"Who can figure bankers?" Pehr Weisengraf mumbled as he returned to the office of his small candy manufacturing business, Professional Confectioners. "They're willing to lend money only to those business owners who don't really need it. If you can prove you don't need it, they'll throw it at your feet. Unfortunately, we need it, and we need it fast."
Pehr called Robert Peltzman, the company's part-time bookkeeper, to see if he could explain what the banker had been talking about when he rejected Pehr's request for $80,000 to purchase new candy-making equipment and to boost the company's working capital base. "They turned down my loan request," Pehr explained to Peltzman. "The banker had those copies of our financial statements that you've been sending her. She said that many of our financial ratios were way off what they should be. I've never even taken a business course much less an accounting course. I have no idea what she was talking about, but she did give me this," Pehr said, thrusting a piece of paper at Peltzman. "I don't know. It's all Greek to me."
Peltzman looked at the page and saw that the banker had calculated several financial ratios based on Professional Confectioner's most recent financial statements and had compared them to the industry average. Here's what he saw:
Ratio Last Year This Year Industry Average
Current Ratio 2.3:1 1.7:1 2.4:1
Quick Ratio 0.7:1 0.4:1 0.8:1
Debt Ratio 0.81:1 0.89:1 0.65:1
Debt to Net Worth Ratio 2.6:1 2.9:1 1.9:1
Inventory Turnover Ratio 4.9 times/yr 4.3 times/yr 7.1 times/yr
Average Collection Period 36 days 43 days 34 days
Net Sales to Working Capital Ratio 10.4:1 9.7:1 12.6:1
Net Profit on Sales Ratio 4.1% 3.8% 9.4%
Net Profit to Equity Ratio 17.6% 18.3% 13.4%
"Can you tell me what this means, and more importantly, what we can do to improve our ratios so we can qualify for a loan?" Pehr said to Robert.
From the financial ratios, we can see that the liquidity for the company decreased from last year tremendously. The current ratio and quick ratio has been reduced to 1.7 from 2.3 last year and 0.4 from 0.7 last year respectively, which shows that the company's ability to pay current debts has been reduced. Moreover, the current ratio is also less than the industry average. This is the first reason why the banker found that lending the money to the company has higher risk for the company to pay short-term obligations on a timely basis.
Moreover, the debt portion of the company is higher than the industry average. We can see this from the increase in debt ratio and debt to net worth ratio from 0.81 to 0.89 and 2.6 to 2.9 ...
This solution discusses Professional Confectioners financial ratios in 428 words.