Case Study: Evaluating for Company to Purchase 1

Case Study: Evaluating for Company to Purchase

University of the People

BUS 5110: Managerial Accounting

Instructor: Dr. Gaberella Green

October 22, 2020.

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Introduction

The trend analysis is the method employs in technical analysis to predict the future stock price

evolution that is recently observed from the trend data to use what transpired in the past as an idea of what

will happen in the future [ CITATION Hay19 \l 1033 ].

Trend Analysis of the two companies, Fashion Forward and Dream Designs

The profit margin ratio is the profit generated for each dollar in net sales and calculated as the net

income divided by the net sales as in the financial data (Heisinger, n.d). See Table 1

Therefore, the profit margin ratio = Net Income ÷ Cost of Sales

Table 1

Fashion Forward Dream Designs

Profit Margin Ratio 9.75% 6.54%
Note that the profit margin ratio focuses solely on the income statement in the financial data (Heisinger, n.d).

The return on assets is that measure which relies on assets required to develop net income of a

company, that is the evaluation of how much net income generated as in concordance with each dollar

invested on assets (Heisinger, n.d). Therefore, the return on assets = Net income ÷ Average total assets

(where average total assets, finding the average after the summation of total assets at the end of the previous,

and current year) (Heisinger, n.d). See Table 2.

Average Total Assets (Fashion Forward) = (2,747,000 + 2,805,000) ÷ 2 = 2,776,000

Average Total Assets (Dream Designs) = (4,381,250 + 4,450,000) ÷ 2 = 4,415,625

Return on assets FF = 136,500/2,776,000 = 0.0492

Return on assets DD = 212,500/4,415,625 = 0.0481

Table 2

Fashion Forward Dream Designs

Return on assets 4.92% 4.81%
However, from the return on assets computation, the Fashion Forward investment will perform better

than Dream Designs. Furthermore, and from the Balance Sheet Data, using the current ratio which is the

reflection of the financial strength of the company, i.e. Current Ratio = Total current assets ÷ Total current

liabilities [ CITATION Edw20 \l 1033 ]. See Table 3

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Table 3

Fashion Forward Dream Designs

Year 2018 2017 2018 2017
Total current assets 1,297,000 1,285,000 2,280,500 2,295,000
Total current liabilities 1,170,000 1,045,000 1,625,750 1,675,000
Current Ratio 1.1085 1.2297 1.4027 1.3702
Moreover, from the above Table 3 analysis of the current ratio in the different years of the financial

data, it shows the current liabilities are covered by the current assets 1.1085 times in 2018, and 1.2297 times

in 2017 for Fashion Forward company. Meanwhile, it is 1.4027 times in 2018, and 1.3702 times in 2017 for

Dream Design company. However, a current ratio can be improved upon by increasing current assets or by

decreasing current liabilities to get a good safety margin [ CITATION Edw20 \l 1033 ].

Quick ratio: This is the indication of a company’s capacity to liquidate its current liabilities without

the need to sell its inventory or seek additional funding. This is the measure of the dollar amount of liquid

assets that are available against the dollar amount of current liabilities of an organization [ CITATION Kin20 \l

1033 ].

Quick ratio = Quick assets ÷ Current liabilities (Heisinger, n.d). Where quick assets are the current

assets excluding items that cannot be easily or quickly converted to cash such as inventory.

Table 4

Fashion Forward Dream Designs

Year 2018 2017 2018 2017
Quick Assets (excluding inventory) 1,185,000 1,180,000 2,080,500 2,080,000
Current liabilities 1,170,000 1,045,000 1,625,750 1,675,000
Quick Ratio 1.0128 to 1 1.1292 to 1 1.2797 to 1 1.2418 to 1
However, from the analysis in Table 4, it indicates that for Fashion Forward; had $1.0128 in quick

assets for every dollar expended in current liabilities. Also, the ratio decreased from 2017 to 2018.

Meanwhile, for Dream Design company had $1.2797 in quick assets which shows an increase from 2017 as

compared to that of Fashion Forward.

The account receivable turnover ratio (AR Turnover Ratio) is one of the accounting tools that

measure the efficiency ratio of a company revenue collection, that is, measuring the number of times that

company collects its average account receivables over a given period [ CITATION CFI202 \l 1033 ].

AR Turnover Ratio = Net Credit Sales ÷ Average Account Receivable [ CITATION CFI202 \l 1033 ].
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Where, average accounts receivable is the summation of the starting and ending accounts receivable over a

period and divided by 2 [ CITATION CFI202 \l 1033 ]. See Table 5.

Table 5

Fashion Forward Dream Designs

Year 2018 2018
Net Credit Sales 2,000,000 4,320,000
Average Accounts Receivable 175,000 262,500
AR Turnover Ratio 11.4286 16.4571
Table 5, shows that the Fashion Forward company collected its average receivable at approximately

11.43 times over the fiscal year ended December 12, 2018. Also, Dream Design company collected its

average receivable at approximately 16.46 times over the fiscal year ended December 12, 2018. The higher

turnover ratio of Dream Designs suggests that its collection process is very efficient and enjoying a high-

quality customer base with a conservative credit policy [ CITATION CFI202 \l 1033 ].

