Question

Review the Watson case using the following financial ratios in a trend analysis. Note that year 199x =1997, y=1998, and z = 1999. While sales growth is strong, this firm has some issues. Can you identify them? Recommend solutions?

1993 1994 1992 Growth in Sales Industry Watson 9.98% 20.00% 10.02% 20.00% Growth in EPS Industry Watson 9.7% 7.7% 9.8% 3.2% Industry 12 Profitability Profit Margin 13 Ratios Net Income/Sales 5.75% 6.26% 5.80% 5.63% Watson 5.81% 5.56% Return on Assets (ROA) Net Income Total Assets Industry Watson 8.22% 9.39% 8.24% 7.79% 8.48% 6.34% Return on Equity (ROE) Industry Net Income/Stockholders' Eq. Watson 13.26% 17.07% 13.62% 15.73% 14.16% 14.25% 9.5X 10.1X 10.0x| 10.0x 6.5X 21 Asset Receivables Turnover Industry 22 Managemer Credit Sales/Receivables Watson 23 Ratios Average Collection Period Industry Accts Rec/Avg Daily Crd Sales Watson 36.0 Days 37.9 Days 35.6 Days 36.0 Days 46.0 Days 55.0 Days Inventory Turnover Sales/Inventory Industry Watson 5.71x| 6.00 5.62x 6.32x 5.84X 6.65X Fixed Asset Turnover Sales/Fixed Assets Industry Watson 2.75x1 2.73x| 2.66% 2.50xl 2.20x 1.85X Total Asset Turnover Sales/Total Assets Industry Watson 1.43x 1.50X 1.42x/ 1.38X 1.46x 1.14X 36 Liquidity 37 Ratios Current Ratio Curr Assets/Curr Liabilities Industry Watson 2.10X 2.25x| 2.08X 1.78X 2.15X 1.45X 39 Quick Ratio (Curr Assets - Inv)/Curr Liab Industry Watson 1.05X 1.00X 1.02X 0.91X 1.10X 0.80x Industry Watson 38.00% 45.00% 39.50% 50.47% 40.10% 55.48% 42 Debt Debt to Total Assets 43 Managemer Total Debt Total Assets 44 Ratios Times Interest Earned (Inc Bef Int and Taxes Vint Industry Watson 5.00x| 5.67X 5.20x| 4.75x 5.26% 3.18X Fixed Charge Coverage Industry (Inc Bef Fix Chgs + Tax)/Fix Ch Watson 3.85x| 3.80X 3.95X| 3.50x 3.97X 2.76X

Answer 1

The sales are strong compared to the industry but the increase in sales is not converting into the profit.

As it can be clearly seen by a decrease in earnings per share and profit margin ratios.
The decrease in profit margin is also affecting the return on asset and return on equity.

Liquidity means the ability of the business to pay its short-term liabilities.

The company's liquidity ratio is also very poor and showing an alarming sign.

The company can fall into a debt trap. (Due to which it can cause the bankruptcy of the company). The company is unable to generate enough profit and it is borrowing more money in the form of debt which is very high above industry standard.

The companies debt to total assets that have increased by 10.48% from 1997 to 1999. Whereas industry debt to total assets that have increased by 2.10% from 1997 to 1999. It is almost 5 times more for Watson.

The company is facing it difficult to pay its interest on its debt. It can be clearly seen to buy a decrease in times to interest earned ratio.

The Watson also has very poor asset Management ratios. The average collection period has significantly increased compared to the industry.

Solutions:
1. To improve working Capital Management.
2. Increase the efficiency of the cash cycle and operating cycle.
3. Reduce debt & don't go for new projects (or massive expansion).
4. Concentrate on increasing profitability.