Report on the Financial Strengths and Weaknesses of Arapahoe
Report on the Financial Strengths and Weaknesses of Arapahoe-Goldstein Supermarkets, Inc. Adaptation is essential to survival. Humans as a species share this primal knowledge of Social Darwinism and have applied it fittingly to our societal interactions and business endeavors. People, as well as companies are subject to its whims and as such must either adapt or fail. However, a company cannot know its standing or how to better its chances of survival in a cutthroat, profit-oriented business world without a thorough understanding of its own abilities and evolutionary advantages (or lack thereof). Therefore, it is necessary to periodically analyze the financial strengths and weaknesses of a company in order to ensure that it is doing everything within its power to ensure that it is operating at its peak in order to survive. After a thorough examination of certain measures of the profitability and liquidity of Arapahoe-Goldstein Supermarkets, Inc. we have come to the conclusion that the company, while on the right track to make a recovery, is currently in a dire situation financially. Indicators and financial analysis ratios within the company indicate an abysmally low profitability. Recommendations to alleviate this problem include slightly increased prices if possible, increased sales, reduced average total assets, and a slow in the speed of credit collection. Other indicators suggest a high short-term liquidity risk that can also be lessened by an increase in accounts receivable by way of longer collection periods resulting in more interest revenue. The last recommendation is to increase long-term debt in order to compliment one of strengths of the company over the last year, which has been its ratio of net income to interest expenses.
In analyzing the strengths and weaknesses of a company, the first thing that potential investors tend to look at is, quite simply, profitability. As well as being an important facet of company performance that is particularly important to investors, profitability analysis is an integral part of a well rounded evaluation of a company’s operations and something that we strongly recommend you take into account in determining the future direction of your company. The primary measure of profitability is the Rate of Return on Assets (henceforth referred to as ROA). What this measures is how well Arapahoe-Goldstein Supermarkets, Inc. has utilized its assets to generate income (irrespective of manner of financing these assets). Your ROA for the years ending in January 31, 2009 and 2010 were .61% and 6.36%, respectively. Another way to look at this is as the amount made off of each dollar of assets (i.e. in 2009 sixty-one hundredths of a cent for each dollar). For a grocery store of your size, a normal ROA would be 16.4% (Industry, 220). As you may have already noticed, your ROA was and is abysmally low, despite the fact that it has increased almost ten-fold over the last two years. Upon delving further into this ratio and the others relating to profitability, the reasons can be seen as to why this is the case. The ROA can be broken down further into two more ratios: first, the Profit Margin for ROA and second, the Total Assets Turnover Ratio. Your Total Assets Turnover Ratio has remained under the industry norm (2.57 in 2009 and 2.67 in 2010 as compared to industry standards of 5.1 and 4.4).
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Your Profit Margin for ROA Ratio has increased from .24% to 2.39% compared with a 3.0 industry standard (Industry, 220). Upon noticing that the ROA can be found by multiplying these two ratios together, it becomes obvious that the majority of the change in your ROA over the past two years has come from the Profit Margin for ROA Ratio, or “a firm’s ability to control the level of expenses relative to sales” (Stickney, 248). In order to improve the ROA you must improve one of these two ratios beyond the current improvement that you have seen in the past two years. One solution would be to raise prices. However, because of the fact that you are a grocer and cannot raise your prices too high for fear of losing customers to other grocers, you will have to change your Total Asset Turnover Ratio by way of increasing sales or reducing total average assets. An ad campaign or promotions may increase sales and the retiring of any unnecessary assets could decrease average total assets. If you are able to accomplish either of these, then your Total Asset Turnover and resultantly your ROA will increase. In this analysis of profitability, it is also worth mentioning a ratio known as Accounts Receivable Turnover. This ratio represents the number of times accounts receivables turnover in a year, or rather how often the company collects on credit. Your accounts receivable turnover ratio was 466.67 in 2009 and 570.00 in 2010 compared with industry norms of 101.6 and 92.8 respectively. Due to the quick turnover of accounts receivable (also partially due to the fact that many transactions are in cash), your company may not be earning as much interest as it has the potential to. One way of solving this issue would be to lower
the speed at which you collect on accounts (which you may have to take up with third-party credit collectors), thereby increasing interest revenue and profitability. In summary, your company has increased profitability significantly over the previous two years, but must continue to increase it in order to stay competitive by either raising prices, increasing sales, decreasing average total assets, or slowing credit collection.
