Running Head: ANANDAM MANUFACTURING COMPANY: ANALYSIS OF FINANCIAL

STATEMENT

Anandam Manufacturing Company: Analysis of Financial Statement

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 Anandam Manufacturing Company: Analysis of
Financial Statement

Question 1

Understanding of balance sheet and income statement.

The balance sheet and the income statement for Anandam Manufacturing Company has
been provided to use in exhibit 1 and 2 of the case. The financial statements are shown for the
three-year period from 2012 to 2014. Although, the income statement and balance sheet for
Anandam Manufacturing Company are not much detailed but it provides the necessary
information to analyze the performance and the financial condition of the company. For instance,
the income statement for Anandam Manufacturing Company shows that the credit sales for the
company comprise of around 90% of the total sales.

The remaining sales of 10% are the cash sales. This means that there might be risk of bad
debts or receivables collection. The balance sheet of the company shows that the company has
been issuing equity over the three-year period as the share capital of the company has increased
from $ 1200 to $ 2000 in 2014. The par value of each share is around Indian Rupees 10 as
specified in the balance sheet. Overall, this balance sheet and income statement would be
employed for answering and analyzing the next questions of the case.

Question 2

Prepare and analyze the common size statement of the company.

The common size analysis of the financial statements is performed either through the
vertical financial statements or through the horizontal financial statements. However, since we
also have to perform a trend analysis for Anandam Manufacturing Company, therefore, we
perform the common size analysis in this question through the vertical financial statement
analysis. The vertical income statement and the balance sheet for Anandam Manufacturing
Company for the three-year period computed in excel spreadsheet and shown in the tables below:

VERTICAL INCOME STATEMENT

2012–13 2013–14 2014–15
Sales
Cash 10.00% 10.00% 10.00%
Credit 90.00% 90.00% 90.00%
Total sales 100.00% 100.00% 100.00%
Cost of goods sold 62.00% 59.00% 60.00%
Gross profit 38.00% 41.00% 40.00%
Operating expenses:
General, administration, and selling expenses 4.00% 9.38% 12.50%
Depreciation 5.00% 8.33% 8.25%
Interest expenses (on borrowings) 3.00% 3.29% 4.25%
Profit before tax (PBT) 26.00% 20.00% 15.00%
Tax @ 30% 7.80% 6.00% 4.50%
Profit after tax (PAT) 18.20% 14.00% 10.50%

VERTICAL BALANCE SHEET

2014– 2013– 2014–
14 14 15
Assets
Fixed assets (net of depreciation) 74.22% 44.64% 51.33%
Current assets
Cash and cash equivalents 1.56% 1.79% 1.16%
Accounts receivable 11.72% 26.79% 22.94%
Inventories 12.50% 26.79% 24.57%

100.00 100.00 100.00

Total
% % %
Equity & Liabilities
Equity share capital (shares of
₹10 each) 46.88% 28.57% 21.84%
Reserve & surplus 14.22% 18.50% 20.49%
Long-term borrowings 28.75% 22.07% 27.30%
Current liabilities 10.16% 30.86% 30.36%

100.00 100.00 100.00

Total
% % %

The vertical financial statements show each component of income statement as a

percentage of sales and each component of balance sheet as a component of total assets. As
stated previously, the credit sales contribute to 90% of the total sales of the company and the
remaining 10% are the cash sales. All the operating expenses of the company such as interest
expense, selling, general and admin expense have all increased for the company but the cost of
sales have declined over the three-year period. The net profit, operating profit and the sales of the
company have shown a negative trend and this is alarming for the company.

The balance sheet of the company shows that although the percentage of accounts
receivables as a percentage of total assets has decreased but the proportion of cash has also
decreased. This might be due to the fact that the company is not able to collect its receivables on
time. The company is following a conservative working capital policies as the inventories are
decreasing for the company. Finally, there has been an increase in the long term debt which
shows that the company is becoming more levered while the current liabilities have declined.

