 4,957,800)
Gross Profit Margin 29.31% 24.83%
Net Sales 9,200,000 6,595,400
Total Current Assets 5,652,200 4,576,900
Current Ratio 1.70 1.39
Total Current Liabilities 3,325,950 3,292,850
Total Liabilities 4,170,300 4,067,900
Debt Ratio 59.51% 69.24%
Total Assets 7,007,800 5,875,400
(Total Current Assets - Inventories) (5,652,200 - 89,800) (4,576,900 - 100,200)
Quick Ratio 1.67 1.36
Total Current Liabilities 3,325,950 3,292,850
Total Liabilities 4,170,300 4,067,900
Debt-to-Equity Ratio 1.47 2.25
(Total Assets - Total Liabilities) (7,007,800 - 4,170,300) (5,875,400 - 4,067,900)

Based on the calculated figures, we’ll be able to run a simple trend analysis for ESGC’s financial

performance from 2017 to 2018.

We can ascertain from its income statement that the gross profit margin has increased by 4.48%,

indicative of healthy sales volume due to an unprecedented increase in overall contracts.

Looking at ESGC’s balance sheet, its current ratio has increased by 0.31 thus leading to a lower

debt ratio in the year 2018, i.e., 9.73% lower than that of 2017’s. This improvement was brought upon by

an increase in cash and notes receivable, since ESGC hasn’t paid any dividends and has also acquired

some additional debts in 2018, respectively.

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Additionally, the acid-test ratio has been employed to determine ESGC’s ability to meet its

upcoming commitments brought upon by the planned service expansion. The 0.31 increase from 2017 to

2018 indicates that it can cover potential current liabilities. Moreover, the D/E ratio is valuable in this

analysis since it’s a good indicator of the company’s capital structure to determine its level of financial

leverage. ESGC’s ability to reduce its D/E ratio by 0.78 from the year 2017 is attributed to its total assets’

significant increase in 2018.

Recommendations and Conclusion

Based on the performed analyses above, we can assert that it’s financially viable and

advantageous for ESGC to push through with its planned service expansion. This recommendation is

backed by the significant increase in contracts, i.e., a positive variance of $2,604,600 from 2017 to 2018 –

thus, leading to a whopping 292.63% increase in net income. Hence, opening its doors to other

publication formats has a high tendency of amplifying this value.

We can observe from the financial statements that the increase in total assets in 2018 resulted

from factors such as non-payment of dividends and acquisition of some additional debts in the form of

promissory notes. The increase in assets has a positive implication since ESGC may necessitate a loan

through a credit facility to launch this expansion project. At this rate, the current ratio indicates that

ESGC can cover new debts, which could make the company appealing to potential loans – thus, augments

its ability to invest in growth.

There’s an opportunity to ask ESGC’s management team for the five-years worth of financial

information to confirm financial trends. Verification of the reason and the process undertaken behind the

non-payment of dividends in 2018, despite the significantly high net income, would also be instrumental

in terms of maintaining and enticing investors.

In conclusion, the results of these analyses indicate that ESGC is financially healthy and capable

to execute the expansion project with the proviso that its five-year financial data supports the trend that it

can serve the growth through new debt whilst maintaining optimum profitability.
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References

Bloomenthal, A. (2020). Gross profit margin. Investopedia.

https://www.investopedia.com/terms/g/gross_profit_margin.asp

Hayes, A. (2020). Debt ratio definition. Investopedia.

https://www.investopedia.com/terms/d/debtratio.asp

Heisinger, K., & Hoyle, J. B. (2012). Accounting for managers. Saylor Foundation.

https://resources.saylor.org/wwwresources/archived/site/textbooks/Managerial

%20Accounting.pdf