Financial Health

Financially weaker engineering corporations often go bankrupt at some point due to macroeconomic change such as occurred in (1) commercial steel industry during the early 1980’s OR (2) commercial construction industry and (3) commercial automotive industry during the recent “Great recession” 2007 – 2009.

Additionally, financially weaker engineering corporations also often go bankrupt due to inability to keep pace with technological change such as occurred during the (4) commercial PC and (5) software revolution in the late 1970’s, the (6) commercial internet revolution from 1993, and (7) commercial handheld mobile smartphone from 1994 & (8) touchscreen tablet revolution from 2010.
Financial Health values and ratios are often the first indicator of a corporations inability to adapt and survive economic or technological change.
Financial Health Assignment and Grading Rubric 10 pts per section:
For one of the eight industry/periods of change identified above,
(1) Identify internal and external financial forms necessary to compute financial values and ratios cited by Ross et al.
a.   Financial health values and ratios are drawn from the Balance Sheet, Income Statement, Statement of Cash Flow, Change in Equity Statement, 10K, 10Q, etcetera.
b.   Corporate financial health is considered in light of financial values and ratios found in financial forms found within a company and in the 10K submitted to the SEC for those corporations supervised by the SEC.
c.   Fundamental to financial health is the directional and competitive nature of financial values such as Revenue (top line) and net income (bottom line) stated in past, present and pro forma balance sheets. Is net income positive? Is it growing? How does that compare to companies in the same competitive business space? Ditto for revenue. Further, the source and nature of revenue and income is important.   The income statement provides insight into income including non-cash expenses such as depreciation. The cash flow statement strips out non-cash expenses and simply looks at cash flows and where they occur at. Are cash flows from operations? Are they from financial events such as an IPO? Are they from investments in outside businesses? While cash flows more new companies may be from issuance of stock, such as an IPO, cash flows from a healthy mature corporation are expected to be positive, with competitive gross margins and occur due to operations.
d.   Financial ratios are another means beyond assessment of values to assess financial health. When using financial ratios to evaluate the complete financial health of a corporation, one needs to consider ratios across the five categories of financial health – liquidity, leverage, turnover, profitability, and market value.
(2) For the industrial sector you have selected, argue the ability of at least two different financial health ratios from two different Ross defined FH categories to signal corporate FH readiness to survive or not survive macroeconomic or technology change.