The second facet of a company to analyze in determining its financial strengths and weaknesses is its short-term liquidity risk. Due to the nature of your industry and its quick turnover of inventory, this portion of the analysis is quite important. The two most important ratios to take into account here are the Current and Quick Ratios. The Current Ratio is a measure of “a firm’s ability to meet its short-term obligations” while the Quick Ratio is the same as a Current Ratio but includes only “those current assets that a firm could convert quickly into cash” (Stickney, 266). The Current Ratios for Arapahoe-Goldstein over the past three years, starting with 2008 have been 2.95, 2.21, and 1.96. The 2010 industry median was 1.7 (Annual, 952), or .26 below your Current Ratio. This provides Arapahoe-Goldstein with the opportunity to reverse its downward trend while still maintaining its standing within the industry. Your Quick Ratios show a similar trend with .55 in 2008, .37 in 2009, and .34 in 2010 as compared to the 2010 industry median of .3 (Annual, 952). The good news is that Arapahoe-Goldstein is still in a good position when it comes to short-term liquidity risk, however, the downward trend in these ratios could be potentially disastrous and immediate action should be taken to improve them. Thankfully, one solution to this problem is the same as the recommendations given above to improve profitability: increase accounts receivable by slowing collection time on credit. Not only will this increase the interest revenue received (as discussed above), it will also increase the Current and Quick ratios, which will ideally reverse the downward trend that we have seen here. In summary, the Current and Quick Ratios of Arapahoe-Goldstein indicate one of the strengths of your company, however, immediate action should be taken to reverse the downward trends in these ratios by increasing sales on credit and lowering the speed of collection on credit.
Finally, an important aspect in any analysis of the financial strengths and weaknesses of a company is the long-term liquidity. This characteristic of the company can be analyzed through the Long-term Debt Ratios and the Interest Coverage Ratios. The Long-term Debt Ratios measure the portion of the company’s assets that are tied up in long-term debt, and therefore how liquid the company is in the long-term. The Interest Coverage Ratio is an important corollary to this because of the fact that the Interest Coverage Ratio examines how well the company can cover the interest that it has to pay on its debts. The Long-term Debt Ratio for Arapahoe-Goldstein is much lower than the industry standard with values of 26.24% in 2008, 25.10% in 2009, and 24.06% in 2010 compared with an industry norm of 60.9% in 2010 (Industry, 220). The result is that your company has a much higher risk of long-term liquidity than is common throughout the industry. The real concern, however, comes from the Interest Coverage Ratio. As I’m sure you know, your company incurred net losses in 2009. As a result, the Interest Coverage Ratio for 2009 would be at a negative value. In 2010, though, Arapahoe-Goldstein managed to drastically improve this ratio to 5.48, which is incredibly similar to the industry norm for a company of this size of 5.5 (Industry, 220). This is very good news because of the fact that your company, assuming it can maintain this ratio, is back on track in terms of this ratio. The only remaining concern in terms of long-term liquidity is the low Long-term Debt Ratio. This ratio can be improved simply by increasing your long-term debt, which in turn will increase the working capital of your company. With a sustained Interest Coverage Ratio and an increased Long-term Debt ratio by way of increased long-term debt, Arapahoe-Goldstein can achieve long-term liquidity security as a strength and an attraction to potential investors.
To sum up the conclusions of this report and give our recommendations to Arapahoe-Goldstein Supermarkets, Inc. we would like to inform you that the profitability and the short-term liquidity risk of the company are currently at levels requiring immediate attention, however, the long-term liquidity of the company is one of it strengths and can be maintained and improved by way of simple measures. To combat low profitability and high short-term liquidity risk, we recommend slightly increased prices where feasible,
increased sales (by means of ad campaigns and promotions), reduced average total assets, and an increase in the amount of time that accounts receivable remain unpaid in order to increase accounts receivable and interest revenue. To secure long-term liquidity security we recommend increases in long-term debt and maintenance of current ratios of income to interest expense.