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Triple-A Office Mart Financial Ratio Analysis

Executive Summary:

The purpose of this study is to assess the financial statements and analyze the firm’s financial

position in order to guide the managers to make decisions about their business and be able to

convince the bank of the firm’s wellbeing. The firm’s current liquidity position is questionable

due to the sudden increase in inventory, causing the current ratio to drop abruptly. Therefore, this

report is to analyze and make recommendations to the firm in order to maintain a better liquidity

position.

Case Summary:

Triple-A Office Mart was founded in 1998 as a profitable company by Wright and Lauren Diaz

after their graduation. The company offers a product line consisting of office equipment,
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Triple-A Office Mart Financial Ratio Analysis
furniture, computers, and supplies. The company has operated profitably since its inception.

Following are the key events and details of the case:

• Triple A experienced excellent growth in revenue and earnings.

• Diaz left the company after 3 years and sold her interests to Wright.

• The firm had its initial public offering in 2000. No more stocks have been issued since.

• The firm expanded and opened the second store in 2012 without long term financing.

• The new store led to an increase in inventory and bank borrowing.

Questions:

1. Calculate the compound average annual growth rate in sales and net income for

Triple-A.

Using the ratio:

((ending investment amount- starting investment amount)1/numbers of years -1)

Final- 2018 Initial- 2015 Period CAGR

Compound average annual
$6,000,000.00 $3,800,000.00 3 16.4455%
growth rate in sales
Compound average annual
$1,820,000.00 $1,340,000.00 3 10.7445%
growth rate in Gross Profit
Compound average annual
$ 538,454.00 $ 437,654.00 3 7.1534%
growth rate in Net Profit

Triple-A Office Mart’s compound average annual growth rate in sales turns out to be 16.45%,

which indicated a healthy growth in firm’s sales each of these years. This is a positive indication
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Triple-A Office Mart Financial Ratio Analysis
of the firm’s growth and expansion. However, the firm’s compound average annual growth rate

in gross profit turns out to be 10.74%, which seems pretty well but is quite lower than the growth

in sales. This indicates that the firm has not been able to control the cost of its goods sold as it

has increased way more than the sales themselves. There might be several reasons due to the

increasing costs, as one of the causes mentioned in the case study was the increasing prices from

suppliers. In addition, we can observe that the net income is growing by an even lower rate, i.e.

7.1534% which indicates that the other operating and administrative costs of the company have

grown much more than its sales.

2. What are the EPS and DPS for Triple-A in each year provided in tables 1 and 2?

Using the ratios:

Earnings per share EPS: (net income/ shares outstanding)

Dividends per share DPS: (net income* 45%)/shares outstanding

Ratios: 2015 2016 2017 2018

EPS (Earnings per share) $3.65 $2.07 $4.14 $4.49
DPS (Dividend per share) $1.64 $0.93 $1.86 $2.02

The firm’s earning per share and dividends per share ratios are quite impressive, which is one of

the reasons for the shareholders’ satisfaction and gratitude. The annual dividend or the payout

ratio was not specified in the case, so the industry’s average of 30%-60% is considered, and the

dividends per share are calculated at the payout ratio of 45%.

3. Calculate financial ratios, create common size and trend statements, and analyze the

financial condition of Triple-A Office Mart. Please include at least two ratios from

each of the areas we discussed in lecture/notes. In particular, be sure to calculate

NI/Sales, Sales/TA, and TA/Equity so that you can create the three components of
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Triple-A Office Mart Financial Ratio Analysis
the DuPont Identity for the ROE. (This questions is designed to help you provide

THE critical analysis that Ms. Wright needs to make thoughtful decisions.) Please

spend your time on the analysis of the ratios you choose to calculate. Make sure that

any statements you make are consistent with the ratios and with each other.

Ratios: 2015 2016 2017 2018

Current 4.72 4.68 3.13 3.74
Quick 1.15 1.16 0.64 0.82
LTD/Assets (%) 20.1% 18.3% 13.9% 12.6%
Total Debt/Assets 35.6% 33.9% 39.3% 34.3%
TIE 21.31 12.51 17.74 22.78
A/R Turnover 333.3333333 349.2063492 291.8170878 310.0775194
Inventory Turnover 2.59 2.89 2.05 2.41
Total Asset Turnover 2.23 2.24 1.97 2.20
Gross Margin 35.26% 28.83% 34.02% 30.33%
Net Profit Margin 11.52% 5.93% 10.24% 8.97%
ROA 25.65% 13.27% 20.18% 19.77%
TA/Equity 1.55 1.51 1.65 1.52
ROE 39.85% 20.08% 33.26% 30.10%
Dupont ROE = NI/Sales
39.85% 20.08% 33.26% 30.10%
* Sales/TA * TA/Equity

The current ratio and the quick ratio are the key indicators of the firm’s liquidity. The firm is

maintaining a pretty decent current ratio, which might be delusional. The current ratio indicates

that the firm’s liquidity position is quite strong despite the sudden decrease in the ratio; however,

when you look at the quick ratio, you realize that most of the firm’s current assets are in the form

of inventory which is pushing the current ratio up. A sharp decrease in the firm’s quick ratio can

be noticed in the year 2017 due to high inventory levels and issuance of short-term debt (notes

payable) from the bank.

The next three ratios, long-term debt (LTD) to assets ratio, debt to assets ratio and times interest

earned (TIE) ratio indicates the firm’s long-term solvency position. The firm is maintaining a
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Triple-A Office Mart Financial Ratio Analysis
very low long-term debt to asset ratio and it is constantly decreasing over the years which

indicates that the firm will have no issues with regard to the solvency in the long term. However,

a low LTD to assets ratio is not necessarily good for the firm as it implies that the firm can utilize

more of the long-term debt to finance its operations or to expand its operations. The total debt to

asset is quite low as well but quite higher than LTD to assets ratio which means that the firm has

high current liabilities and short term borrowing which is a bad indication of the firm’s liquidity.

