Case Analysis on

Financial
Management 1
The Case of the Unidentified Industries

Caroline T. Jaro
CBET-01-501P
August 08, 2014

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Introduction

Financial and operating ratios allow one to focus on various areas of business

management, to compare results against industry averages, and to gauge the financial

health of an investment prospect. Ratios can be the keys to success in the many areas

where identification of norms, benchmarks, internal eccentricities, or long-term trends are

critical.

Ratios are intended to show relationships between dollars, numbers, and

percentages taken from balance sheets and/or income statements. An analysis of the

transformed data from these two financial statements makes it possible to draw

inferences, make comparisons, and track long-term results.

The more you know about one company --or industry--underlying economics, the

more solid footing you're on when analyzing its prospects. Understanding the impact of

the cost structure on a company's or industry's profitability is a big step toward

understanding why some businesses simply have better economical strategies than others

do.

This paper analyzes the case of 14 industries (online book seller, book store chain,

online direct factory, pharmaceutical manufacturer, advertising agency, computer,

software development, health maintenance organization, family restaurant chain retail

grocery chain, department store chain, retail drug chain, electric and gas utility, airlines,

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commercial bank) and their corresponding balance sheets and financial ratios (Appendix

A).

A- Online Book Seller

There is significant evidence that this firm match the industry because it has a

high ratio of inventory turnover which is 11.4 but a relatively low inventory 15% at the

same time. This means that they acquire books faster and then sell them to consumers just

as fast. Due to the fact that it is an online business, the number of plant and equipment

should be lower than the other retail business that has a physical store.

B- Book Store Chain

Retail firms like bookstore chain are likely to have shorter RCP (less than 30

days), which means only A, B, H, I, K and M match this description. Furthermore,

bookstore chain has relatively high plant and equipment (P&E), i.e. P&E / Assets is no

less than 25%, thus A can be eliminated. Other than that, the inventory of book store is

relatively high; therefore M (with no inventory), H and I can be eliminated as well.

Moreover, the inventory turnover (cost of goods sold/inventory, indicates how often the

company sells and replaces its inventory) of the book store chain is normally very low,

because the books are neither perishable goods nor every day’s necessities, and its

accounts receivable should be very low as well.

C- Online Direct Factory (to customer personal computer vendor)

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 First of all, it is a pre-sold company, so the inventories should be relatively low

which is 2 in this case. And it mentioned that more than half sales to business customers

which could be inferred to a big number of accounts receivable. The manufacturing

outsourced means they do not need a large plant to operate the business. Therefore it has

a low plant and equipment with the number of 9. The famous American laptop brand Dell

is a successful example for this industry.

D- Pharmaceutical Manufacturer

Being a manufacturer; a firm must need plenty of raw materials to make final

products, which belongs to the concept of other assets. This is the reason it has a

relatively high number of other assets. By knowing this, we can conclude it could be D,

E, G or J. We first exclude E and G since they are service providers with no inventories

which pharmaceutical manufacturer is obviously not. For D and J, we compare the

receivables collection period. It turns out D’s period is longer, which match the feature of

a non-retail business.

E- Advertising Agency

As a service firm, it does not contain inventory, so first of all, it can be narrowed

down to E, G, M, and N. And generally B firms provide credit terms to their customers

which result in receivables collection periods(RCP) is larger than 30 days, therefore it can

be further narrow to E,G,N. Furthermore, based on the given hints, the media purchase is

made on behalf of the client, this means the account receivable and account payable

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should be roughly equal, since the agency does not pay for the media services until their

client pays.

F- Computer Software Developer

As a software developer, it focuses on providing services. However, there will be

few percentages in inventories like software CD-ROM. Hence, computer software

developer would be C, D, F, H or L. Additional; Computer software developer focus on

wholesale. Therefore, the inventory turnover ratio will be low, C, Hand L can be

excluded. Because of the service type would be online; computer software developer will

be a low percentage of plant and equipment. So computer software developer must be F

which has only 4% of the balance. For instance, Microsoft is the biggest computer

software developer. The current ratio in this industry is the highest which is 2.18.

Moreover, net profit/ total assets is 0.181 which is the greatest of all the fourteen

industries. Therefore computer software developer industry is the most profitable. The

receivables collection period in this industry is 77 which is the fourth longest of the

fourteen.

