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For this assignment I would like to use the company Apple. I am not looking for the whole 2,500 word essay, I am just looking for advice on how to get started, tips, websites that will give me the required information, how best to go about writing it out, etc… The more detailed the response the better. It’s not due for several weeks so take your time if necessary.

Throughout this course you will prepare a 2,500-word (excluding tables, figures, and addenda) financial analysis of a chosen company following the nine-step assessment process introduced below and detailed in Assessing A Company’s Future Financial Health.

Analysis of Fundamentals: Goals, Strategy, Market, Competitive Technology, Regulatory and Operating Characteristics
Analysis of Fundamentals: Revenue Outlook
Investments to Support the Business Unit(s) Strategy(ies)
Future Profitability and Competitive Performance
Future External Financing Needs
Access to Target Sources of External Finance
Viability of the 3-5 Year Plan
Stress Test under Scenarios of Adversity
Current Financing Plan

Note: It is best to select a company that is public and enjoys extensive analyst coverage (i.e., Apple, GE, Southwest Airlines, etc.) to insure access to material regarding your subject company. The more information available, the easier it will be to perform the financial analysis.
As you conduct the analysis, you will research the market for data on your chosen company, including analyst reports and market information. Disclose all assumptions made in the case study (e.g., revenue growth projections, expense controls) and provide supporting reasons and evidence behind those assumptions.
Finally, in order to assess the long-term financial health of the chosen company, synthesize the research data and outcomes of the nine-step assessment process.

9-911-412REV: JANUARY 28, 2011
Asssessing a Comgmpany’s Futur Finansrencial HHealthAsssessing the loong-term finaancial health of a company is an imporyrtant task for management in itstformuulation of goa and stratealsegies and for outsiders as they conside the extensi of credit, longerionterm ssupplier agreeements, or an investment in a companntny’s equity. HHistory aboun with examndsmplesof commpanies that embarked up overly amponmbitious programs and subbsequently discovered that theirtportfoolios of progrrams could n be finance on acceptanotedable terms. The outcome ffrequently wa theasabanddonment of programs in mmid-stream at considerable financial, orgganizational, and human ccost.It is the responnsibility of mmanagement t anticipate ftofuture imbalaance in the ccorporate finaancialsystem before its semeverity is refllected in the financials, an to conside corrective action before bothnderetime and money are exhaussted. The aavoidance of bankruptcy is an insufyufficient stanndard.Manaagement mus ensure the continuity o the flow of funds to al of its stratestofllegically impoortantprogrrams, even in periods of addversity.Figgure A provid a conceptdestualization of the corporate financial system, with a sesuggested steep-bystep pprocess to asssess whether i will remain in balance oitnover the ensui 3-5 years. The remaind ofingderthis nnote discusses each of the steps in the process and then provid an exerci on the vaseeddesiseariousfinanc measures that are useful as part of the analysis. The final secialsfection of the note demonsstratesthe rrelationship between a firm’s strateegy and opperating characteristics, and its finaancialcharacteristics.
________________________________________________________________________________________________________________________Professo Thomas Piper prorrepared the origina version of this no “Assessing a Fialote,irm’s Future Financ Health,” HBS N 201-077, which is beingcialNo.replaced by this version prdrepared by the sam author. This note was prepared as t basis for class dmeethediscussion.ghtresident and Fellow of Harvard Collewsege. To order copi or request permiesmission to reproduc materials, call 1-8ce800-545Copyrig © 2010, 2011 Pr7685, wr Harvard Businriteness School Publishhing, Boston, MA 02163, or go to wwww.hbsp.harvard.eedu/educators. Th publication may not behisydigitized photocopied, or otherwise reprodud,uced, posted, or trannsmitted, without t permission of HtheHarvard Business SSchool.
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Figure A
Assessing a Company’s Future Financial Health
The Corporate Financial SystemGoalsStrategy
Step 1
Market, Competitive TechnologyRegulatory and OperatingCharacteristicsStep 2
Revenue Outlook• growth rate• volatility, predictability
Step 3
Step 4
Investment in Assets• to support growth• improvement/deteriorationin asset management
Economic Performance• profitability• cash flow• volatility, predictability
Step 5
Step 6
External Financing Need• $ amount• timing, duration• deferability
Target Sources of Finance• lending/investing criteria• attractiveness of firmto each target sourceStep 7Viability of 3-5 Year Plan• consistency with goals• achievable operating plan• achievable financing planStep 8Stress Test for ViabilityUnder Various scenariosStep 9Financing and Operating Plan forCurrent Year
Steps 1, 2: Analysis of FundamentalsThe corporate financial system is driven by the goals, business unit choices and strategies, marketconditions and the operating characteristics. The firm’s strategy and sales growth in each of itsbusiness units will determine the investment in assets needed to support these strategies; and theeffectiveness of the strategies, combined with the response of competitors and regulators, will2
Assessing a Company’s Future Financial Health
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strongly influence the firm’s competitive and profit performance, its need for external finance, and itsaccess to the debt and equity markets. Clearly, many of these questions require information beyondthat contained in a company’s published financial reports.