a.   Are the two or more ratios selected from different financial ratio categories? If all from the same category, then -3.
b.   How persuasive is the argument that the first ratio provides leading indication of financial deterioration or strengthening at some point in the life cycle of a firm? For example, liquidity ratios are near term ratios where for example a lower than one and rapidly declining acid ratio may indicate impeding bankruptcy while a higher than one and increasing acid ratio may indicate short term financial strength. Up to -2
c.   How persuasive is the argument that the second ratio provides indication of financial deterioration or strengthening at a different point in the life cycle of a firm such as longer term? A market value ratio such as a declining price-earnings ratio may be an early indicator of change in financial health than the previously mentioned liquidity ratios which are very late FH signals. Declining P/E ratios may indicate declining faith in management and/or product line offerings to grow profits in the future. P/E ratios out of line with the industry indicate investor reduced belief in the future competitiveness of a corporation. Increasing price-earnings ratios may indicate investor confidence to grow earnings in the future. Useful midterm signals may include days in inventory combined with profit margins when compared to competitors. If inventory is sitting and so is everyone else’s inventory, then this may signal economic downturn. If inventory is sitting and competitor inventory is not, then technological shortfall in product, process, and/or services may have emerged. Up to -2.
d.   Miscellaneous considerations? – Are the definitions and statements just student assertions or are they presented in a scholarly fashion supported at a minimum by cited experts like Ross et al or industrial experts such as Warren Buffet (Please review Chapter 1&2 lecture where Buffet identifies ROA, ROE, and Profitability as his recommended financial ratios used to assess businesses competitively with peers. ROA and ROE focus more on efficient profitability of existing assets and may not be as applicable as other ratios for rapidly changing technology firms. Other competing ratios for technology firms are market ratios as they rely more heavily on assessment of potential for future invention and innovation to compete. Leverage ratios may indicate the ability or inability of a firm to access capital as well as the price of that capital.)? -1 per issue
(3) As evidence of the signaling in advance of financial health strength or weakness by the two ratios, identify two corporations – one that succeeded and one that eventually went bankrupt or was bought out – whose financial ratios support your argument.
a.   What is the extent corporation “A” data is presented and is discussed in terms of the chosen measures? Are the measures discussed over time? Is there discussion of change in the direction, velocity, or acceleration of the value of each of the measures over one of the eight industry/periods of change as well as the time period leading up to and after? Up to -2 per issue.
b.   What is the extent corporation “B” data is presented and is discussed in terms of the chosen measures? Are the measures discussed over time? Is there discussion of change in the direction, velocity, or acceleration of the value of each of the measures one of the eight industry/periods of change as well as the time period leading up to and after? Up to -2 per issue.
c.   Miscellaneous considerations? Data from valid sources such as 10K?-(Please review Chapter 3&4 lecture discussion on how Carly Fiorina traced multiple year EPS reductions to lines of businesses within HP, showed through pro forma extrapolations how HP would be bankrupt in a few years unless they changed business strategies and lines of business, and then presented multi-year pro forma EPS projections if HP bought Compaq) – 1 per issue
(4) What can you infer about the reliability of these ratios to signal financial health strength or weakness in firms in different industries from the prior two that you cited?
a.   How persuasive is the selected case and argument presented by the student about the level of correlation of the ratio combination to signal financial ill health of a given firm and increased likelihood to fail during a period of technological or economic change? Did the corporation go into the change period blind to financial ratios and fail by not having the financial resources to survive the economic downturn? Or did the corporation fail to act within time and with sufficient financial resources in order to fund transformation of its technologies/products/processes/services to remain competitive?   Are traditional associations between two or more ratios presented and supported such as declining turnover ratios with decreasing profitability OR increasing leverage leading to inability to maintain liquidity OR some other combination associated with a financially unhealthy firm? Is the industry sector considered? Market considered? Up to -2
b.   How persuasive is the selected case and argument presented by the student about the level of correlation the ratio combination to signal financial health of a given firm and increased likelihood to survive or even prosper during a period of technological or economic change? Did the corporation act on leading financial ratios and raise sufficient capital prior to the change period in order to survive the economic downturn? Or did the corporation act on leading financial ratios in time and with sufficient capital to transform its technologies/products/processes/services to remain competitive? Are traditional associations between two or more ratios presented and supported such as increasing market value ratios with increasing profitability OR increasing turnover with increasing profitability OR some other combination associated with a financially healthy firm? Is the industry sector considered? Market considered? Up to -2
c.   Miscellaneous considerations? Is there mention for the need of other financial ratios to more fully evaluate financial health? As indicated by Ross et al, Warren Buffet, and other experts, due to accounting differences and artificialities as well as investor and client perceptional variance, no one financial ratio is a consistent indicator of financial health throughout the economic life cycle of a firm. Further, corporate FH measures may be confounded by other divisions. For example the severe poor health of Ford automotive division in 2005 was mask in part by the positive FH of their lending division. Are any of these limitations mentioned? Are combination ratios such as the Dupont Identify discussed? -2 per issue
(5) Beyond the book and notes from Dr. Proctor, cite at least two additional references. Cite and reference your contrasting examples in support of your written response. List the complete references using APA style.   Quality and uniqueness of reference will influence reference assessment. Literature may contain named expert or analysis assessments, news articles from reputable news agencies, corporate 10Ks, annual reports or press releases, or other such documents. Do NOT list sources in the reference list that are not cited in the body of the essay. If using internet sites or references, then provide the complete internet site link. If I am unable to bring the link up, then the site or reference will be discarded for grading purposes.
a.   At least two references. -5 for each missing reference
b.   Quality of the references: Up to -3 each
Limit your written response to highlights and key points using your own words in 750 words our less. All responses will be evaluated for originality using Turnitin.com.
The best performing students on this question tied specific financial health ratios from time period EARLIER than the crash period and used them as timely signals to CEO’s about impeding financial or technological change. As opposed to near term liquidity FH signals which are very late signals, early or long term signals, such as industry non-competitive P/E ratios (market signals), and medium terms signals, such as non-competitive days’ sales in inventory combined with profit margin, are the most beneficial to CEO as they provide greater reaction time than a short term FH signal such as a quick ratio. Corporate change that corrects technological deficiencies due to change in competing product, process, or services or corporate change required to survive macroeconomic change requires financial resources. Long term and midterm FH signals give the CEO’s time to identify and react to the issues which may require raising significant amounts of capital. Raising capital is more expensive and less available if a corporation is in the midst of a change or a crisis then if it the needs are foreseen prior to a crisis. Alan Mullay is the poster board success story in the automotive area as he saw these negative, declining, and uncompetitive Financial Health signals in the Ford financial statements in 2006 and reacted immediately to them by raising significant amounts of capital to address either future “economic or technology” challenges.

