Page 42 - DCOM302_MANAGEMENT_ACCOUNTING

Unit 3: Analysis of Financial Statements

Notes

Task In financial statement analysis, what is the basic objective of observing trends in
data and ratios? Suggest some other standards of comparison.

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Case Study Evaluation of Ford on the basis of Accounting Trends

he success of Ford Motor Company, as well as other corporations, can be measured
by analyzing the two most important goals of management, maintaining adequate
Tliquidity and achieving satisfactory profitability. Liquidity can be defined as having
enough money on hand to pay bills when they are due and to take care of unexpected
needs for cash, while profitability refers to the ability of business to earn a satisfactory
income. To enable investors and creditors to analyze these goals, Ford Motor Company
distributes annual financial statements. With these financial statements, liquidity of Ford
Motor Company is measured by analyzing factors such as working capitol, current ratio,
quick ratio, receivable turnover, average days’ sales uncollected, inventory turnover and
average days’ inventory on hand; whereas profitability analyzes the profit margin, asset
turnover, return on assets, debt to equity, and return on equity factors.
Liquidity
Working Capital
Ford Motor Company’s working capital fluctuated significantly in the years 1991-1995. This
phenomenon is directly attributable to the fact that Financial Services current assets and
current liabilities are not included in the total company current asset and current liability
accounts. For example, the fluctuation from 1994 ($1.4 billion) to 1995 (-$1.5 billion) of
$2.5 billion would suggest that Ford would be unable to pay liabilities during the current
period. However, examination of the Financial Services side of the business reveals that
surpluses of $13.6 billion existed in both 1994 and 1995, convincingly mitigating the figures
indicating negative working capital.
Current Ratio & Quick Ratio
The current ratio in the years 1991-1995 has remained stable, fluctuating between 0.9
and 1.1. The quick ratio has also remained stable, fluctuating between 0.5 and 0.6. The
larger fluctuation in the current ratio versus the quick ratio is caused by inventories being
included in the asset side of the equation. Although inventories were significantly higher in
both 1994 and 1995, current liabilities were also higher. In addition, marketable securities
decreased substantially in 1994 and 1995. These factors resulted in the stability of both the
current ratio and quick ratio.
Receivable Turnover & Average Days’ Sales Uncollected
An examination of trends in Ford Motor Company’s receivable turnover and average days’
sales uncollected ratios reveal positive indicators of Ford’s liquidity position. The receivable
turnover, a function of net sales and average accounts receivable, has nearly doubled in the
years 1993-1995 versus 1991-1992. This trend indicates an extensive increase of net sales in
relation to accounts receivable. Receivables were relatively higher in 1994 than in any other
of the five years, affecting the ratio for both 1994 and 1995. However, net sales increased
30% in 1994 and 34% in 1995 over the average net sales of 1991-1993. The average days’
sales uncollected ratio has decreased significantly over the same period, from 16.9 days in
Contd…

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