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A ratio analysis of the firm’s financial performance is the most reliable way to identify the issues and opportunities for the joint venture. Generally, a ratio analysis includes four groups: (1) Liquidity ratio, (2) Accounting activity ratio, (3) Profitability ratio, and (4) Leverage ratio. Table 1 is a liquidity ratio analysis of LEI, SW, and CF. The current and quick ratios are designed to measure the firm’s short-term liquidity, or the firm’s ability to meet its short-term debts from its current assets. The debt-to-equity ratio measures the firm’s ability to fulfill its long-term obligations.
Table 1: Liquidity Ratio Analysis Name of CompanyCurrent RatioQuick Ratio LEI1. 491. 17 SW2. 141. 09 CF1. 911. 23 *All calculation based on LEI, SW, and CF 2004 financial information provided by University of Phoenix. From Table 1, the current ratio for LEI, SW and CF are all acceptable. With 1. 91:1 for CF, or the consolidated firm has $1. 91 of current assets to meet $1. 00 of its current liability, the ratio indicates the merger creates adequate liquidity for the firm to meet current liability. The quick ratio stands in good shape as well. With 1. 12:1 for CF, or the consolidated firm has $1. 23 of quick assets to meet $1. 0 of its current liability. Table 2 is the accounting activity ratio analysis of LEI, SW, and CF. Accounting activity ratio is designed to measure the firm’s efficiency in turning inventory, sales, assets, accounts receivables or payables. This ratio also ties in to the firm’s ability to meet both short- and long-term obligations. Table 2: Accounting Activity ratio Analysis Name of CompanyAsset Turnover RateDSO (day)Inventory Turnover Rate LEI1. 6457. 3415. 03 SW0. 8763. 294. 75 CF1. 3937. 419. 63 *All calculation based on LEI, SW, and CF 2004 financial information provided by University of Phoenix.
From Table 2, the asset turnover rate indicates the use of assets is effective for the consolidated firm with ratio at 1. 39. DSO, or Days Sales Outstanding, has reduced to 37. 41 days, meaning the consolidated firm takes only 37. 41 days to turn account receivables into cash. Industry standard is about 30 days. The inventory turnover rate shows that the consolidated firm is able to turn around inventory 9. 63 times in the fiscal year of 2004. This ratio indicates the turn around time is sufficient. Table 3 is the profitability ratio analysis of LEI, SW, and CF.
Profitability ratio measures a firm’s return or profit made on investments. Table 3: Profitability Ratio Analysis Name of CompanyReturn on Asset (ROA)Return on Equity (ROE)Profit Margin LEI12. 1%19. 1%7. 4% SW8. 7%35. 3%10. 0% CF10. 9%21. 8%7. 9% *All calculation based on LEI, SW, and CF 2004 financial information provided by University of Phoenix. Table 3 shows that both LEI and SW are profitable companies with healthy financial ratios; especially with SW’s robust financial performance. However, these returns come with a price. Please see Table 4 for the explanation of risk.
When combined, the company should also generate 10. 6% per dollar returns on assets, 21. 8% returns on equity, and 0. 79 cents per dollar on sales. Generally a 10% return ROE would enable the firm to distribute dividends to shareholders or to reinvest in growth projects. Table 4: Leverage Ratio Analysis Name of CompanyDebt RatioDebt-to-Equity Ratio LEI0. 360. 56 SW0. 752. 91 CF0. 500. 82 *All calculation based on LEI, SW, and CF 2004 financial information provided by University of Phoenix. From Table 4, the debt ratio for SW is high while debt ration for LEI is acceptable.
The combined debt ratio is about 50%, which is acceptable. Likewise, debt-to-equity ratio for LIE is low but for SW is very high. The combined debt-to-equity ratio is a bit high at 82%, meaning that the consolidated firm has $0. 82 in debt and $1. 00 in equity to meet its obligations. This is mainly due to the combination of SW’s large financial leverage or large amount of long-term debt and liabilities and LEI’s high dividend payout. Upon merged, LEI would need to design a capital structure that yields 50% in debt-to-equity ratio by reducing long-term debt and dividend payout.