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Analysing wEfeedU’s Financial Position

economy

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Analysing wEfeedU’s Financial Position

Analysing the company’s liquidity status by calculating the liquidity ratios

Liquidity ratios measure a business’s ability to cover its obligations, without having to borrow or invest more money into business.One of the most common liquidity ratios is the Current ratio. It is calculated by dividing current assets by current liabilities. Fortunately, the BML program calculated this value so it did not require any additional effort to calculate it. This ratio could also be seen as a measure of working capital.

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Current Ratio

9,935

15,4082

6,4372

6,4199

6,4425

16,7939

5,2586

6,5917

5,4572

9,9389

As it can be clearly seen the the company had a lot of working capital which means the company could be in a position to expand and improve its operations. Since the company had never negative working capital it had always sufficient resources to meet its current obligations therefore it was always in the position to take advantages of opportunities for growth. In the second quarter of the year 91 and 92 the current ratio was extremely high compared to the other quarters. The reason for it is that in that time the accounts payable was very low. The current ratios in the second quarter of 91 varied greatly if the other 7 companies are considered as well. The first company had the lowest current ratio (0,5836) which means that they had liquidity problems at that time and the company with the highest current ratio was the sixth company (19,9883). The average value of current ratios was at that time 10,49. The company wEfeedU had always higher current ratio than the average in a given quarter which further proves that it had no liquidity problems. However, it also means that beside the fact that the company was always in the position to take advantages of opportunities for growth it did not fully exploit its opportunities, the company did not allocate enough resources to grow its business. The cash management of the company was not really efficient. Comparing the company’s current ratio to the key business ratio shown at creditguru.com (1.50) the company had extremely high current ratios. It is also have to be taken in consideration that the company has no long term debt which means that the possibility of collecting money in order to be able cover long term debt should be excluded. The reason for this high current ratio is that the company did a poor job in investing its money.

Another ratio that indicates the company’s liquidity is the acid-test ratio which is also called quick ratio. It is calculated by current assets minus inventories and this result divided by current liabilities. Inventory is a current asset that may or may not be quickly converted into cash. This depends on the inventory turnover ratio. By excluding inventory the quick ratio considers that part of current assets that can be readily converted into cash. The ratio shows how much of the company’s short-term debt can be met by using the company’s liquid assets at short notice.

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Acid test ratio

0,717656

10,62399

6,086525

0,822385

-1,31419

13,63234

2,090702

4,193928

1,444899

9,077319

This ratio varied greatly among quarters but it was usually high. In the first quarter of the year 1991 this value was below 1 (0,718) which means that on 71,8 % of the company’s short term debt could be met by using the company’s liquid assets. The reason for it was the high inventory level (345999) compared to the cash and accounts receivables (399877). Also in the first quarter of the year 1992 the company had problems concerning quick ratio because the value was -1,31419. For this also the extremely high inventory (459575) was the reason (in that quarter was the inventory the highest compared to the other quarters). In this quarted had the company the fewest cash (only 35000). The average cash in a month was 237 181,2 and in the first quarter of the year 1992 it was only the 14,76% of the average cash amount. In those two months the company’s current assets were highly dependent on inventory. However, it has to be mentioned that in the following quarter (2nd quarter of 1992) was the quick ratio the highest, 13,632 because the inventory was reduced to approximately 10% (58372) compared to the previous month (only 4200 pieces were produced from product 1) and the cash level increased to 230490. According to creditguru.com the ideal quick ratio in the manufacturing industry of household appliances would be 0,62.

Another tool to determine the company’s liquidity is the cash ratio analysis. At this analysis inventory and accounts receivable are not taken in consideration. It can be calculated by dividing the total value of cash and other marketable securities by the current liabilities. A strong cash ratio is useful to creditor when they decide about the amount of debt.

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Cash ratio

3,309997

8,270645

4,477448

1,83702

0,30037

6,242112

1,221719

2,0439

1,04799

4,634675

Just as the other figures showed this figure also proves that the company was inefficient concerning its cash management. The company’s cash ratio varies greatly from quarter to quarter and it was unacceptably high in the 1st, 2nd, 3rd quarter of 91, in the 2nd quarter of 92 and 93. This indicates that the company should have used its extra money to search greater returns and not to generate excessive cash asset ratio.

Analysing the company’s indebtedness by calculating indebtedness ratios

To analyse the company’s indebtness debt to equity ratio is calculated. It is a measure of a company’s financial leverage calculated by dividing its total liabilities by stockholders’ equity. This ratio was calculated by BML.

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Debt/Equity

0,0747



0,0482

0,0972

0,1304

0,1291

0,0451

0,1566

0,1173

0,1384

0,076

As it can be clearly seen the debt equity ratio was very low. It shows that the company did not finance its growth with debt. It means that the company was not dependent on the change of interest rates. If this ratio would be higher than the company could potentially generate more earnings than it would have without outside financing. However, it should be mentioned that the cost of debt financing could be very high (sometimes may outweigh the return that the company could generate on the debt through investment and business activities) and could lead to bankruptcy. Since the company had very low ratio the company was not in the danger of bankruptcy (beside the fact that it had very little earnings). According to Investopedia this ratio in capital intensive industries tends to be above 2 but at less capital-intensive industries it tends to be under 0,5. Since it is a manufacturing company it is rather capital intensive therefore it would be practical if this ratio was higher. Because this means that the company did not really use any kind of loans which is necessary for bigger investments and if the company does not invest money then it can not generate higher profit. Comparing this ratio to the other firm’s debt/equity it was always lower but not surpassingly lower (except compared to company 1 whose debt/equity ratio was always above one and once it was 6,3739)

There is another ratio calculation that indicates how much the company is indebted. This ratio is called debt to share ratio. It was also calculated by the simulation.

