Financial Statement Analysis and Loan Decision. The Konrath Company, a wholesaler in the midwest, is considering extending credit to the Hawk Company, a retail chain operation that has a number of stores in the midwest. The Konrath Company has had a gross margin of approximately 60 percent in recent years and expects to have a similar gross margin on the Hawk Company order, which is estimated at $2 million per year. The Hawk Company’s order is approximately 15 percent of the Konrath Company’s present sales. Recent statements of the Hawk Company are given below.
Hawk Company Balance Sheet (in Millions of Dollars) As of December 31, 20X1, 20X2, and 20X3
20X1 20X2 20X3
ASSETS
Current assets
Cash $ 2.6 $ 1.8 $ 1.6
Government securities (cost) 0.4 0.2
Accounts and notes receivable (net) 8.0 8.5 8.5
Inventories 2.8 3.2 2.8
Prepaid assets 0.7 0.6 0.6
Total current assets $14.5 $14.3 $13.5
Property, plant, and equipment (net) 4.3 5.4 5.9
Total Assets $18.8 $19.7 $19.4
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Current liabilities
Notes payable $ 3.2 $ 3.7 $ 4.2
Accounts payable 2.8 3.7 4.1
Accrued expenses and taxes 0.9 1.1 1.0
Total current liabilities $ 6.9 $ 8.5 $ 9.3
Long-term debt, 6% 3.0 2.0 1.0
Total liabilities $ 9.9 $10.5 $10.3
Stockholders’ equity 8.9 9.2 9.1
Total liabilities and stockholders’ equity $18.8 $19.7 $19.4
Hawk Company Income Statement (in Millions of Dollars) For the Years Ended December 31, 20X1, 20X2, and 20X3
20X1 20X2 20X3
Net sales $24.2 $24.5 $24.9
Cost of goods sold 16.9 17.2 18.0
Gross margin $ 7.3 $ 7.3 $ 6.9
Selling expenses $ 4.3 $ 4.4 $ 4.6
Administrative expenses 2.3 2.4 2.7
Total expenses $ 6.6 $ 6.8 $ 7.3
Earning (loss) before taxes $ 0.7 $ 0.5 $ (0.4)
Income taxes 0.3 0.2 (0.2)
Net income $ 0.4 $ 0.3 $ (0.2)
Hawk Company Statement of Changes in Financial Positions (in Millions of Dollars) For the Years Ended December 31, 20X1, 20X2, and 20X3
20X1 20X2 20X3
Sources of funds
Net income (loss) $ 0.4 $ 0.3 $(0.2)
Depreciation 0.4 0.5 0.5
Funds from operations $ 0.8 $ 0.8 $ 0.3
Sale of building 0.2
Sale of treasury stock 0.1 0.1
Total sources $ 1.0 $ 0.9 $ 0.4
Uses of funds
Purchase of property, plant,
and equipment $ 1.2 $ 1.6 $ 1.0
Dividends 0.1 0.1
Retirement of long-term debt
Total uses $ 1.3 $ 2.7 $ 2.0
Net increase (decrease) in net
working capital $(0.3) $(1.8) $(1.6)
(a) Calculate for the year 20X3 the following ratios: (1) return on total assets; (2) acid-test ratio; (3) profit margin; (4) current ratio; and (5) inventory turnover.
(b) As part of the analysis to determine whether or not Konrath should extend credit to Hawk, assume the ratios below were calculated from Hawk Co. statements. For each ratio indicate whether it is a favorable, unfavorable, or neutral statistic in the decision to grant Hawk credit. Briefly explain your choice in each case.
20X1 20X2 20X3
(1) Return on total assets 1.96% 1.12% (0.87)%
(2) Profit margin 1.69% 0.99% (0.69)%
(3) Acid-test ratio 1.73 1.36 1.19
(4) Current ratio 2.39 1.92 1.67
(5) Inventory turnover (times) 4.41 4.32 4.52
Equity relationships
Current liabilities 36.0% 43.0% 48.0%
Long-term liabilities 16.0 10.5 5.0
Shareholders’ equity 48.0 46.5 47.0
100.0% 100.0% 100.0%
Asset relationships
Current assets 77.0% 72.5% 69.5%
Property, plant, and equipments 23.0 27.5 30.5
100.0% 100.0% 100.0%
(c) Would you grand credit to Hawk Co.? Support your answer with facts given in the problem.
(d ) What additional information, if any, would you want before making a final decision? (CMA, adapted.)