Question 3

Prepare the cash flow statement (operating, investing and financing CF’s) of the Company.

The cash flow statement for Anandam Manufacturing Company has been prepared for the
three-year period in excel spreadsheet and is shown below:

CASH FLOW STATEMENT

2013–14 2014–15
Cash Flows from Operating Activities
Net Income $672 $840
Add Expenses Not Requiring Cash:
 Depreciation 400 660
Amortization of Goodwill 0 0
Other 0 0
Other Adjustments:
Subtract Increase in Accounts Receivable -1200 -600
Add Increase in Current Liabilities 1468 1052
Subtract Decrease in Accounts Payable 0 0
Subtract Increase in Inventory -1180 -750
Other 0 0
Net Cash from Operating Activities $160 $1,202
Cash Flows from Investing Activities
Purchase of New Equipment -900 -2460
Other 0 0
Net Cash Used for Investing Activities -$900 -$2,460
Cash Flows from Financing Activities
Proceeds from share issue $400 $400
Proceeds from LTD 500 1264
Other 0 0
Net Cash from Financing Activities $900 $1,664
NET INCREASE/(DECREASE) IN CASH $160 $406
CASH, BEGINNING OF YEAR 40 100
CASH, END OF YEAR $200 $506

The income statement activities of the company show a positive cash increase in the net
cash flow from the operating activities. The interest expense was also moved to finance section
and the addition of the depreciation as non-cash charge helped to boost the cash flow. As stated
previously, the company has adopted a conservative working capital policy and its inventory has
been kept tight and this has helped to boost the cash flow from operating activities of the
company.

The investing activities show that there have been no major investments for PPE during
the last two years but investment has been made in 2014. Lastly, the financing activities of the
company show that the company has not only raising external financing through debt but it is
also issuing equity. In each of the two years, that is 2013 and 2014, the cash has been injected by
issuing equity equal to $ 400 in each year. The dividends have not been included as there is no
evidence of them. Overall, the cash position of the company is strong and it has positive cash
balance to cover its obligations.

Question 4

Compute and analyze the trend analysis of the company.

Although, the horizontal financial statement analysis is part of common size analysis, but
since we have computing trends of different income statement items and balance sheet items,
therefore, we have prepared horizontal financial statements for 2013 and 2014 which are shown
below:

HORIZONTAL INCOME STATEMENT

2013–14 2014–15
Sales
Cash 140.00% 66.67%
Credit 140.00% 66.67%
Total sales 140.00% 66.67%
Cost of goods sold 128.39% 69.49%
Gross profit 158.95% 62.60%
Operating expenses:
General, administration, and selling expenses 462.50% 122.22%
Depreciation 300.00% 65.00%
Interest expenses (on borrowings) 163.33% 115.19%
Profit before tax (PBT) 84.62% 25.00%
Tax @ 30% 84.62% 25.00%
Profit after tax (PAT) 84.62% 25.00%

HORIZONTAL BALANCE SHEET

2013–14 2014–15
Assets
Fixed assets (net of depreciation) 31.58% 88.00%
Current assets
Cash and cash equivalents 150.00% 6.00%
Accounts receivable 400.00% 40.00%
Inventories 368.75% 50.00%

Total 118.75% 63.50%

Equity & Liabilities
Equity share capital (shares of
₹10 each) 33.33% 25.00%
Reserve & surplus 184.62% 81.08%
Long-term borrowings 67.93% 102.27%
Current liabilities 564.62% 60.88%

Total 118.75% 63.50%

The trend analysis performed above shows that the sales of the company have been
following a negative trend and they have declined from 140% to 66.67% which is quite alarming
for the management of the company. The net profit and operating profit have both declined. The
net profit has declined from 84.62% to 25% and same is the percentage decline for operating
profit. This means that cost of sales and sales decline is the contributing factor for declining
profitability of the company. The GP margin is the evidence for this which has also followed a
declining trend.

