Download Liquidity Ratios

Andres
Andres is a very large company and they are one of the oldest wineries in Canada. It is
considered a stable company in the mature phase of its lifecycle. Historically Andres was
primarily a producer of table wine, however Andres has recognized the consumer trend
towards premium wines. They have been expanding their selection of premium wine,
primarily through strategic acquisitions of smaller estate wineries, specifically Peller
Estates and Hillebrand Estates. Andres has wineries in Ontario, British Columbia, Alberta
and Nova Scotia. On May 31, 1999, Andres sold Les Vins Andres du Quebec Ltee, a whollyowned subsiduary for a gain of $7.29 million (after-tax $5.2 million). They do not grow the
majority of their grapes, but instead purchase them from growers. The company relies on
both the domestic production of grapes and importation of wine from other countries
around the world. The company markets wines produced from grapes grown in Ontario’s
Niagara Peninsula, British Columbia’s Okanagan Valley and vineyards around the world.
They sell their wines through the LCBO and through the Wine Shoppe (an independent
retailer in Ontario).
Andres Wines Ltd.
Balance sheet As at March 31, 2000
Assets
Actual
Numbers
Percentage
Of Assets
Current Assets
Accounts Receivables
Inventories
Prepaid Expenses
Capital Assets
Investments
$12,068
9.56%
48,062
38.07%
857
0.68%
60,987
48.31%
59,760
47.34%
5,485
4.35%
126,232
100.00%
Bank Indebtedness
21,024
16.66%
Accounts Payable
10,557
8.36%
Dividends Payable
741
0.59%
3,091
2.45%
Total Assets
Liabilities
Current Liabilities
Income and other taxes payable
Current portion of long-term debt
Long-term debt
Future income taxes
Shareholder's equity
Capital Stock
Retained Earnings
2,107
1.67%
37,520
29.72%
19,053
15.09%
4,632
3.67%
61,205
48.49%
4,420
3.50%
60,607
48.01%
65,027
51.51%
Total Liabilities and Shareholder’s
Equity
126,232
100.00%
Andres Wines Ltd.
Income Statement
For the year ending March 31, 2000
Actual
Numbers
133,638
Percentage of Sales
Cost of Goods
84,332
63.10%
Gross Profit
49,306
36.90%
Selling and Administration
32,760
24.51%
Earning before interest and amortization
Sales
100.00%
16,546
12.38%
Interest
2,405
1.80%
Amortization
3,817
2.86%
Earnings before unusual items
10,324
7.73%
Gain on sale of Quebec Winery
7,290
5.46%
17,614
13.18%
5,591
4.18%
712
0.53%
6,303
4.72%
11,311
8.46%
Earnings before income taxes
Provision for income taxes
Current
Future
Net Earnings
Liquidity Ratios
Liquidity ratios reflect a company’s short-term ability to pay its debts.
Current Ratio— Provides some indication of the firm’s ability to generate cash in the short run.
Current Ratio
=
Current Assets
Current Liabilities
=
60,987
=
1.6255
Acid Test or Quick Ratio—Also provides some indication of the firm’s ability to generate cash
in the short run, but inventories are excluded because inventories are usually less liquid than
cash and accounts receivable.
Quick Ratio (acid test)
= Current Assets – Inventory =
Current Liabilities
=
0.3445
37,520
Inventory Turnover—Indicates management’s efficiency in inventory management. The
denominator is estimated by taking the average of beginning and ending inventories for the
period.
Inventory Turnover
=
COGS
Average Inventory
=
=
(48062+55581)/2
Average Collection Period, Receivables Turnover, and Aging of Receivables—Indicates
the quality and liquidity of accounts receivable. They are influenced by the efficiency of the
firm’s credit and collection policies.
Average Collection Period
=
Receivables Turnover
=
Receivables
=
Average Daily Credit Sales
Annual Credit Sales
Receivables
=
12,068
=
133,638/365
133,638
12,068
=
32.9608
11.0737
Note: All sales were assumed to be on credit. This was done to simplify the problem.
Aging of receivables is not a ratio technique. It categorizes the receivables according to the
length of time that they have been outstanding.
Leverage and Coverage Ratios
Primarily debt holders use leverage and coverage ratios. The debt holders are interested in two
things primarily.
1.6274
1. Leverage Ratios—How much debt is there currently in the company’s capital structure?
The debt holders are trying to assess the probability of potential default.
2. Coverage Ratios—Will the company be able to make the interest payments on a timely
basis?
Debt-to-Equity—Indicates the probability of potential default.
Debt to Equity Ratio
=
Long-term Debt
Shareholders' Equity
=
19,053
=
0.2930
Total Debt-to-Assets—Looks at the proportion of the firm’s total assets that are financed
through debt and other liabilities.
Total Debt-to-assets
=
Total Debt
Total Assets
=
61,205
=
0.4849
Leverage Ratio or Equity Multiplier—Another measure of the amount of assets a firm
finances with debt. The higher the ratio, the higher the portion financed through debt.
Leverage or Equity Multiplier =
Total Assets
Shareholder's Equity
=
=
1.9412
65,027
Times-Interest-Earned—Indicates the safety of periodic interest payments. EBIT is used
because these are the earnings that are available to pay interest charges.
Times Interest Earned
=
EBIT
Interest Charges
=
16,546-3,817 =
2,405
5.2927
Fixed-Charges-Coverage—A serious shortcoming of the times-interest-earned ratio is that it
ignores both lease obligations and sinking fund requirements. This ratio addresses this problem.
Fixed charges coverage
=
EBIT, lease charges, and =
taxes
Interest + lease charges +
Before-tax sinking fund
payments
Note that this is the same as the Times-Interest-Earned ratio.
16546-3817
2,405
= 5.2927
Profitability and Activity Ratios
These ratios are used to attempt to assess the overall managerial efficiency and profitability of a
company.
Gross and Net Operating Margins, Net Profit Margin—Indicate the company’s efficiency at
various levels of the income statement.
Gross Operating Margin
=
Sales - COGS
Sales
=
49,306
133,638
=
0.3690
Net Operating Margin
=
EBIT
Sales
=
16546-3817
133,638
=
0.0952
Net Income Margin
=
Net Profit
Sales
=
6,111
133,638
=
0.0457
Asset Turnover—Measures the sales generated by each dollar invested in assets and
indicates the efficiency achieved in employing assets to produce a given level of output.
Asset Turnover
=
Sales
Total Assets
=
133,638
=
1.0587
Return on Assets—Measures the dollar return per dollar invested in assets and indicates how
well management is employing assets to earn profits.
ROA
=
Net Profit
Total Assets
=
=
0.0484
126,232
Return on Equity—Measures how well management served shareholders’ interests.
ROE
=
Net Profit
Book Value of Equity
6,111
65,027
=
0.0940
The Dupont System—The idea is to decompose the ROE into its critical components in order
to give insight into three different areas of company performance and to identify adverse
impacts on ROE. This allows analysts to see what is contributing to strong (or weak) company
profitability as measured by ROE. The textbook only goes into three components, but different
approaches will decompose it into a different number of components.
Net Income
Equity
Net Income Sales Assets

