Purpose To enable students in utilising financial ratios for the purpose of eval

Question

Purpose

To enable students in utilising financial ratios for the purpose of evaluating a firm’s financial performance and financial position as well as in recognising firms facing financial distress and using ratios to make decisions for improvement.

Requirement : Financial Statement Analysis

The owners of Foodhall Co., have hired you to help them diagnose and solve problems that the company has had in maintaining adequate liquidity. As a first step, you perform a liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations and appropriate industry norms are listed.

Ratio                                                                              Foodhall                                  Industry norm

Current ratio 4.5                                               4.0

Quick ratio 2.0                                               3.1

Inventory turnover 6.0                                               10.4

Average collection period 73 days                                     52 days

Average payment period 31 days                                     40 days

Required:

a.What recommendations relative to the amount and the handling of inventory could you make to the new owners?(3)

b.What recommendations relative to the amount and the handling of accounts receivable could you make to the new owners? (3)

c.What recommendations relative to the amount and the handling of accounts payable could you make to the new owners?(3)

d.What results, overall, would you hope your recommendations would achieve? Why might your recommendations not be effective?(3)

e.Highlight the usefulness as well as the drawbacks of conducting ratio analysis. (2)

Explanation / Answer

(a)Recommendations on Inventory Turnover:

Less Inventory ratio shows that the company is having more Inventory holding period, which increases the storage costs and also leads to damage of inventory. Some Recommendations are:

(b)Recommendations on Accounts Receivable:

More collection period implies that the more funds are locked in working capital and company is not having effective collection policy. Some Recommendations are:

(c)  Recommendations on Accounts Payable:

Less payment period again implies that more funds are locked in working capital. Company should not make early payments, but also company should not delay payment to suppliers. Some Recommendations are:

1)Good Payment Poilcy. Company should maintain a good payment policy to avoid early or delayed payment.

2)Automation. Since company has more responsibilities, it may oversight supplier payment. So, it should introduce automated payments to suppliers thereby complying with the credit policy.

3)Discounts. Company can make early payment, if sufficient discount is offered by the suppliers.

(d)Impact of recommendations:

The following are the benefits of the above recommendations.

Situation where recommendations will be ineffective:

When the inventories are maintained according to the sales forecast, there are chances that company cannot cater to the needs of customers during emergency situation.

(e)Usefulness and Drawbacks of Ratio Analysis:

Usefulness:

Drawbacks:

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