Porter Lumber Co.
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PORTER LUMBER
KEY LEARNINGS:
This is a case where Financial Ratio Analysis is brought to the fore for purposes of deciding on whether to lend a prospective borrower a given amount or not. ÐŽ§In order to finance this increase and at the same time to continue taking purchase discounts, the company sought an additional bank loan of $200,000ÐŽÐ, says the case. Thus we are challenged to make the necessary calculations „oif we were taking the point of view of a prospective lender„o in order to decide whether indeed the said borrower is deserving of the (additional) loan.
The way Financial Ratio Analysis aids in such a decision is typically as follows: (1) we compute the pertinent historical financial ratios, as a basis for making a judgment on ability-to-pay (that is to say: solvency, liquidity, profitability, value to stockholders and to creditors, others); (2) using the computed ratios, we attempt to forecast the companyÐŽ¦s financial statements (both Income Statement and Balance Sheet) for the next few years (around 2-5 years), depending on whether key operating assumptions are tenable for only up to the short-term or up to the medium-term; (typically, Common-Size income statements would be used to forecast future income statements, except where operational details enable us to forecast certain items directly, and the computed ratios along with the forecast income statement items would be used to forecast the balance sheet items, leaving some ÐŽ§PayableÐŽÐ account blank as the balancing item) [Guide Question no. 5 is crucial for finding this out!] (3) using this procedure, the account that is left as the balancing figure will determine whether the company ought to be lent to or not. (4) in addition, we make statements as to the financial and operational status of the firm, viz.: sales trends, cost ratios, profitability (relationships between revenues and costs), market value (market measures), ability-to-pay and ability to remain as a going-concern, working capital requirements, solvency and liquidity.
In the case of Porter Lumber, we could be inspecting the following aspects which seem to stand out: (a) sales increases are real and, thus, call for some boost in cash levels in order to accommodate such increased operational revenues; (b) profitability: the relationship between purchase discounts (cost to the firm) and customer discounts (ÐŽÒcontra-costÐŽ¦ or income to the firm) seems to be lopsided; if this imbalance is not checked, it may cause some profit squeeze in the near future; this is also shown by the tightening Payable-to-Receivable