Case 2 examines what can happen when attention to detail in managing a business is not a priority. We will look at the situation of a specific company, Koala Fun, to determine what has caused the issues the company faces, as well as what might be done to turn the company around. As you review the case, imagine you were in the owner’s position: What would be your decision-making process, and what information would you need to make your decisions?
First, review the Koala Fun case (Case 2) in your textbook, as well as your responses to the case study review in Module Three, and then explain your answers to the quiz questions. In addition, address the following in your journal entry:
Risks: Describe the risks that Koala Fun faced as a company.
Management: In what ways was Koala Fun not being managed to obtain optimum performance from its assets? Explain.
Decisions: How does this case demonstrate the importance of analyzing financial data when making financial decisions?
Recommendations: What recommendations regarding risk and profitability would you make to Koala Fun’s owners to improve their company? Briefly describe your recommendations.
Support your answers by referencing the case and providing information, including the financial ratios you calculated when you first worked on this case in Module Three.
Brock Haner Finance 610 Koala Case Study March 1, 2018 1. Using the data in exhibits C2.1 and C3.3, calculate and analyze the firm’s 2012 and 2013 ratios. Enter the ratios in the table below in the 2012 and 2013 columns, respectively: Ratio Type 2012 2013 Current (times) 3.73 3.43 Quick (times) 2.39 1.83 Debt (%) 37.66% 35.32% Times interest earned (times) 8.51 11.62 Inventory turnover (times) 6.40 4.80 Total asset turnover (times) 2.78 2.71 Average collections period (days) 54.96 50.99 Return on equity (%) 11.60% 10.81% Koala is a very liquid company as their current and quick ratios exceed the industry average. Koala has a lower debt percentage, and their interest earned ration is increasing, which indicates that they can cover their debt obligations without paying interest. Koala can improve their return on equity by using more debt financing instead of equity will improve this ratio. 2. Part of Owen’s evaluation will consist of comparing the firm’s ratios to the industry as shown in Exhibit C3.3 of the text. Discuss the limitations of such a comparative financial analysis. In view of these limitations, why are such industry comparisons so frequently made? (Note: Sales are forecast to be $8.25 million in 2014). Financial ratios are a tool that provides management insight into the performance and operations of the company. Ratio analysis, and other metrics are used to provide a comparative basis for a company against its industry and its experience in previous years (book, p. 17). They allow us to quickly examine a company’s financial statements to determine how performance has changed over time, and/or against its competitors. No two companies are exactly alike. They may have different geographic coverage, different product lines, dissimilar economies of scale, accounting practices used, different fiscal year-end closing dates, seasonal products, and size and product portfolio of other companies in the industry. Therefore, based upon the differences, ratio data can lose meaning. They are a benchmark to make adjustments to the products, such as pricing and asset turnover in order to keep a product line profitable. 3. Owen thinks that the profitability of the firm has been hurt by Tessa’s reluctance to use much interest-bearing debt. Is this a reasonable position? Explain. With a debt strategy, the company would be more capable to purchase necessary resources, such as equipment and technology that would be needed to aggressively grow the company, and remain profitable. Another benefit of debt strategy to reinvest in the company is that loans require payments to be made on a schedule, with an interest cost to the company, which will affect their cash flow. Loans also would not cause the company to surrender an ownership stake of the company. If the company was to overuse debt, especially with high interest rates, the reduced cash flow could prevent desired growth of the company. 4. The case mentions that Tessa rarely takes trade discounts, which are typically 1½/10, net 30. Does this seem like a wise financial move? Explain. Management should prefer to pay invoices as late as possible in order to hold onto cash for as long as possible to increase cash flow that can be used to reinvest in the company. However, if the savings from paying early are beneficial, the savings must be significant enough for the company to surrender the funds early. A 1.5% discount does not seem to be that significant of a savings to merit such a concern on early payments, as the company seems to need the cash as Tessa continues to grant payment extensions to customers. The company is in more need to hold on to cash while it waits to collect from customers. 5. Is the estimate of $35 to $40 for Owen’s shares a fair evaluation? Explain. The estimation of Owen’s shares at $35-40 is a little high, but could be considered a fair evaluation. In 2012, the company’s stock price was $23.74 per share. It rose in 2013 to $30.04 per share. As a founding partner of the company, Owen should be compensated above the current share price. In 2014, sales estimates are expected to increase to $8.25 million, making the company more valuable, and the stock price to increase. 6. What do you recommend Owen and Tessa do to improve their company? Owen and Tessa need to leverage debt more effectively to grow their company as long as they can generate a higher rate of return on the investment than the interest rate on its loans. Their debt percentage dropped from 2012 to 2013, and is 50% below the industry average in 2013. The company’s times interest earned ratio is far above the industry average, and indicates that they are not using their financial leverage in the most efficient way showing a misappropriation of earnings. Avoiding debt has significantly reduced the company’s financial flexibility as all new projects will have to be equity financed. This means that the company cannot pay dividends to its shareholders as all earning have been reinvested. The company needs an infusion of capital to maintain and grow the company.