Good Example Of Memorandum Case Study

Type of paper: Case Study

Topic: Finance, Company, Ratio, Financing, Wealth, Business, Investment, Liquidity

Pages: 3

Words: 825

Published: 2021/01/03

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Re: Financial forecasts and associated discussion

Dear CEO,Following your request, please find attached the financial statement forecasts for 2016 which include the income statement and the balance sheet. The points to be discussed in this memo will be addressed below:
As can be seen from the forecasted financial statements, the increase in sales does not required additional fixed assets, therefore the company’s investing needs are nil this year. However, to reach the fixed objective of bringing days payables outstanding to 40 days, accounts payable will need to be reduced to $0.9m, compared to a previous year amount of $1.8m. This reduction will thus require a financing need of $0.9m. Thus our total amount of financing required for the year 2016 is $0.9m.

The liquidity ratios of the business are the following:

Current ratio = 7.5/5.4 = 1.4This ratio is obtained by dividing the current assets by the current liabilities. A ratio greater than 1 is satisfactory as it means that the business has enough current assets to honor its current liabilities
Quick ratio = (7.5-3.8)/5.4 = 0.7This ratio is obtained by subtracting the inventories from the current assets, and then dividing this result by the current liabilities. It is a more stringent measure of liquidity than the current ratio mentioned above as it assumes that inventories cannot be turned readily into cash (this is a reasonable assumption among certain industries). A ratio of less than one could indicate liquidity problems if inventory is not sold quickly.
Days payables outstanding = (1.8/(7.8/365)) = 84 daysThis ratio is obtained by dividing the accounts payables by the daily cost of goods sold. This means that the company takes on average 84 days to pay its suppliers. This is considered a large number for most industries. Overall, liquidity ratios are average – improvement could be done.

The efficiency ratios are:

Asset turnover ratio = 14.2/12.7 = 1.1This ratio is obtained by dividing the sales by the total assets. It measures how efficiently the company can use its asset base to generate sales. This ratio is satisfactory however interpretation requires specific details about the industry and business model.
Average collection period = 3.6/(14.2/365) = 93 daysThis ratio is obtained by dividing the accounts receivable by the daily sales. It means that the company needs on average 93 days to collect the cash from a sale. It is reasonable but a reduction would be an improvement as it would reduce the working capital requirement of the company.
It is likely that the bank would react positively if the company tried to raise this amount of money. The reason is that the leverage of the company is reasonable (debt/equity ratio under 1) and the short-term debt would amount to 1x pre-tax earnings. The bank would likely be very cautious if the company had to raise larger amounts.

Our financing can be of two sorts: internal or external financing:

Looking at internal financing, instead of reducing the days payables, the company could try to reduce the days sales outstanding – in another words improve on bill collection. This would decrease the working capital requirement and increase the liquidity available to the firm. This is a very appropriate source of financing as it does not increase the financial risk of the firm. A second type of internal financing could be monetizing long-term assets such as buildings, by selling them and leasing them back. It would provide liquidity and make the business model more asset-light. Compared to improvements in working capital, this is harder to do and less optimal for the firm.
Looking at external financing, the firm could either borrow money under the form of a long-term loan with a collateral, either sell an equity stake to another investor. Both options are suboptimal – the debt financing because it increases the leverage and risk of the business; the equity sale because the owner will dilute his interest in the venture and is costly to do. To conclude, internal financing – and particularly focusing on current assets – is the most optimal and cost-effective way to unlock cash.

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WePapers. (2021, January, 03) Good Example Of Memorandum Case Study. Retrieved May 07, 2021, from https://www.wepapers.com/samples/good-example-of-memorandum-case-study/
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"Good Example Of Memorandum Case Study." WePapers, Jan 03, 2021. Accessed May 07, 2021. https://www.wepapers.com/samples/good-example-of-memorandum-case-study/
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"Good Example Of Memorandum Case Study," Free Essay Examples - WePapers.com, 03-Jan-2021. [Online]. Available: https://www.wepapers.com/samples/good-example-of-memorandum-case-study/. [Accessed: 07-May-2021].
Good Example Of Memorandum Case Study. Free Essay Examples - WePapers.com. https://www.wepapers.com/samples/good-example-of-memorandum-case-study/. Published Jan 03, 2021. Accessed May 07, 2021.
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