XYZ Company Is in Decent

¶ … XYZ Company is in decent financial condition. They experienced poor financial performance in 2000, but have recovered somewhat in 2001. This performance came on the heels of a major increase in assets in 1999.

Despite the recent bad year, the company is liquid, has a healthy capital structure, has good margins and has been able to increase its revenues rapidly over the past several years.

The spike in assets in 1999 and financial struggles in 2000 appear to pertain to an acquisition made in 1999 and the costs of integrating a new company into XYZ. The firm acquired debt, which it is in the process of paying down. Research and development costs skyrocketed, but XYZ reduced those. Other expenses were held in check, while the revenue gains from the new operation begun to be realized.

Despite the strong recovery in 2001, there are still some challenges that remain for XYZ. The company needs to work on its working capital management, as its receivables turn did not see much improvement in the past year, and is at a relatively low level. Also, the company needs to curtail selling expenses, which are growing almost as quickly as revenues, indicating that the sales and marketing teams are not improving their efficiency.

Those opportunities for improvement aside, the company is strong. They have returned to profitability and continue to grow at a phenomenal rate. Returns to the shareholders are excellent, and the company makes efficient use of its assets. They are solvent and they are liquid. If they continue on their present path, they will be very successful.

Financial Ratio Analysis

XYZ's liquidity ratios have shown modest improvement. The current ratio is strong at 1.55 and has generally been strong, except for in the one weak year of 2000. The company's cash ratio is a strong 0.72. Again, except for 2000, the cash ratio has been relatively strong for several years. The current times interest earned is 71 times, which again is very strong. Even in the weak year of 2000, times interest earned was 9.7 times, indicating that even in that year the firm had sufficient liquidity.

Accounts receivable turnover is at 10.89 times at present. This metric has been on a fairly consistent downhill slide. For example, in 1999 it was at 14.89 and in 1997 it was at 21.78 times. The 2001 number represents only a modest improvement from the 2000 number, which was10.57 in a year where receivables ballooned. Inventory turnover has been very high throughout the life of the company. Currently it is at 216.9 and this figure has steadily increased. The firm simply does not keep much inventory on hand, just the works in progress.

The current operating margin is 10.0%, and this represents a slight decrease from 1999, but an increase from the pre-expansion days. Returns on both assets and equity are both high, at 29.8% and 71.9% respectively. However, both of those represent declines over previous years.

XYZ has an acceptable capital structure. They have a debt to equity ratio of 1.001. This represents a significant improvement from 2000 (2.29) but aside from that aberration of a year the company has had a relatively healthy capital structure. Their struggles in 2000 thankfully did not lead them to a huge increase in debt.

Understanding the XYZ's Financial Situation

XYZ's finances are heavily influenced by an expansion undertaken in 1999. This acquisition dramatically altered the firm's balance sheet, but it also resulted in changes to their cost structure as well. The most significant change were the integration costs, most of which were realized in 2000. Research and development expense in particular skyrocketed post-acquisition. The company also saw a change to the balance sheet, as some debt appears to have been acquired in 1999.

The two years following the acquisition show the cost of absorbing the enterprise into the existing company. Revenues increased sharply, but so did many costs, resulting in the firm posting a loss in 2000. However, we can see in 2001 that the company has worked out many of the difficulties associated with the purchase. The long-term debt is being reduced. Many of the costs that had skyrocketed were brought under control. Thus, while revenues increased, expenses such as R&D and interest decreased. Other expenses grew at a slower rate than did revenues. Selling expenses grew at half the rate of revenues, and G&a expenses were held stable in 2001. These cost controls returned XYZ to profitability.

Overall, XYZ is a rapidly growing company with a strong financial position. They have strong liquidity ratios and can easily meet the interest on their debt obligations. They are whittling down their long-term debt as well. The firm enjoys high rates of return on both assets and equity as well, although the new, larger firm does not return as well as it did when it was small and growing exponentially.

While many key metrics are not as strong as they were in the past, there are two things to consider. As an example, the receivables turnover is at a relatively low level compared with past performance. However, the level is still respectable. Moreover, it improved last year. The operating margin is worse today than it was a few years ago, but again it is not poor by any means.

The other main point to consider is that XYZ is a growing company. In their early years, financial improvements were exponential. The firm was very profitable, but the business was clearly limited. The company made a large acquisition in 1999 and their performance slipped thereafter. Yet, this is merely growing pains. Growth rates decline as infant companies begin to mature. Acquisitions that are critical for long-term growth and strength may not have readily apparent benefits to the bottom line. In fact, the absorption and turnaround period for XYZ following its acquisition was very rapid, and the company is making excellent progress towards returning financial performance to its pre-acquisition levels.

There is nothing in these financial statements to cause concern for an investor in XYZ. The company is strong, its metrics are good. There was a slight blip related to a major event in 1999 that we can reasonably understand to be an acquisition. Equity is growing, debt is decreasing; revenues are growing, expenses are decreasing. Customization is emerging as a great business for XYZ, where revenues grew 43.5%. There are a lot of reasons for optimism and few reasons for pessimism when the company's long-term financial performance is taken into account.