Step 3: Investments to Support the Business Unit(s) Strategy(ies)The business unit strategies inevitably require investments in accounts receivable, inventories,plant & equipment, and possibly, acquisitions. Step 3 of the process is an attempt to estimate theamount that will be tied up in each of the asset types by virtue of sales growth and theimprovement/deterioration in asset management. An analyst can make a rough estimate by studyingthe past pattern of the collection period, the days of inventory, and plant & equipment as a percent ofcost of goods sold; and then applying a “reasonable value” for each to the sales forecast or theforecast of cost of goods sold. Extrapolation of past performance assumes, of course, that the futureunderlying market, competitive and regulatory “drivers” will be unchanged from the conditions thatinfluenced the historical performance.
Step 4: Future Profitability and Competitive PerformanceStrong sustained profitability is an important determinant of (1) a firm’s access to debt and/orequity finance on acceptable terms; (2) its ability to self-finance growth through the retention ofearnings; (3) its capacity to place major bets on risky new technologies, markets, and/or products;and (4) the valuation of the company.A reasonable starting point is to analyze the past pattern of profitability.1.
What have been the average level, trend and volatility of profitability?
2.
Is the level of profitability sustainable, given the outlook for the market and for competitiveand regulatory pressures?
3.
Is the current level of profitability at the expense of future growth and/or profitability?
4.
Has management initiated major profit improvement programs? Are they unique to the firmor are they industry-wide and may be reflected in lower prices rather than higherprofitability?
5.
Are there any “hidden” problems, such as suspiciously high levels or buildups of accountsreceivable or inventory relative to sales, or a series of unusual transactions and/or accountingchanges?
Step 5: Future External Financing NeedsWhether a company has a future external financing need depends on (1) its future sales growth;(2) the length of its cash cycle; and (3) the future level of profitability and profit retention. Rapid salesgrowth by a company with a long cash cycle (a long collection period + high inventories + high plant& equipment relative to sales) and low profitability/low profit retention is a recipe for an everincreasing appetite for external finance, raised in the form of loans, debt issues, and/or sales ofshares. Why? Because the rapid sales growth results in rapid growth of an already large level oftotal assets. The increase in total assets is offset partially by an increase in accounts payable andaccrued expenses, and by a small increase in owners’ equity. However, the financing gap issubstantial. For example, the company portrayed in Table A requires $126 million of additionalexternal finance by the end of year 2010 to finance the increase in total assets required to support 25%per year sales growth in a business that is fairly asset intensive.3
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Assessing a Company’s Future Financial Health
Table A
Assuming a 25% Increase in Sales ($ in millions)
AssetsCashAccounts receivableInventoriesPlant & equipmentTotalLiabilities and EquityAccounts payableAccrued expensesLong-term debtOwners’ equityTotalExternal financing needTotal
2009$ 12240200400$852$10080272400$8520$852
↑ 25%↑ 25%↑ 25%↑ 25%
↑ 25%↑ 25%Unchangedfootnote a
2010$ 15300250500$1,065$ 125100272442$ 939126$1,065
a It is assumed (1) that the firm earns $60 million (a 15% return on beginning of year equity) and pays out $18 million as a cashdividend; and (2) that there is no required debt repayment in 2010.
If, however, the company reduced its sales growth to 5% (and total assets, accounts payable andaccrued expenses increased accordingly by 5%), the need for additional external finance would dropfrom $126 million to $0.High sales growth does not always result in a need for additional external finance. For example, afood retailer that extends no credit to customers, has only eight days of inventory, and does not ownits warehouses and stores, can experience rapid sales growth and not have a need for additionalexternal finance provided it is reasonably profitable. Because it has so few assets, the increase in totalassets is largely offset by a corresponding, spontaneous increase in accounts payable and accruedexpenses.
Step 6: Access to Target Sources of External FinanceHaving estimated the future financing need, management must identify the target sources (e.g.,banks, insurance companies, public debt markets, public equity market) and establish financialpolicies that will ensure access on acceptable terms.1.2.
How will the firm service its debt? To what extent is it counting on refinancing with a debt orequity issue?
3.
Does the firm have assured access on acceptable terms to the equity markets? How manyshares could be sold and at what price in “good times”? In a period of adversity?
4.
4
How sound is the firm’s financial structure, given its level of profitability and cash flow, itslevel of business risk, and its future need for finance?
What criteria are used by each of the firm’s target sources of finance to determine whetherfinance will be provided and, if so, on what terms?
