Executive Summary
Bridge Quay Pasta Palace Pty Ltd.’s application for loan with SayBank Bank is recommended as the company is found to be highly profitable, highly liquid and appears to have a good financial condition as revealed by the financial analysis of the company. The purpose of this paper is to evaluate the loan applicant by conducting a financial analysis for Bridge Quay Pasta in terms of profitability, liquidity and financial stability analysis based on submitted financial information that included computed ratios, percentages and calculations. As found, the most significant findings include the profitable and efficient operation of the business, its highly liquid position and good financial stability position. This paper has recommended ways to maximize profitability by investing excess funds into assets that could produce more profits and maximize wealth for owners.
Introduction
Bridge Quay Pasta Palace Pty Ltd is a restaurant business owned by Lai Hoong Lau. Wanting to have a restaurant upgrade, the owner is applying for loan of $1,000,000 from SayBank Bank to finance the upgrade the said restaurant. Acting as loan evaluation officer, this researcher is to evaluate the company-applicant’s financial statements by conducting financial analysis using profitability, liquidity and financial stability ratios. This paper is expected to make recommendation whether the loan application by the owner of Bridge Quay Pasta should be given the loan.
Profitability
The return on assets of Bridge Quay Pasta Palace Pty Ltd shows increasing trend from 2006 through 2008. From 23.26% in 2006, it almost doubled at 41.73 in 2007 and increased by almost 50% in 2008 at 69.49%. The same may be said of its return on equity where the increase from 2006 to 2007 is almost doubled and the increase in 2008 from 2007 is almost 50%.
The price – earnings ratio for 2006 and 2007 are not available and it is only in 2008 that a ratio is reflected at 2.72 times. This could be due to unavailability of data to compute the same. Nevertheless, the reflected ratio can be considered as increase in 2008 compared to earlier years if lower ratios are assumed for 2006 and 2007. No dividend was declared in 2005 but $0.46 million was declared in 2007 and this amount increased to $.60 million in 2008. Despite the increase in dividend however, dividend payout in 2008 is lower than in 2007.
The company may be asserted to be profitable as indicated by the increasing trend in return on assets and return on equity and the company has correspondingly paid its dividends to stockholders in 2007 and 2008. There was less payment of dividends paid in 2008 compared to 2007 however based on the net income of the respective years because of other use of funds by the company in 2008.
The range of 18% to 60% return on equity encourages investors to invest with the company as it would mean that for every $100 investment, the investors expect returns of about 18% to 60%. These rates could be viewed as something unprecedented for a company like Bridge Quay Pasta Palace Pty Ltd. To have return on equity of 60% is many times more the present US Federal Reserve Bank base rate of less than 1% (Housepricecrash, 2008). The present profitability rate that company enjoys is something that must be the envy of many other companies since the rates would be almost impossible to earn from any of the stocks in the market because of the financial crisis that has engulfed not only the US but almost every part of the global economy.
Liquidity
The liquidity of Bridge Quay Pasta Palace Pty Ltd shows the capacity of the company to meet its currently maturing obligations () and the same could be measured by the current ratios and quick ratios. Bridge Quay Pasta’s current ratios reflected 5.69:1 in 2006, declined to 4.1:1 in 2007 but increased slightly to 4.22:1 in 2008. On the other hand, its quick ratios showed 3.44: 1 in 2006, declined a little at 2.3:1 in 2007 and then decreased further to 2.22:1.
The same behavior of the company’s liquidity may be observed in terms of both current and quick ratios and despite the noted declines for both ratios in 2007, the company could be still declared to be highly liquid if not too liquid.
To distinguish quick ratio from current ratio, the first is a better measure for liquidity since inventory is excluded from the quick assets. As a general rule for a company to have a good liquidity, the ratio of current or quick assets to current liabilities should be at least one since this would mean that a company must be able to match one dollar from it current assets to every dollar of its currently maturing obligations. Failure of a company to do this could mean bankruptcy and may force the company to stop operation. This must be so since the salaries of its employees which must come every payday cannot wait longer for people need to have their living expense.