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b) The following are the examples of financial health values obtained from Ford Motor Company for the years 2013, 2012 and 2011
Ford Motor Group   2013   2012   2011
Current Ratio   Total Current Assets/Total current liabilities   2.11   2.32   2.26
Quick Ratio   TT C/ Assets – inventories /TT/ C Liabilities   1.98   2.18   2.15
Inventory Turnover   Cost of goods sold/Average inventory   17.00   17.51   19.87
Asset turnover   Sales/Average total assets   0.75   0.73   0.76
Dividend yield    Div per Share / Current Share price   0.03   0.01
Dividend cover   EPS/ Dividend per Share   4.55   7.40
Net assets turnover   Net assets / total sales   1.24   1.27   0.85
Times interest earned   EBIT/Annual Interest Expense   9.45   11.83   11.63
Debt to total Asset    Debt/Assets   0.57   1.03   0.56
Interest cover   EBIT/Annual Interest Expense   9.45   11.83   11.63
Profit margin on sale   GP/sales   0.13   0.13   0.14
R.R return on assets   EAT/Total Assets   0.04   0.03   0.11
R.R com stock equity   Profit after taxes/Shareholders equity   0.27   0.36   1.35
Earnings per share   Profit after taxes-pref div)/No. of comm O/S   1.54   1.48
Payout Ratio   cash dividends/income   0.00   0.00   0.00
ROE   Return On Equity (ROE)   0.27   0.36   1.35
ROA   Return on average Assets   0.04   0.03   0.11

These figures were obtained from the following information derived from Ford’s financial records, annual reports and form K-10

2013   2012   2011
Ford   000,000   000,000   000,000
GP   18823   17452   18380
Net Profit   7155   5665   20213
EAT   7155   5665   20213
Share holders Equity   26383   15947   15028
Total Assets   202026   189406   178348
Total Liabilities   19531   19308   63093
Inventories   7708   7362   5901
Cost of Goods   128094   116107   117225
Average inventory   7535   6631.5   5901
Debt   114688   195058   99488
EBIT   7830   8433   9498
Sales   146917   133559   135605
TT Assets- Inventories   123877   117812   114307
Interest Expense   829   713   817
Average Receivables   84589   80205   78541
Current Assets   131585   125174   120208
Current Liabilities   62412   53992   53226
Average total assets   195716   183877   178348
Receivables   87309   81869   78541
Outstanding shares   3.88   3.88 B   3.88 B
Payables   19531   19308   63093
Dividend per share   0.4   0.2   0
Earnings per share   1.82   1.48
Net assets   182495   170098   115255
Net assets turnover   1.24216   1.273579467   0.84993
Net profit margin   0.0487   0.042415711   0.14906
Total Dividend Paid   1.574B