The cash balance for the company shows a negative trend in the horizontal balance sheet
as it has reduced from 150% to 6% in 2014. The long term debt of the company has increased
from 67.93% to 102.27%. This is quite risky for the company as it is becoming more levered to
finance its operations. Secondly, the decision for loan approval might be rejected as the credit
rating is reduced for the company due to high level of risky debt. The equity share capital has
also shown a negative trend despite an increase in long term debt. The total assets have declined
from 118.75% to 63.50%. The trend analysis shows a poor performance of the company
regarding its sales, assets and profitability.
 Question 5

Compute and analyze the ratios and their comparison with industry ratios.

All those ratios that are provided in exhibit 3 have been computed for Anandam
Manufacturing Company for the three-year period. These ratios are shown below:

RATIO ANALYSIS
Ratios 2012–13 2013–14 2014–15 Sector Average
Current ratio 2.54 1.79 1.60 2.30:1
Acid test ratio (quick ratio) 1.31 0.93 0.79 1.20:1
Receivable turnover ratio 6.00 2.88 3.43 7 times
Receivable days 60.83 126.74 106.46 52 days
Inventory turnover ratio 3.88 1.89 2.13 4.85 times
Inventory days 94.19 193.33 171.09 75 days
Long-term debt to total debt 73.90% 41.70% 47.35% 24%
Debt-to-equity ratio 47.06% 46.89% 64.50% 35%
Gross profit ratio 38.00% 41.00% 40.00% 40%
Net profit ratio 18.20% 14.00% 10.50% 18%
Return on equity 30.33% 42.00% 42.00% 22%
Return on total assets 14.22% 12.00% 9.17% 10%
Total asset turnover ratio 0.78 0.86 0.87 1.1
Fixed asset turnover ratio 1.05 1.92 1.70 2
Current asset turnover ratio 3.03 1.55 1.80 3
Interest coverage ratio (times 9.67 7.08 4.53 10
interest earned) 0
Working capital turnover ratio 5.00 3.50 4.77 8
Return on fixed assets 19.16% 26.88% 17.87% 24%

The gross margin ratio for Anandam is around 40% and it matches the industry average
which is also 40%. This shows that the firm is not pressurized by the competition in the market
or it has not reduced its prices by reducing the margins to attract more sales. On the other hand,
the net margin ratio has declined from 18.20% to 10.50% in 2014. The average for the sector is
18%, so this is alarming for the management of Anandam. The return on equity is much higher
than sector average but the return on assets is low but the difference is minimal.
 The liquidity position for the company is weak as it has lower than average industry
current and quick ratios and these are decreasing. If the sales declined or there is a decline in the
operational performance of the company, then the company might be forced to face termination.
In other words, the short term obligations are higher for the company than its short term assets.
The company is making inefficient use of its assets especially fixed assets because the total asset
turnover and fixed asset turnover are both too low as compared to average of industry ratios.
Despite a conservative working capital policy, the current asset turnover for the company is low
than sector average. Inventory turnover and receivables turnover days’ ratios are lower than the
industry average ratios of 52 days and 75 days respectively. The efficiency ratios and liquidity
ratios are both weak for Anandam.

The industry average ratio for LTD to total debt is 24% however, Anandam has 47.35%
of LTD on its balance sheet in 2014. This shows serious risks faced by the company as it
becomes highly levered. The company has also issued new equity to service the debt of the
company and this is not a good sign of its financing capability. This is evident by the debt to
equity ratio of 64.5% which is almost double of the sector average. Furthermore, the interest
coverage ratio has also been computed as shown in the table above. It shows that this ratio has
declined from 9.67 times to 4.53 times in 2014 and in each of the three years is has been lower
than sector average of 10 times. This means that the capability of the company to repay interest
on its debt is weak. Overall, the performance and financial condition of Anandam is weak.