Finance text books normally discusses many different financial ratios. Such as liquidity ratios and the rest. What is their purpose? Can any ratio or combination of ratios predict a company's long-term viability? Can you think of an example whereby one ratio incorrectly looks "good" only because another ratio is "bad"?
Finance text books normally discusses many different financial ratios. Such as liquidity ratios and the rest. What is their purpose? Can any ratio or combination of ratios predict a company's long-term viability? Can you think of an example whereby one ratio incorrectly looks "good" only because another ratio is "bad"?
Related questions
Under "Mistake 1: Managing to the Income Statement," starting in about the fifth paragraph of that section, the Note talks about a metals refining firm that decided to bother its clients with calls reminding them to pay their bills on time, something they had never done in the past and something their sales people said "will drive customers to the competition." The Note states that it did cause sales to decline for the firm.
Which answer below best states the relevant working capital facts and analysis of how that change created a positive financial benefit?
CASE NOTE: The Jones Electrical case has facts about ways to create an overall positive financial benefit for the company through different management of working capital accounts. Look for a similar opportunity in that case as the one found in the metals refining firm of the Note.
| a. The benefit was $112 million of new profit. The reduction in receivables was $115 million, and clearly outweighed the loss in sales from demanding faster payment, which was $3 million. | |
| b. The benefit was $115 million of new profit. Reducing the days of receivables from 185 days to 45 days put the equivalent of $115 million in recovered capital back into the bank account of the company. | |
| c. The benefit was $5 million a year of new profit, each year after that. The 45 days of receivables created $115 million less of the "accounts receivable" than did 185 days of receivables. That extra $115 million asset had been funded with money that cost $8 million a year, and the sales declined by only $3 million a year. |
QUESTION: Under "Mistake 3: Overemphasizing Quality in Production," starting in about the fourth paragraph of that section, the Note talks about an Italian food manufacturer that stopped "aging" some of its products in its inventory for 12 - 24 months to increase product quality. Management originally insisted the "aged" products were profitable and should be kept.
Which answer below best states the relevant working capital facts and analysis of how that change created a positive financial benefit?
CASE NOTE: Again, the Jones Electrical case has facts about ways to create an overall positive financial benefit for the company through different management of working capital accounts, like this company tried.
| a. The sole effect was a one-time increase in cash. This occurred when the inventory that had been built up for 24 months was sold and no longer kept by the company. | |
| b. Return on sales improved. Although quality dipped, the changes was imperceptible to customers, and thus the impact on margins was negligible. | |
| c. Return on invested capital improved. The invested capital was the tens of millions of euros (the currency in Italy) that was tied up in working capital represented by the "aging" products that had to be held in inventory for 12 - 24 months. Those "aged" products did not have as good a return on that invested capital as other products did on their invested capital. |
QUESTION: Look at the example given under "Mistake 5: Applying Current and Quick Ratios" in the fourth paragraph of that section, of a French consumer goods company.
Which answer below best states the overall big picture of the mistake the company was making?
CASE NOTE: For the Jones Electrical case, you will need to summarize the overall picture of whether or not something that appears good,in ratios or other numbers, really is good from the perspective of working capital management. You will need to look at the effects good and bad working capital management can have in the long run for a company. Is Jones Electrical better off in the future? Look at their working capital issues, like the ones listed in these case analysis questions.
| a. The higher current and quick ratios meant there was a large amount of capital tied up in receivables and inventory. The company's cost of invested capital could have been too high for the company to maintain those large amounts. That could be why they went bankrupt 6 months later. | |
| b. The higher quick ratio meant the company did keep higher inventory levels, but there were not enough receivables to repay their loans in the event of distress to the company. That could be why they went bankrupt 6 months later. | |
| c. The higher current ratio meant there were not enough receivables and inventory to repay their loans in the event of distress to the company. That could be why they went bankrupt 6 months later. |