To have a liquidity ratio above 1:1 would mean an excess liquidity which may be inferred the existence of idle use of funds which could have been invested in more productive use to generate more profitability. By referring to the common size analysis to see how the breakdown of the company’s quick assets, it can be found that the bulk of its quick and current assets is in cash. Cash represented about the range of 17% to 24% of its total asset for the last three years, which is even higher than the ratio of its inventory to total assets of about 16% on the average for the last three years. It is heavy investing in excess cash which may not be maximizing profitability of the company. The company is not a financial institution of be highly liquid. Thus, there is doubt if it has an investment policy for excess funds.
The company’s level of accounts’ receivable in relation to total inventory is less than one third to the level of its inventory and represents merely about of 3.9% to 5.71% of the total assets. Being so low, it is not surprising to have a low collection period of 20 days in 2007 which is almost the same as that in 2007 after it has improved further from 23 days in 2006. The lower ratio of receivables compared to that of inventory in relation to total assets may still be proven evident by the higher number of inventory turnover days which averaged by almost 26 days for the last three years as compared to an average of 21 days for collection period for the same three year periods. This could mean that the company collects faster than it sells. This could be indicative of efficiency in collection since normally a company should have enough working capital to finance it operations. The company’s efficiency definitely improves the company’s profitability and efficient operations mean better use of resources which have their alternative uses.
Financial Stability
Financial stability refers to the company’s long-term capacity to keep up it financial position over the long term (Meigs and Meigs,1995). This could be measured by the debt ratio, with the formula of having the total debt of the company divided by its total assets. The debt ratios Bridge Quay Pasta Palace Pty Ltd are 18.95%, 22.35% and 21.37% respectively for the years 2006, 2007 and 2008 respectively where a fluctuation in their behavior is evident due to decrease followed by an increase.
Despite the fluctuation, the present ratios are indeed indicative of very good financial position of the company. The lower the ratio, the better it is for the company in terms the level of risks from the point of view of investors. Thus it could be asserted that there was deterioration of financial condition in 2007 but was it was followed by an improvement in 2008. This behavior is confirmed by decrease and subsequent increase of equity ratio where the higher ratio is better time compared to the debt ratio. The company’s equity is above industry average of 64% which means that the company is relatively more stable than its competitors in the industry.
The same behavior of debt asset ratio and equity ratios are supported further by the capitalization ratio where there was an increase and followed by a decrease in the ratio. This time the lower the ratio the better it is for the company in terms of risk. Thus from 1.23:1 in 2006, it deteriorated to 1.29:1 in 2007 and then improved to 1.28:1 in 2008.
Asset turnover improved for the most recent two year periods consecutively and stayed higher than industry average of 3.37:1. This means that the company experienced continued improvement in efficiency for the recent two years. Time interest earned for two consecutive years in 2007 and 2008 also improved. Times interest earned ratio is too high which confirms earlier findings of too much liquidity. Because of the company’s financial stability as revealed by the debt asset ratios and better debt equity ratios than its competitors, the company could be expected to be stable over the coming years.
Conclusion
The company is highly profitable, highly liquid and has stable financial condition as revealed by the analysis. The paper attained is purpose of evaluating the financial performance of the company as well is liquidity and financial stability by using the relevant ratios and making the necessary inferences arising from the relationships of the financial ratios which are based on the actual financial statements of the company for the years 2006 through 2008.
Recommendation
Since the company is still too liquid with the current and quick ratios still exceeding 1.0:1, it is recommended that the company would have to invest the excess funds of the company to income generating assets so that profits and earnings per share could be maximized. This could in turn increase the price of its stock and the same will attain the wealth maximization objective of the company.
It is further recommended based on analysis made that is it safe for SayBank Bank to go ahead with the $1,000 load requested by Lai Hoong Lau as the company is highly profitable to sustain its very high liquidity and it could be expected to able to repay the loan over its term since the company is also considered to be financially stable.
Since this researcher is acting as loan evaluation officer of the bank, it may be unethical for to tell Lai Hoong Lau that the latter may just have to maximize the liquidity of the company and apply for a lower loan.
Reference List
Hoggett, J, Edward, L & Medlin, J (2006). Accounting, John Wiley & Sons Australia Ltd, Australia.
Housepricecrash (2008) Main Central Bank Base Rates, Web.
Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, New York, USA