G- Health Maintenance Organization (HMO)

First of all, similar to the Advertising agency, it is also a service provider,

therefore it has 0 inventory (E, G, M, N), and low P&E which eliminate M. On the other

hand, as a health company, its obligation is to provide or arrange managed care for health

insurance, health care benefit plans etc, the transaction are normally not involve cash,

therefore the amount of both accounts receivable and payable must be very high, which

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also indicate its RCP is large as well. Moreover, HMO typically can expect to have a total

asset turnover ratio much greater than 1.00 (ratio of revenue to total assets), it is because

HMO collects revenues (premiums) that it will distribute to its participating providers and

except in a minority of cases, the HMO itself will own very few assets, so its total asset

turnover can be higher (McLean, 2003). Therefore only G matches these descriptions.

H- Family Restaurant Chain

“Classic Savory” is a good example for this industry. Because the profitability of

a restaurant highly depends on the location, equipment and taste, the percentage of plant

and equipment would be most of the balance. And the quantity of customers would be

huge; hence the inventory turnover would be very high. Due to the most customers pay

by cash and credit cards immediately, the receivables collection period would be the

lowest of all the fourteen industries. The revenue/total assets in this industry are 1.9

which is the 6th highest of fourteen.

I- Retail Grocery Chain

As a retail chain, it will have high inventories and P&E for daily operation, and its

inventory turnover should be relative high because it indicates the number of times

inventory (grocery) is sold or used in a time period is relatively high. The RCP should be

low because it normally involves cash transaction. The high level of revenue to assets but

low level of net profit to revenue indicates the high volume and low margin nature of the

grocery. Based on these it could be concluded that I is the matching choice.

J- Department Store Chain

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 We take an example as Robinson’s Department Store. In this industry, company

has a high percentage of inventory, plant and equipment. Moreover, the inventory

turnover is 2.3. It is quite lower than other retail store. For store chain, most of the

payment is credit cards. So that the percentage of accounts receivable would be high and

the receivables collection period is higher than other retail industry. Also, net profit/ net

worth in this industry are very low which is 0.104.

K- Retail Drug Chain

As the drug chain being a non-services company or a manufacture company it

could be very hard to define their position. Only I and K are left so the K should belong

to the retail drug chain. As a chain store the inventory for retail drug chain is very high.

As the drug is an expensive item most of the customer will pay by credit so the account

receive will be higher than the cash. As a chain store the equipment will cost a lot of

money and K should be in the retail drug chain. Also, the retail drug chain like other

retailers, have a low collection period which results in low account receivables. The retail

drug chain source of revenue comes from selling prescription drugs, which is cheaper

than purchasing them from the vendor.

L- Electric and Gas Utility (with 72% of its revenue from electricity sales and 28% of its

revenue from natural gas sales)

From the case, this company has 28% of its revenue from natural gas sales and

electric utility so there would be no inventory. Also, the percentage of inventory must be

very low and the percentage of plant and equipment should be huge. “Meralco” and

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“Maynilad” are good examples in this industry. The receivable collection period due to

the process of billing customers would be around 30 days. Due to the high cost of

infrastructure, the profitability of this industry is 0.096 which is the second lowest of

fourteen industries.

M- Airlines

It is a service firm (similar to an advertising agency), so its inventory is zero as

well (G, M, N), and moreover, it is also a Business to Customer firm, its receivable

collection is relative short(less than 30 days), so only M (RCP=12) is left which matches

the description.

The airlines asset turnover is extremely high. The airline has a high plant and

equipment ratio. The airline has notes payable because some of the aircraft is taking

longer than a year to pay for. Net profit/net worth shows that the industry is profitable.

N- Commercial Bank

The same with an advertising agency, it is a service firm. Therefore, its inventory

is zero as well (only G and N are left which match the requirement). Moreover, banks use

a lot of “other peoples’ money” so that common total debt/total assets ratio is very high,

i.e. N (total debt/total asset=0.88) fits this description. Also, the commercial bank has its’

own number system. The loans of the commercial bank are classified as accounts

receivables, and the deposits as accounts payable. Commercial bank has high long term

investments. The notes payable are very high, because it will normally take longer than a

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year for some payments to be paid off. The receivable collection days are very long due

to loans, investments, etc.

Conclusion

This paper was intended to show that one industry has a balance sheet and

financial characteristics that set them apart from others. These characteristics are often

used to compare firms within an industry. Summarized data should be used with caution,

however. Different firms (even in the same industry) classify identical items differently.

Thus the analyst should examine original financial statements to achieve better

comparability. Differences among firms may be due to operational or classification

differences. When management is available to answer questions, these differences are

often useful starting points for obtaining a better understanding of the firm.