Economic and Financial Analysis of a Business

Explain why a company's annual accounts are analysed and name three stakeholder groups interested in this analysis (management itself, banks lending money, and investors considering buying equity), stating what each group is interested in finding out.

A company has current assets of $\$900\,000$ (inventories, trade receivables, and cash) and current liabilities of $\$600\,000$ (debts due in less than a year). a) Calculate its working capital: $FM = \text{current assets} - \text{current liabilities}$. b) Interpret the result: explain what a positive working capital means and why it provides a buffer to pay short-term debts.

The figure shows a simplified balance sheet of a company: on the left are assets, divided into non-current and current assets, and on the right equity and liabilities, with current liabilities at the top. a) Calculate the working capital, marked with "?". b) Looking at the figure, explain what proportion of current assets is financed by permanent capital and why this provides stability to the business.

A company presents the following data: inventories $\$400\,000$, trade receivables $\$300\,000$, cash $\$100\,000$, trade payables $\$240\,000$, and a loan of $\$360\,000$ maturing in six months. a) Group the line items into current assets and current liabilities and calculate the working capital. b) Interpret the result: is there short-term financial equilibrium? Justify your answer.

Another company has current assets of $\$500\,000$ and current liabilities of $\$800\,000$. a) Calculate its working capital. b) Explain what negative working capital means and what immediate problem it could cause (risk of insolvency: debts come due without short-term cash to meet them). c) Propose two measures to correct it (renegotiate debts from short to long term, raise equity capital, sell unused assets) and justify them.

A company has current assets of $\$1\,200\,000$, current liabilities of $\$800\,000$, total liabilities of $\$1\,200\,000$, and equity of $\$1\,200\,000$. a) Calculate its liquidity ratio (current ratio), $L = \frac{\text{current assets}}{\text{current liabilities}}$, and evaluate it knowing that a recommended benchmark is between 1.5 and 2. b) Calculate its gearing ratio (debt ratio), $E = \frac{\text{liabilities}}{\text{equity} + \text{liabilities}}$, and evaluate it knowing that it typically should not exceed 0.6 (60% of total financing).

An investment group is analysing two companies in the agri-food sector to acquire one of them. The data for the last closed financial year are as follows:

• Company North: Total assets = $\$200,000$; Total liabilities = $\$50,000$; EBIT = $\$30,000$; Financial interest = $\$2,000$; Tax rate = $25\ \%$.

• Company South: Total assets = $\$120,000$; Total liabilities = $\$60,000$; EBIT = $\$19,200$; Financial interest = $\$3,200$; Tax rate = $25\ \%$.

1. a) Determine the return on assets (ROA) and the return on equity (ROE) for each company and argue which one exploits its productive investments more efficiently and which one provides a better return on the capital contributed by the shareholders.
2. b) Formally explain why Company South achieves a substantially higher ROE than Company North, even though the difference between their ROAs is minimal. Relate this fact to its level of indebtedness and the financial leverage effect.
3. c) If in the next financial year a demand crisis reduces the EBIT of both companies by $60\ \%$ and financial expenses remain constant, predict how the ROE of each company will change. Based on the results, justify which company has assumed a riskier financial structure and why.

A company requires $\$2\,000\,000$ in assets and expects an annual EBIT of $\$240\,000$. It is considering two financing options (ignore taxes): Option A, entirely financed with equity; Option B, half financed with equity and half with a loan at $6\ \%$ per year. a) Calculate the net profit and return on equity (ROE) for each option. b) Explain why the ROE increases when taking on debt (leverage effect) even though net profit in pesos is lower. c) Repeat the calculation assuming EBIT falls to $\$100\,000$ and conclude: what are the benefits and risks of financial leverage?

A footwear manufacturing company presents the following average periods of its operating cycle during the financial year:

• Storage of raw materials: $20\ \text{días}$.

• Manufacturing of the products: $10\ \text{días}$.

• Sale of finished products held in the warehouse: $15\ \text{días}$.

• Collection from customers: $30\ \text{días}$.

• Payment to raw material suppliers: $25\ \text{días}$.

1. a) Calculate the economic Average Maturity Period and the financial Average Maturity Period. Justify precisely the conceptual difference between the two concepts and their impact on cash management.

1. b) Interpret the consequences for the company of the value of the financial Average Maturity Period that you obtained in part a) and identify which balance sheet items must finance the operating activity during that period.

1. c) The finance department sets itself the goal of reducing the financial AMP to $30\ \text{días}$ without altering the duration of the production process. Design two concrete strategies in different operating areas to achieve it and explain how this reduction will affect the company's operating funds requirements (required working capital).