Financial Analysis and Forecasting

1
Financial Analysis and Forecasting

• Safe Packaging Company
• Presented by
• Israel Pena and Hubert Chen

2
Profile on Safe Packaging Company (SPC)

• Manufactures boxes and shipping containers for
  farm products, including a patented egg carton
• More than 80 percent of sales come from the
  western part of the United States, primarily
  California, Texas and Idaho

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Financial Information

• Pacific National Bank
• Computerized Analysis System generates a negative
  report on the company
• Gross profit is drastically decreasing
• Total Operating Expenses and Total Interest are
  substantially increasing
• Latest SPC report reveals a number of adverse
  trends in key financial ratios, including ROE and
  ROA

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1995 SPC Report

• Current ratio 1.82 versus industry 2.0
• Quick ratio 0.74 versus industry 1.0
• Debt ratio 60 percent versus industry 55 percent
• Altman Z score 3.09 versus 3.20 minimum

5
Recent Industry Problems

• Recession of the early 1990s
• Severe droughts for two straight summers
• Drastic curtailment of demand for agricultural
  shipping containers

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SPCs Response

• Reducing prices
• Increasing production
• Inventories increased sharply
• Relaxing its credit standards
• Increase in Accounts Receivable
• Aggravated the companys Cash Flows problems

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Days of Sales Outstanding
8
Results

• Long-Term loan in 1994
• Increase in Short-term credit lines in 1994 and
  1995
• Company began to delay payments of its Accounts
  Payable
• Signing of a binding contract for a plant
  expansion 12,750,000 in 1996

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Main Problem

• Increasing Total Interest, Total Operating
  Expenses, and COGS cut deeply into Net Income
• Lenient Credit policies plus increased production
  leave too much cash tied up in Accounts
  Receivables and Inventory

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Income Statement Data
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Management Assumptions

• Project Sales Growth of 10 percent from 1995 to
  1996 and 12.5 percent from 1996 to 1997
• Return to standard industry credit practices and
  pricing strategy that fully cover costs plus
  normal profit margins
• Target DSO Industry Average
• Target Inventory Turnover 5.50
• Reduction in Cost of goods Sold (CGS) from 85
  percent in 1995 to 83 percent in 1996, and 80
  percent in 1997

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Accounts Receivable
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Inventory
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More Mgmt Assumptions

• Reduce Administrative and Selling Expenses from
  8.5 percent in 1995 to 8 percent in 1996, and 7.5
  percent in 1997
• Cut Miscellaneous Expenses from 2.50 percent in
  1995 to 1.80 percent in 1996, and 1.40 percent in
  1997
• Cash Dividends eliminated until firm regains its
  financial health

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EBIT
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Even More Mgmt Assumptions

• Optimal Cash Balance 5 percent of Net Sales
• P/E ratio of 12 in 1996 and 14 in 1997
• Federal-plus-State Tax rate 40 percent
• Level of interest rates 8.50 percent in 1996 and
  9 percent in 1997

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Weaknesses

• Sharp increase in ST debt causes doubts that SPC
  will be able to pay back all of its obligations
• Large Inventory used inefficiently
• Increase in Account Receivables decreases Cash
  Flows
• COGS growing at a faster pace than Net Sales
• High Total Operating Expenses

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Current Liabilities
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Liquidity Ratios
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Leverage Ratios
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Strengths

• Projected increase in Net Sales
• Internal weaknesses can be reversed with good
  Asset Management
• Payout Ratio above Industry Average before the
  turmoil
• Chapter 11 of the Bankruptcy Act will allow SPC
  to recuperate in 1 to 3 years

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Sales Growth
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Outcome

• Enough cash generated to pay back Short Term
  loans in 1996
• Extra cash above optimal balance allowed
  investments in Marketable Securities
• Dividend Payout reinstated in 1997
• All key ratios raised above Industry Average

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Profitability Ratios
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More Profitability Ratios
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Sensitive Results

• Sales Growth
• COGS percentage
• Administrative Expenses

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Sales Growth Sensitivity Analysis
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COGS Sensitivity Analysis
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Admin. Exp Sensitivity Analysis
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What If

• All ST and LT loans are called in immediately?
• Enough cash available
• Cash falls below Optimal Balance

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Conclusions

• If there is no Sales growth, COGS remains high,
  and Expenses unchanged, most ratios still meet
  contractual limits
• By modifying Accounts Receivable and Inventory to
  meet industry averages, we free up cash and pay
  back the ST loans

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Thank You!