c) The financial trend of a company reveals the growth patterns of a company. The following is the financial trend for Ford motor company and its closest rival in the US, General Motors.
Financial Trends   Ford   GM
2013   2012   2013   2012
GP   7.86   -5.05   66.97   -43.40
Net Profit   26.30   -71.97   -13.61   -32.67
EAT   26.30   -71.97   -13.61   -32.67
Share holders Equity   65.44   6.12   17.56   -4.92
Total Assets   6.66   6.20   11.32   3.33
Total Liabilities   1.15   -69.40   15.59   1.44
Inventories   4.70   24.76   -4.59   2.72
Cost of Goods   10.32   -0.95   -2.88   7.83
Average inventory   13.62   12.38   -0.98   1.36
Debt   -41.20   96.06   91.97   -5.23
EBIT   -7.15   -11.21   -127.63   -390.27
Sales   10.00   -1.51   2.08   1.32
TT Assets- Inventories   5.15   3.07   22.03   9.26
Interest Expense   16.27   -12.73   -31.70   -9.44
Average Receivables   5.47   2.12   51.64   36.84
Current Assets   5.12   4.13   16.44   7.81
Current Liabilities   15.59   1.44   15.59   1.44
Average total assets   6.44   3.10   7.39   1.67
Receivables   6.64   4.24   38.94   73.69
Payables   1.15   -69.40   -0.45   2.21
Net assets   7.29   47.58   17.56   -4.92
Net assets turnover   -2.47   49.84   -13.16   6.56
Net profit margin   14.82   -71.54   -15.37   -33.54

The financial trends reveal that the Gross profit for ford increased by 7.6% in the year 2013 compared to the year 2012. The same case applies to GM whose Gross Profit grew by 66.97% in the year 2013 compared to the year 2012.The results for both companies were however disappointing in the year 2012 as they both registered a reduction in GP. Ford experienced a reduction of 5.05% compared to the year 2011 while GM registered a decrease of 43.4% in the year 2012 compared to 2011. The Net profit for Ford increased by 26.3% in 2013 while in 2012 it decreased by 71.97%. GM experienced a decrease in NP for both years, 13.61% and 32.67% in 2013 and 2012 respectively. (Ford Motor Company Annual Report, 2013)
Liquidity
Fords current ratio for the years 2013, 2012 and 2011 were 2.11, 2.32 and 2.26 respectively. These ratios represent the rates of current assets compared to the current liabilities. A ratio of 2.11 that’s 2.11 current assets compared to current liabilities means that the company is in a better position to pay off all its liabilities comfortably. The quick ratios for Ford for the same period were 1.98, 2.18 and 2.15 respectively. The quick ratios represent the total current assets less the inventories divided by the current total liabilities. These ratio measures higher liquidity levels requirement in case of emergency needs and how quickly the current assets can be converted into liquid cash.
Leverage
The total debt ratio equals to 86.94% while the equity multiplier is 7.66 for the year 2013.
The structure of Ford’s capital is made up of loans or borrowed money. In 2013, the long-term debts were $114, 688 million while in the year 2012 and 2011 the debts amounted to 105, 058 and 99488 respectively. The total stockholder equity amounts to $26,383 Million and $15,947 million for the same period. Ford Company is highly levered and it needs to cut down on borrowing. General Motor’s long term debts amounted to $6573 Million and $3424 Million for the year 2013 and 2012 while the total stockholders equity amounted to $42,607, $36,244 and $38120 for the years 2013, 2012 and 2011. Gm is relatively levered.
Turnover
The asset turnover ratio for ford in 2013 was 0.75 while in 2012 it was 0.73. The inventory turnover for 2013 was 17 and 17.51 in 2012. The net assets turnover was 1.24 and 1.27 for the years 2013 and 2012
Profitability
The rate of return on net sales for the company was 1.24% in 2013 compared to 2012 achievement of 1.27. The profit margin on sales amounted to 13% for both years i.e. 2013 and 2012. However, in 2011 the profit margin amounted to 14%. The company’s percentage rate of return on all its total assets amounted to 4% compared to the previous year rate of 3 % in 2011 while in 2011 it was 11%. The earnings per share of the company’s common stock was $ 1.54 in 2013 compared to 1.48 in 2012. The profitability ratios indicate a position of strength to the company.
Market value
The market value
Price earnings ratio for ford for the year 2013 was 1.54.
2. The ratios provided on the liquidity of the Ford Motor company can be affected by the macroeconomic development. If the GDP of the USA decreases then most of the profits from companies also decrease. The drop in GDP creates unemployment which reduces the citizen’s purchasing power hence the sales also decrease. This was the case between 2007 and 2009 when the US GDP dropped to negative 4.5. The sales of Ford were affected during that period as in indicated on the diagram below.