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The evaluation of a firm’s financial structure can vary substantially depending on the perspectiveof the lender/investor. A bank may consider a seasonal credit a very safe bet. Considerableshrinkage can occur in the conversion of inventory into sales and collections without preventingrepayment of the loan. In contrast, an investor in the firm’s 20-year bonds is counting on itssustained health and profitability over a 20-year period.
Step 7: Viability of the 3-5 Year Plan1.
Is the operating plan on which the financial forecasts are based achievable?
2.
Will the strategic, competitive, and financial goals be achieved?
3.
Will the resources required by the plan be available?
4.
How will the firm’s competitive, organizational, and financial health at the end of the 3-5years compare with its condition at the outset?
Step 8: Stress Test under Scenarios of AdversityFinancing plans typically work well if the assumptions on which they are based turn out to beaccurate. However, this is an insufficient test in situations marked by volatile and unpredictableconditions. The test of the soundness of a 3-5 year plan is whether the continuity of the flow of fundsto all strategically important programs can be maintained under various scenarios of adversity for thefirm and/or the capital markets—or at least be maintained as well as your competitors are able tomaintain the funding of their programs.
Step 9: Current Financing PlanHow should the firm meet its financing needs in the current year? How should it balance thebenefits of future financing flexibility (by selling equity now) versus the temptation to delay the saleof equity by financing with debt now, in hopes of realizing a higher price in the future?The next section of this note is designed to provide familiarity with the financial measures that canbe useful in understanding the past performance of a company. Extrapolation of the pastperformance, if done thoughtfully, can provide valuable insights as to the future health and balanceof the corporate financial system. Historical analysis can also identify possible opportunities forimproved asset management or margin improvement, as well as provide an important, albeitincomplete, basis for evaluating the attractiveness of a business and/or the effectiveness of amanagement team.
Financial Ratios and Financial AnalysisThe three primary sources of financial data for a business entity are the income statement, thebalance sheet, and the statement of cash flows. The income statement summarizes revenues andexpenses over a period of time. The balance sheet is the list of what a company owns (its assets),what it owes (its liabilities), and what has been invested by the owners (owners’ equity) at a specificpoint in time. The statement of cash flow categorizes all cash transactions during a specific period oftime in terms of cash flows generated or used for operating activities, investing activities, andfinancing activities.The focus of this section is on performance measures based on the income statements and balancesheets of SciTronics—a medical device company. The measures can be grouped by type: (1)5
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Assessing a Company’s Future Financial Health
profitability measures, (2) activity (asset management) measures, (3) leverage and liquidity measures.Please refer to the financial statements of SciTronics as shown in Exhibits 1 and 2 at the end of thenote. As you work through the questions that follow, please also consider three broad questions:1.
What is your assessment of the performance of SciTronics during the 2005-2008 period?
2.
Has its financial strength and its access to external sources of finance improved or weakened?
3.
What are the 2-3 most important questions you would ask management as the result of youranalysis?
Sales GrowthSales growth is an important driver of the need to invest in various type assets and of thecompany’s value. It also provides some indication of the effectiveness of a firm’s strategy andproduct development activities, and of customer acceptance of a firm’s products and services.1.
During the four-year period ended December 31, 2008, SciTronics’ sales grew at a _____%compound rate. There were no acquisition or divestitures.
Profitability Ratio: How Profitable Is the Company?Profitability is a necessity over the long-run. It strongly influences (1) the company’s access todebt; (2) the valuation of the company’s common stock; (3) the willingness of management to issuestock; and (4) the capacity to self-finance. One measure of profitability of a business is its return onsales, measured by dividing net income by net sales.1.
SciTronics’ profit as a percentage of sales in 2008 was ______ %.
2.
This represented an increase/decrease from ______% in 2005.
Management and investors often are more interested in the return earned on the funds investedthan in the level of profits as a percentage of sales. Companies operating in businesses requiring verylittle investment in assets often have low profit margins but earn very attractive returns on investedfunds. Conversely, there are numerous examples of companies in very capital-intensive businessesthat earn miserably low returns on invested funds, despite seemingly attractive profit margins.Therefore, it is useful to examine the return earned on the funds provided by the shareholders andby the “investors” in the company’s interest-bearing debt. To increase the comparability acrosscompanies, it is useful to use EBIAT (earnings before interest but after taxes) as the measure of return.The use of EBIAT as the measure of return also allows the analyst to compare the return on investedcapital (calculated before the deduction of interest expense), with the company’s estimated cost ofcapital to determine the long-term adequacy of the company’s profitability. EBIAT is calculated bymultiplying EBIT (earnings before interest and taxes) times (1—the average tax rate).EBIT x 1 tax rateplus interest bearing debt
Owners ′ equity3.