Furthermore, to calculate the average collection period is to take the number of working days in a

year, and multiply by average accounts receivable, then divide the value by net credit sales or the total sales

[ CITATION Ind15 \l 1033 ].

For Fashion Forward:

Average Collection Period = (no. working days’ x average accounts receivable) ÷Net credit sales

= (300 x 175,000) ÷ 2,000, 000 = 26.25 days

This shows it took about 26 days for a sale to be converted into Cash.

For Dream Designs:

Average Collection Period = (300 x 262,500) ÷ 4,320,000 = 18.23 days

This shows it took about 18 days for a sale to be converted into Cash.

While it takes Dream Designs company about 2 weeks and 4 days to collect Cash from the sales; it

takes longer close to a month (26 days) for Fashion Forward company and some of the balances may become

uncollectable with a possible cause that the company is designing and selling products to highly marginal

customers with dubious means of payment. The management of Fashion Forward should take remedial

action for collections and stop future sales until prior payment is received.
 Case Study: Evaluating for Company to Purchase 5

Moreover, the inventory turnover ratio is that ratio depicting how many times an organization has

sold, and replace inventory over a given period [ CITATION Har201 \l 1033 ].

Inventory Turnover Ratio = Cost of Goods Sold ÷ Average inventory (Heisinger, n.d). Where, Average

inventory = (Beginning inventory + Ending inventory) ÷2 [ CITATION Har201 \l 1033 ].

For Fashion Forward:

Average inventory = (105,000 + 112,000) ÷2 = 108,500

Therefore, Inventory Turnover Ratio = 1,400,000 ÷ 108,500 = 12.90

For Dream Designs:

Average inventory = (215,000 + 200,000) ÷2 = 207,500

Therefore, Inventory Turnover Ratio = 3,250,000 ÷ 207,500 = 15.66

The inventory turnover ratio is high with Dream Designs as compared to the Fashion Forward company

which implies there are stronger sales in the former than the latter hence Dream Design is desirable and good

business.

Average Sales Period: this is one of the phases of the average maturity of business i.e. the interim

space that takes place the moment a product is finished and stored until sales are instituted by the company

[ CITATION Abd20 \l 1033 ]. This is the period that indicates how many days it will take on the average to sell

the company's inventory (Heisinger, n.d). Average Sales Period = Cost of Sales ÷ 365 days [ CITATION

Abd20 \l 1033 ].

For Fashion Forward:

Average Sales Period = 1,400,000 ÷ 365 = 3,835.62

For Dream Designs:

Average Sales Period = 3,250,000 ÷ 365 = 8,904.11

Debt to Equity Ratio: This is an important metric used in corporate financing to measure the extent to

which an organization is financing its operations through debts versus wholly-owned resources [CITATION
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Hay201 \l 1033 ]. Debt to Equity Ratio = Total Liabilities ÷ Total Shareholder Equity (Hayes, 2020; Heisinger,

n.d).

For Fashion Forward (2018):

Debt to Equity Ratio = 1,345,000 ÷ 1,402,000 = 0.96

For Dream Designs (2018):

Debt to Equity Ratio = 1,901,250 ÷ 2,480,000 = 0.77

However, with the higher value of the Debt to Equity Ratio indicates that the company or its stock are

at higher risks to investors or shareholders [ CITATION Hay201 \l 1033 ]. Hence, Forward Fashion shareholders

are at risk with their investments. Therefore, Dream Designs is very good for the shareholders with minimal

risk of their investments.

Conclusion

In conclusion and from the trend analysis, it will be better for the organization to invest in Dream

Designs even though its Average Sales Period seems higher but all other variables from the computation are

very favorable for investors and shareholders alike.

References

Abdullah, S. (2020). Average Sales Period. Retrieved on 18 October 2020 from

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https://notesread.com/average-sales-period-pmv/

CFI Education Inc., (2020). What is the Accounts Receivable Turnover Ratio? Retrieved on 18

October 2020 from https://corporatefinanceinstitute.com/resources/knowledge/accounting/accounts-

receivable-turnover-ratio/

Edward Lowe Foundation, (2020). How to Analyze Your Business Using Financial Ratios?

Retrieved on 17 October 2020 from https://edwardlowe.org/how-to-analyze-your-business-using-

financial-ratios-2/

Hayes, A. (2020). Debt-To-Equity Ratio – D/E. Retrieved on 18 October 2020 from

https://www.investopedia.com/terms/d/debtequityratio.asp

Hayes, A. (2019). Trend Analysis. Retrieved on 16 October 2020 from

https://www.investopedia.com/terms/t/trendanalysis.asp

Hargrave, M. (2020). Inventory Turnover. Retrieved on 18 October 2020 from

https://www.investopedia.com/terms/i/inventoryturnover.asp

Heisinger, (n.d). Accounting for Managers. Retrieved 10 September 2020 from

https://2012books.lardbucket.org/books/accounting-for-managers/index.html

IndustriusCFO.com, (2015). Understanding Financial Ratios and Industry Average Financial

Ratios. Retrieved on 18 October 2020 from http://www.industriuscfo.com/understanding-financial-

ratios-and-industry-average-ratios/

Kindness, D. (2020). Quick Ratio. Retrieved on 18 October 2020 from

https://www.investopedia.com/terms/q/quickratio.asp