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Financial Analysis of Ace Company
Accounts Receivable Collections
The account receivables for the company seem to be increasing year on year, which indicates that their clients are increasingly paying on credit. It also shows a rising trend that could impact available cash flow (Marshall et al., 2020). Another crucial dimension of the accounts receivable is the speed at which customers are settling their bills. The company needs to receive cash sooner rather than later so that they can pay their financial obligations. Account receivable turnover ratio is a great indicator of a companys collection performance. For the years 2016 and 2017, the ratios were 4.68 and 5.06, respectively. These values indicate that Ace Company is doing a better job of collecting receivables. The mean duration for the 2016 accounts receivables was 365/4.68 = 77.99 days, while in 2017, the number was 365/5.06 = 72.13 days. The difference between the two numbers is 5.86 days, further indicating improvement in their collection process. Since Ace Company is collecting credit at a faster rate, it is a vote of confidence in its methods of collecting credit.
Inventory Turnover
Inventory turnover ratio is an indicator of how often the company replaces its inventory around the year. Ace Company had inventory turnover ratios of 1.94 and 1.82 for 2016 and 2017; the ratios are not dramatically different, indicating stability. Businesses use this ratio to better inform their decisions concerning purchases of new products and pricing (Marshall et al., 2020). According to Inventory Turnover (n.d.), the average for unclassifiable industries is 13 and 71 for all sectors; these are relatively higher than that of Ace Company. A high inventory turnover ratio indicates strong sales or an adequate inventory with the potential for a stockout in the event demand increases. Low inventory turnover is an indicator of weak sales and that the company may have too much inventory, which can be costly to store. Higher inventory turnover is an indicator of efficiency. A higher ratio shows that the stock is moving out of storage faster, indicating better performance. If a company is not moving their products, it shows that they are holding many of their products, leaving their competitors to take a larger market share. If there are increased sales, inventory turnover could go either direction depending on the firms buying process. The ratio is better at showing how good a company is at managing its inventory.
Liquidity
In 2016, Ace Company had a current ratio of 1.53, while in 2017, it was 1.79. Current ratio is a measure of a companys current assets against its current liabilities, including inventory (Marshall et al., 2020). For the two years, Ace Companys current ratios have been comfortably above 1, indicating that the organization could settle its short-term debt obligations (Marshall et al., 2020). Time interest earned (TIE), also called interest coverage ratio, indicates a companys ability to meet its debt obligations using its current income. In 2016, Ace Company had a TIE of 8 times, while in 2017, the same was 10.2. The values indicate that Ace Company had enough earnings compared to interest obligations.
Decision
Ace Company has a favorable current ratio from the above analysis, indicating it could meet its short-term debt obligations. Its TIE suggests that it has sufficient income against its interest obligations, but this would change if it took more debt. However, debt-to-equity ratios of 3.78 and 2.49 in 2016 and 2017, respectively, indicate that the company is already financing its operations with debt. This metric suggests that the company should not acquire more debt lest it encounters some distress.
References
Inventory turnover (days)Breakdown by industry. (n.d.). ReadyRatios. Web.
Marshall, D. H., McManus, W. W., & Viele, D. F. (2020). Accounting: What the numbers mean (12th ed.). McGraw-Hill Education.
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