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Debt/Share

0,2503

0,1656

0,3431

0,4036

0,4063

0,1364

0,4393

0,3424

0,4071

0,2287

 As it can be clearly seen debt/share ratio changed proportionately with debt/equity ratio. This ratio just as the debt/equity ratio was always lower than the competitors’ debt/share ratio.

Methods to improve liquidity and indebtedness ratios

Since the company never had liquidity problems (current ratios, acid test ratios and cash ratios were always extremely high) the company does not need to use factoring. Factoring is useful for those who are not able to cover their short term liabilities and in order to avoid using special loans (which have extremely high interest rate 36%), they want to use factoring where the accounts receivables are transformed into cash (especially it is sold for cash but factoring company does not pay the whole amount of accounts receivables). It is especially good for those companies whose cash ratio is very low. Since these ratios are much higher than it is usual for the industry it should be decreased. By buying bonds or buying back stocks the company could reduce these ratios. If the company buys back some of its stocks then the stock price would increase which is quite necessary for the company.

The ratios which show the company’s indebtedness are very low. This means that the company does not use external financial resources to finance its investments. This can be a safe policy but the company with this policy can not generate as much profit as it could because without investment it is not possible. For bigger investments loans are required. The company could take long term loan in order to invest in building a new plant in Area 2 and the indebtedness ratio would be higher.

The development of stock price of wEfeedU on the Bull Bear Stock Exchange

Quarters

1/91

2/91

3/91

4/91

1/92

2/92

3/92

4/92

1/93

2/93

Book Value of Share(€)

3,352

3,432

3,5285

3,0942

3,1485

3,0224

2,805

2,9195

2,9416

3,0084

Current Stock price(€)

3,34

3,29

3,29

2,72

2,61

3,1

2,93

3,23

3,1

3,24

Difference between book value of share and the current stock price(€)

-0,012

-0,142

-0,2385

-0,3742

-0,5385

0,0776

0,125

0,3105

0,1584

0,2316

Net Income

-11794

24033

28960

-10193

16291

52236

24805

35331

9236

23075

Bull Bear Stock index

112

117,13

116,37

109,4

108,3

111,85

113,8

113,5

112,8

119,1

Dividends/share (qtr)(€)

0

0

0

0,4

0

0,3

0,3

0

0

0,01

As it can be seen the share prices of wEfeedU was under-evaluated until the 6th quarter of the simulation. The share price development of wEfeedU did not change in parallel to the change in Bull Bear Stock Index. The share price of the company has decreased until the 6th quarter of the simulation. Meanwhile the Bull Bear Stock Index increased in the first two quarters then decreased in the 3rd, 4th and 5th quarter and then increased again until the 8th quarter when there was a slight fallback and to the last quarter there was an extremely high increase. The share price of wEfeedU decreased until the 5th quarter of the simulation then started to increased to the 6th quarter but it was followed by a fallback in share price in the 7th quarter. In the 8th quarter the share price increased then in the 9th quarter it decreased again and to the last quarter it increased again. The value of this price changes is not extremely high which can show that the company stagnates.

Net Income greatly affects the share price. The company had very little net income compared to its competitors and this can be the main reason why its share price did not increase as much as its competitors’ share prices (moreover the 8th quarters share price compared to the 1st quarter share price is 0,1 € less). The company started its operation with -11794 € which can be a possible reason why its stocks were immediately under-evaluated. This statement is further proved by the fact that the company’s stocks became over-evaluated when it achieved its highest net income (52236€) in the 6th quarter. The current stock price changed in parallel with the change in net income.

Another factor that affects the development of share prices is how much dividend is paid per share. If dividend is paid more regularly and a high dividend is paid then the share price will increase. This effect did not show up always in the results, because the first dividend was paid in the 4th quarter but the share price increased only in the 6th quarter.

The number of stocks on the market also affects the stock price of the company. The company purchased shares in the last three quarters but it did not have immediate visible effect on the development of share prices. Since the company had excess cash in hands it could have paid more dividends and maybe the share prices would have increased.

Company

1

2

3

4

5

6

7

8

Stock prices in the last quarter

5,87

7,92

5,86

2,79

7,44

3,1

5,34

3,1

Comparing the closing stock prices of the companies, wEfeedU closed at a very low stock price. The main reason for this low stock price is that the company was not able to generate high net income. The company could have gave more dividends or purchased more stocks back since the company had excess cash in hand and this could increase the stock price of the company. All in all the company had not such efficient financial strategy because they had very high liquidity ratios which means they did not invest its money at all so it missed the opportunity for profit generation. Because of the lack of investments the company was not able to develop in a good way it simply stagnated both in the view of product development and both in the view of financial development.

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