FINANCIAL ANALYSIS & CASH FLOW - Exotic lamp Company

When Carl Brown took the job of assistant to the President, two years ago, things were going well in Exotic Lamps Company. The company was in an expansionary path and had branched into the business of the cordless lamps. Expectations and prospects were good and strong economy. The threat of competition was not too serious. Due to the expectation of increased demand for cordless lamps, the company had established two additional manufacturing facilities and significantly increased its inventory.

Exotic lamp Company had enjoyed a high performance in profits in recent years. However, when the financial statements were prepared for the current year, the results showed a lower net profit margin. More importantly, there was a severe drop in the cash balance of the company and had recently dropped the price from $ 7 to $ 5.50 per share.

Carl knew that the shareholders would be very concerned and possibly angry. He was also convinced that his boss, Donald Smith, would have to find some viable answers and suggestions about how they might mitigate liquidity problems. This concern was especially important as the company had been hoping to get some short-term capital in the immediate future. Carl expectations were fulfilled when Donald called him and asked to prepare a report explaining the financial situation of the company.

Table 1 and 2 shows the Income Statement and Balance Sheet for the last two years.

Table 1

Income Statement

                                                                           2004                                        2003

Net Sales                                                         2.050.000                                1.678.894

Cost of Goods sold                                         1.537.500                                1.343.115

Depreciation                                                         79.000                                     51.000

Selling & Administrative Expenses                     40.000                                     32.945

Earnings before Interest and Taxes                  393.500                                   251.833,8

Interest Paid                                                      155.000                                      44.000

Taxable Income                                                 238.500                                    207.833,8

Taxes (40%)                                                        95.400                                      83.133,52

Net Income                                                       143.100                                    124.700,3

Dividends                                                           42.930                                      37.410,08

Additions to Retained Earnings                       100.170                                      87.290,20

Table 2:

Balance Sheet

                                                              2004                                        2003

ASSETS

    Cash                                                    5.000                                     40.000

    Accounts Receivable                      540.000                                   200.000          

    Inventories                                   1.300.450                                   650.000

    Total Current Assets                    1.845.450                                   890.000

    NWC                                               950.450                                   535.000

    Gross Fixed Assets                      1.300.000                                   510.000

    Accumulated Depreciation             232.000                                   153.000

    Net Fixed Assets                         1.068.000                                   357.000

Total Assets                                     2.913.450                                 1.247.000

LIABILITIES & EQUITY

    Accounts Payable                           145.000                                   55.000

    Notes Payable                                 750.000                                   300.000

    Total Current Liabilities                  895.000                                   355.000

    Long-term Debt                           1.226.280                                   200.000

    Common-stock and Paid

       In surplus

    (22.000 shares outstanding)            600.000                                   600.000

    Retail Earnings                                192.170                                     92.000

Total                                                 2.913.450                                1.247.000

Questions:

1.      Why has reduced the share price, even the net income has increased?

2. How liquid would say that this company is? Calculate the absolute liquidity of the company. How does it compare to the liquidity position last year? * Hint: Calculate some of the financial ratios that measure liquidity and compare the results of the last two years?

3. How do you compare the market value of the shares to their book value? Is the book value or in books accurately reflect the true condition of the Company?

4. The Board is not clear why the cash balance has fallen sharply in spite of the increase in sales and gross profit margin. What must Carl tell to the Board? * Hint: In order to identify the items that have caused the drastic decline, need to prepare the cash flow statement for 2004 *

5. Measure the cash flow of the company. What does that mean?

6. Calculate the net working capital of the company for each of the two years. What can you conclude about net working capital of the company?

7. Should shareholders be concerned about the decrease in cash flow or should be happy that increased earnings per share? Explain your answer.