*
*
Sales
Assets Equity
6,111 133,638 126,232

*
*
133,638 126,232 65,027
 0.0457 *1.0587 *1.9412
ROE 
 9.4%
Market Value Ratios
These ratios are primarily used by investors and by the firm’s management to try to read
investors’ perceptions of management’s decisions.
Price-Earnings Ratio—Reflects what investors are prepared to pay for each dollar of reported
earnings.
Price/ Earnings Ratio
= Price per common share
EPS
EPS =
6,111,000
4,737,054
=
=
11.80*
1.29
=
9.15
1.29
* From BigCharts.com, this is the closing price for Andres on March 31, 2000.
Dividend Payout Ratio—Indicates the percentage of earnings paid to shareholders in the form
of dividends.
Dividend Payout
= Dividend/Common Share
Earnings/Common Share
=
=
0.4853
1.29
Dividend Yield—Indicates the dividend income received by shareholders and how much they
are willing to pay for it.
Dividend Yield
= Dividend/Common Share
Price/Common Share
=
0.6261
11.80
=
0.0531
Tobin’s q Ratio and the Market-to-Book Ratio—Measures the firm’s overall financial wellbeing. It is generally viewed as a measure of future growth opportunities for the firm. A q ratio
above one indicates that the company is worth more as an ongoing entity than the sum of the
replacement value of its existing assets. A q ratio of less than one could indicate that either
management is poor, the company faces strong competition, the industry is regulated, or that
the industry is declining. Any of these factors would make the company an ideal takeover target.
The Market-to-Book ratio is an approximation of the q ratio that is more commonly used.
q ratio 
market val ue of both the firm' s debt and equity securities
replacemen t cost of the firm' s assets
Market - to - book ratio 
market val ue of the firm' s debt and equity securities
book value of assets