Tootsie Roll Industries Inc loan package analysis

Accounting

Tootsie Ratio Analysis in Support of a Loan

In order to grow firms need to make investments. Investment takes capital, which will often involve the raising of capital through borrowing. The investment that is being made will need to be assessed to ensure that it is viable and will create value. However, one of the most important considerations for any potential lender will be the ability of the firm to repay the debt (Howells and Bain, 2007). The firms' financial position needs to be assessed to determine if the firm will have the ability to repay the loan, and to assess the risk which may be associated with that loan. The assessment of assets will also be important to determine the potential level of security which may be available, particularly pertinent when the lender may require some type of charge, such as a floating charge (Libby et al., 2010). To assess the position of the firm and determine is the risk of increasing the total liabilities by 10% is viable a ratio analysis may be conducted looking at liquidity, solvency and profitability.

2.

Liquidity

Liquidity is an important consideration as this refers to the ability of the firm to pays its current debts, which are usually defined as payments due within the next twelve months (Libby et al., 2010), out of the current assets. This ratio is calculated by dividing the current assets by the current assets. The result shows how many times the current assets of the firm will cover the current liabilities (Libby et al., 2010).

Table 1; Current ratio for Tootise Roll Industries Inc.

Current ratio

2006

2007

Current assets (a)

190,917

199,726

Current liabilities (b)

62,211

57,972

Ratio (a/b)

3.07

3.45

From this it is apparent that the firm is liquid, with the current assets able to cover the current liabilities 3.45 times. Furthermore, the ratio is an improvement on the previous year, so there is not the potential for a negative trend. This is a good ratio for a lender. However, there is the assumption that the current assets could be liquidated at the book value; if there is the need to sell the current assets quickly they may not realize their full value, this s particularly true for inventory (Libby et al., 2010). For this reason as well as the current ratio, there may also be the use of the quick ratio, where the same calculation takes place, but the inventory value is excluded from the total current assets.

Table 2; Quick ratio for Tootise Roll Industries Inc.

Quick ratio

2006

2007

Current assets (a)

190,917

199,726

Inventories (b)

63,957

57,402

Net current assets (a-b) (c )

126,960

142,324

Current liabilities (d)

62,211

57,972

Quick ratio (c/d)

2.04

2.46

Even after the deduction of the inventory, the firm appears to be liquid, with a current ratio of 2.46. So far the firm looks to be a good potential candidate for a loan.

3.

Solvency

The current and quick ratio looks at the short-term ability of a firm to meet its obligations. A lender will also want to look at the longer term position and the ability to repay the entire debt plus interest and fees (Libby et al., 2010). The solvency ratio assesses the level of cash generated in a year as a percentage of the debt. The cash generated is calculated by taking the net profit after tax and adding back the depreciation. The total liabilities are calculated by adding together the current and the long-term (non current) liabilities.

Table 3; Solvency ratio for Tootise Roll Industries Inc.

2006

2007

Net profit after tax (a)

65,919

51,625

Depreciation (b)

15,816

15,859

Adjusted net profit (a + b) (c )

81,735

67,484

Current liabilities (d)

62,211

57,972

Non-current liabilities (e)

98,747

116,523

Total liabilities (d + e) (f)

160,958

174,495

Solvency ratio (c/f)

50.78%

38.67%

The solvency ratio has decreased from 50.78% in 2006 to 38.67% in 2007, showing that the cash generated as a percentage of the indebtedness is increasing this may be a concern and indicate some inefficiency in the firm. However, it is generally believed that where the ratio is below 20% there are indications of problems. Tootise is well above the danger level, but a lender may wish to explore the reasons behind the decline further to assess risk.

4.

Profitability

The ability of a firm to repay debt will inevitably reflect the firms' ongoing profit; firms which make losses are unlikely to survive. The firm needs to be generating sufficient profit to repay the loan and meet other obligations and expectations. Profit margins are a primary efficiency ratio. Profit is usually measured using the operating or the net profit margin; both will be assessed in this paper. The operating profit margin shows the percentage of the operating profits (sales less the operating costs only) as a parentage of sales. The net profit margin shows the net profit which is the sales less all costs including interest and deprecation, as a percentage of the sales.