Working capital management in the Skyline Corporation case

Finance & Management

Skyline Corporation

The acid test, or quick, ratio adjusts current assets by removing less liquid assets, primarily inventories. It is expressed as coverage of so many times and is used to calculate working capital as the excess of current assets over current liabilities. By subtracting the inventories, or less liquid assets, it adjusts the assets to calculate for a truer working capital picture.

The current ratio measures short-term solvency, the extent current assets are sufficient to cover current liabilities. This ratio relates total current liabilities to cash, marketable securities, and receivables. If the current ratio is less than 1 and a competitor in the same industry is higher than 1, it shows that the company is carrying less inventory than its industry counterparts.

The inventory turnover ratio measures the liquidity of the inventory by calculating the number of times on average a company sells the inventory during a period. Analysts compute this ratio from beginning and ending inventory balances. The more times the inventory turns over the higher the liquidity is in inventory.

The accounts receivable turnover is used to evaluate the liquidity of a company's accounts receivables. It measures the number of times on average a company collects its receivables during the period. This ratio tells how successful the company is in collecting its outstanding receivables. In turn the accounts payable ratio evaluates how quickly the creditors get paid. The total asset turnover ratio tells the overall utilization of all the assets and how profitable the assets are.

Return on equity measures the profitability of the company's equity. It tells how many dollars of net income the company earned per dollar invested by the owners. It helps investors judge the worthiness of a stock when the overall market is not doing well. The rate of return on assets tells how well a company has achieved the use of its assets. The operating profit margin measures the rate of profit on sales after operating expenses. It analyzes the use of property, plant, and equipment. It is another measure of how well the company uses its assets.

The dividend payout tells the interest to investors and measures cash dividends to net income. It is important to investors that a payout is sufficiently high to provide a good yield on stock. The debt to equity ratio measures the proportion of debt to the company's equity. It tells how well the company is financed. The interest coverage ratio measures the extent the operating earnings can decline without causing inability to meet annual interest cost. The gearing ratio measures the percentage of total interest bearing funds that have been provided by creditors.

West-City Bank would consider the total asset turnover, the operating profit margin, and the debt to equity ratios. Total asset turnover will tell how well the company is utilizing the available assets and resources. The debt to equity ratio would determine if the company is over financed and help to determine how solvent the company is. The operating profit margin would measure the sales to operating expenses for profitability.

The Hondas Company would consider the debt equity ratio, interest coverage, and gearing ratios. The debt equity ratio would tell the proportion of debt to equity the company already has. A high ratio is not a good sign. The interest coverage ratio would determine if the operating earnings are sufficient to cover the interest costs. And the gearing ratio will tell how much interest bearing funds have already been provided by creditors. A high ratio could be a bad sign.

McLennan Trust would consider the current ratio, acid test ratio, and the dividend payout ratio. The current and acid test ratios determine how solvent the company is. The dividend payout ratio would determine if the yield on the stock is sufficient.

Working capital Management Committee would consider the acid test ratio, operating profit ratio, and total asset turnover ratios. The acid test tells the liquidity of the company. The operating profit ratio would determine the net profit per dollar of sales. And the total asset turnover tells the overall asset utilization that would bring in revenue for working capital.

The accounts receivable turnover, return to equity, debt equity ratio, and the gearing ratio are all above industry average. All the other ratios are below industry. Compared to industry average, Skyline Corporation has a low short-term solvency. They are less liquid than their competitors. The inventory turnover, accounts payable turnover, and the total asset turnover reveals they are not selling the amount of inventories the competitors are and cannot pay their creditors as fast. The return on assets ratio is below industry revealing the assets are not being utilized as much as they could be. The operating margin is revealing the expenses are high compared to the expenses of other industry businesses. The dividend payout is below what the competitors can pay. The interest expense of the company is high and the total borrowing is a little higher than industry.

With the earnings, dividends, working capital and the price of the company's stock not moving the same direction as the sales volumes, or within the same price pace as most rivals in the industry, it indicates the company has made some bad management decisions. The debt and expense ratios need to be considered by each company. They may not have a diversified debt mix to utilize in the company's best interest. The interest expense is high and could reveal that the company has not considered all the debt alternatives in supply and working capital resources.