Financial statement analysis The financial statements of Zach Industries for the

Question

Financial statement analysis The financial statements of Zach Industries for the year ended December 31, 2019, follow a. Use the financial statements to complete the following table .Assume the industry averages given in the table are applicable for both 2018 and 2019. b. Analyze Zach Industries' financial condition as it is related to (1) liquidity. (2) activity, (3) debt, (4) profitability, and (5) market. Summarize the company's overall financial condition. a. The current ratio is 1.04 (Round to two decimal places.) The quick ratio is 0.40. (Round to two decimal places.) The inventory turnover is 2.33. (Round to two decimal places.) The average collection period is 57 days. (Round to one decimal place.) The debt ratio is 95.83% (Round to one decimal place.) EEB

Explanation / Answer

Current Ratio = Current Assets/Current Liabilities
Quick ratio = (Current Assets-Inventories)/Current Liabilities
Inventory Turnover ratio = Cost of Goods sold/Inventories
Average Collection Period = 365/(Sales/Accounts recievables)
Debt Ratio = Total liabilities/Total Assets
Times Interest Earned = EBITDA(Operating profit+Depreciation)/Interest
Gross Profit Margin= Gross Profit/Sales
net profit Margin=Net profit/Sales
return on Total Assets= Net Profit/Total Assets
Return on Equity = Net Profit/Shareholder's Equity
Market/Book value = (Price*No.of shareholder's equity)/(Total Assets-Intangible assets-liabilities)

b) 1. Liquidity : Zachs Industries current and quick ratio has decreased from FY2018 and is less than the industry average which means the company's liquidity position is not strong. The company might face difficulty in meeting its short term obligations if any.

2. Activity : Zachs Inventory turn over ratio and average collection period has increased in FY2019 which means that the company is having a tough time in converting its inventories into cash. Even the average collection period which has increased drastically indicates a poor credit conversion. The company should have a stricter credit facility to reduce its collection period. Thus, even the activity ratio is not strong and Zach is unable to convert its balance sheet accounts in to revenue efficiently.
3. Debt : Debt Ratio of the company is good and has reduced. This means around 61% of the company's assets are financed by debt which is comparable as per industry standards. Even times interest earned is more than the industry average which implies that the company is in a good position to meet its debt payments.
4. Profitability: Gross Profit margin has declined however, net profit margin has increased for FY2019. This refers to an increase in cost of goods sold in FY2019, however, the the company was efficient in managing its operating expenses leading to an increase in its net profit margin indicating an efficient operating environment.
Return on Total Assets and Return on Equity has also increased and is more than the industry average which means the company is efficient in deploying its assets and at the same time has been able to generate good profits on the shareholder's investment.

5. Market : Market to Book value of the company is more than the industry average and is above 1 which means the company is trading at a price more than the book value of the company.

Overall, Zach Industries has strong fundamentals with lower debt as compared to the industry and a higher interest coverage ratio. These are indicative of a strong balance sheet profile.

The company's net profit margin is better than the industry average and return on equity is also above industry average. While the market-to-book value of Zach Industries is higher than the industry average, I don't see this as a metric to judge overvaluation. The company's net profit margin and ROE are higher than the industry average and this can potentially justify premium valuation as compared to peers.

Ratio Industry Average Actual 2018 Actual 2019 Current ratio 1.80 1.84 1.04 Quick ratio 0.70 0.78 0.38 Inventory Turnover ratio 2.50 2.59 2.33 Average collection oeriod 37.50 36.50 57.03 Debt ratio 65.00% 67.00% 61.30% Times Interest Earned 3.80 4.00 4.43 Gross Profit Margin 38% 40% 33.8% Net Profit Margin 3.50% 3.60% 4.09% Return on total Assets 4.00% 4.00% 4.36% Return on Equity 9.50% 8.00% 11.27% Market/book ratio 1.10% 1.20% 1.29

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