The debt to assets ratio is almost as three times higher than the LTD to assets ratio due to the

high short-term borrowings and very low long-term borrowings. The TIE ratio is used to indicate

the relationship between earnings before interest and taxation (EBIT) and the interest expense of

the company. If the TIE ratio is too low, it indicates the firm might not be able to meet its

obligations in the long term. However, Triple-A has maintained a good TIE ratio.

Receivables turnover, inventory turnover and assets turnover ratios indicates how efficiently the

firm is utilizing its resources. The company is performing quite well as per the receivables

turnover and assets turnover, however, its inventory turnover ratio is quite low which indicates

either weak sales or excessive inventory. In our case the sales are constantly growing, therefore,

the only thing limiting the inventory turnover ratio is the excessive inventory held by the firm. In

order to improve it, the firm must get rid of the obsolete inventory.

Lastly, we have the profitability ratios: gross profit margin, net profit margin, return on assets

and return on equity. The firm shows high profitability ratios which indicates that the firm is

indeed profitable and is generating enough net income with respect to the assets and equity kept.

The firm has been able to maintain a pretty high gross profit margin; however, the net profit

margin is pretty average which indicates that the firm is incurring high administrative and selling

expenses. In order to improve the net profit margin, the firm needs to control and minimize its
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Triple-A Office Mart Financial Ratio Analysis
expenses in order to receive more profits. The return on equity is also considerably high, which

indicates that the firm is highly profitable considering the capital held by the firm. It indicates

that the firm is able to generate profits without need of much capital.

4. Is Triple-A a good short-term borrowing client for the bank? (Yes or no with a short

explanation.)

No, Triple A is not an ideal client for short term borrowing from the bank because of its weak

quick ratio that is less than 1. Quick ratio is an indicator of company's short-term liquidity. It

measures the ability to use its quick assets (cash and cash equivalents, marketable securities, and

accounts receivable) to pay its current liabilities. A quick ratio of at least 1 indicates a high

solvent position, whereas Triple-A’s position is 0.82 which is less than the benchmark. This

position indicates that the company relies too much on inventory or other assets to pay its short-

term liabilities. Although Triple-A still has a strong cash basis and a good receivable turnover,

excessive inventory can create liquidity issues for the company due to which it may not be able

to meet its short-term obligations.

5. Triple-A operates in an industry with a debt ratio of 0.52 (52%) and a compound

annual growth in gross profit of 8%. What advice would you give Triple-A concerning

its debt ratio?

As Triple-A’s current debt ratio is 34% compared to the industry average of 52%, it is evident

that the firm is not quite leveraged, and they have the opportunity to borrow more long-term

debt. The company’s compounded annual growth rate in gross profit is over 10% when the

industry average is barely 8%. This indicates that the firm is performing better than its

competitors and have a great opportunity to expand their operations considering the fact that

their debt ratio is quite lower than the industry so the long-term debt will be readily available to
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the company. We would suggest Triple-A to borrow long-term debt and expand its operations in

the region to capture even more market share.

6. Assume Triple-A’s compound sales growth slows to half of its present rate. What

would be the likely effect on external financing needs? What is the desired effect on

inventory levels?

Currently, the compound average annual growth rate in sales of the company for the last three

years is 16.45%. If the sales growth slows down to half, then the company faces a decrease in

revenue which will first lead to liquidity issues and then later, if not addressed, insolvency too.

Therefore, the company must, in any case, reduce its inventory levels in order to sustain and

avoid a liquidity crisis. The inventory levels were pretty high even considering the rapid growth,

and if the growth rate slows to half of its present rate, the company would not be able to meet its

short-term obligations considering the high short-term borrowings. The compound average

growth rate in gross profit of Triple A amounts to 10.7445%, and its debt ratio throughout the

period of 2015 to 2018 is less than 40 %. Triple-A has a higher growth and a lower debt ratio.

Hence, Triple-A should reduce its inventory and refinance its short-term borrowings as long term

borrowing If needed.

7. What is the company’s compound annual sales growth? What is the company’s

compound annual growth in net income? How is this difference likely to influence

borrowing needs? Is the firm’s dividend payout ratio appropriate relative to the firm’s

growth in sales? Why/why not?

Triple-A Office Mart’s compound average annual growth rate in sales is 16.45%, whereas its

compound average annual growth rate in net income is 7.1534%. The company’s annual growth

in net income is good compared to the industry, but still quite lower than the growth in sales.
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Triple-A Office Mart Financial Ratio Analysis
There can be certain impacts of low growth in net income, including the influence on borrowing

needs. The growth in company’s net income is even less than half the growth of the sales, which

is not a very good sign and indicates poor management of costs. If the firm intends to borrow

more to expand, it will further increase the expenses of the firm and further shrink the net income

of the company. As the company expects to expand in the region, they will need either more

capital through equity or borrow from the bank, therefore, they must be able to reduce their costs

in order to make the expansion meaningful and meet their debt obligations.

8. Based on the information provided and upon your ratio analysis only, will the bank

likely recommend more long-term borrowing for the firm or provide short-term

funding?

Based on the information provided and the analysis made, it is quite obvious that the bank will

recommend more long-term borrowing for the firm instead of providing short term funding. If

Triple-A still intends to borrow short-term, they should try to increase their current assets and

decrease their current liabilities in order to improve their current and quick ratio to be considered

by the bank.