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Falcon

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How to Analyze Financial Statements

FALCON MANUFACTURING COMPANY
(Suggested Analysis)

Liquidity Ratios : 2006 2007
Current Ratio 1.5 2.33
Quick Ratio 0.88 1.42

Liquidity ratios measure the ability of the firm to meet its short term liabilities out of its current assets.

• Current ratio has increased from 1.5 to 2.33 which indicates that the liquidity position has improved in 2007.
• Quick ratio also shows an improvement in 2007 as compared to 2006.
• From the balance sheet, it can be seen that investment in current assets in 2007 has increased by 75% from 2006 whereas liabilities increased only by 12.5%. This has obviously contributed to the improvement in the liquidity ratios.
• It should also be observed that Cash has decreased from AED 900,000 in 2006 to only AED 50,000 in 2007. Similarly the majority of current assets are in the form of Accounts receivable, therefore it is important that the company collects its receivables quickly to maintain liquidity.

Asset Utilization Ratios 2006 2007
A/R turnover 6.4 times 3 times
Avg. collection period 57 days 120 days
Inventory turnover 5.1 times 4.7 times

The above ratios are a measure of how quickly the firm converts its current assets into cash.

• Both the A/R turnover and Average collection period indicate an unfavourable trend. This means that the company is taking a very long time to collect its accounts receivable.
• From the financial statements, we can see that in 2006, A/R represented 15.7% of Sales for the year but in 2007, A/R represented 33% of sales for the year.
Why? Are the customers not paying promptly? Is the company very lenient in collecting its receivables? It could also mean that the company may have given extended credit terms.

• Inventory turnover has

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