6
SciTronics had a total of $______ of capital at year-end 2008 and earned beforeinterest but after taxes (EBIAT) $______ during 2008. Its return on capital was_____% in 2008 which represented an increase/decrease from the _____% earnedin 2005.
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From the viewpoint of the shareholders, an equally important figure is the company’s return onequity. Return on equity is calculated by dividing profit after tax by the owners’ equity.Profit after taxesOwners ′ equity
Return on equity
Return on equity indicates how profitably the company is utilizing shareholders’ funds.4.
SciTronics had $_____ of owners’ equity and earned $_____ after taxes in 2008. Itsreturn on equity was _____% an improvement/deterioration from the _____%earned in 2005.
Activity Ratios: How Well Does the Company Employs Its Assets?The second basic type of financial ratio is the activity ratio. Activity ratios indicate how well acompany employs its assets. Ineffective utilization of assets results in the need for more finance,unnecessary interest costs, and a correspondingly lower return on capital employed. Furthermore,low activity ratios or deterioration in the activity ratios may indicate uncollectible accounts receivableor obsolete inventory or equipment.Total asset turnover measures the company’s effectiveness in utilizing its total assets and iscalculated by dividing total assets into sales.Net salesTotal assets1.
Total asset turnover for SciTronics in 2008 can be calculated by dividing $_____into $_____. The turnover improved/deteriorated from _____ times in 2005 to_____ times in 2008.
It is useful to examine the turnover ratios for each type of asset, as the use of total assets may hideimportant problems in one of the specific asset categories. One important category is accountsreceivables. The average collection period measures the number of days that the company must waiton average between the time of sale and the time when it is paid. The average collection period iscalculated in two steps. First, divide annual credit sales by 365 days to determine average sales perday:Net credit sales365 daysThen, divide the accounts receivable by average sales per day to determine the number of days ofsales that are still unpaid:Accounts receivableCredit sales per day2.
SciTronics had $_____ invested in accounts receivables at year-end 2008. Itsaverage sales per day were $_____ during 2008 and its average collection periodwas _____days. This represented an improvement/deterioration from theaverage collection period of _____ days in 2005.
A third activity ratio is the inventory turnover ratio, which indicates the effectiveness with whichthe company is employing inventory. Since inventory is recorded on the balance sheet at cost (not at
7
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Assessing a Company’s Future Financial Health
its sales value), it is advisable to use cost of goods sold as the measure of activity. The inventoryturnover figure is calculated by dividing cost of goods sold by inventory:Cost of goods soldInventory3.
SciTronics apparently needed $_____ of inventory at year-end 2008 to support itsoperations during 2008. Its activity during 2008 as measured by the cost of goodssold was $_____. It therefore had an inventory turnover of _____ times. Thisrepresented an improvement/deterioration from _____ times in 2005.
An alternative measure of inventory management is days of inventory, which can be calculated bydividing cost of goods sold by 365 days to determine average cost of goods sold per day. Days ofinventory is calculated by dividing total inventory by cost of goods sold per day.A fourth and final activity ratio is the fixed asset turnover ratio which measures the effectivenessof the company in utilizing its plant and equipment:Net salesNet fixed assets4.
SciTronics had net fixed assets of $_____ and sales of $_____ in 2008. Its fixedasset turnover ratio in 2008 was _____ times, an improvement/deterioration from_____ times in 2005.
Leverage Ratios: How Soundly is the Company Financed?There are a number of balance sheet measures of financial leverage. The various leverage ratiosmeasure the relationship of funds supplied by creditors to the funds supplied by owners. The use ofborrowed funds by reasonably profitable companies will improve the return on equity. However, itincreases the riskiness of the business and the riskiness of the returns to the stockholders, and canresult in financial distress if used in excessive amounts.The ratio of total assets divided by owners’ equity is an indirect measure of leverage. A ratio, forexample, of $6 of assets for each $1 of owner’s equity indicates that $6 of assets is financed by $1 ofowners’ equity and $5 of liabilities.1.
SciTronics’ ratio of total assets divided by owners’ equity increased/decreasedfrom _____ at year –end 2005 to _____ at year-end 2008.
The same “story” of increasing financial leverage is told by dividing total liabilities by total assets.2.
At year-end 2008, SciTronics’ total liabilities were _____% of its total assets, whichcompares with _____% in 2005.
Lenders—especially long-term lenders—want reasonable assurance that the company will be ableto repay the loan in the future. They are concerned with the relationship between a company’s debtand its total economic value. This ratio is called the total debt ratio at market.Total liabilitiesTotal liabilities market value of the equityThe market value of the equity is calculated by multiplying the number of shares of common stockoutstanding times the market price per share.8
Assessing a Company’s Future Financial Health
3.
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The market value of SciTronics’ equity was $175,000,000 at December 31, 2008.The total debt ratio at market was _____.
A fourth ratio that relates the level of debt to economic value and performance is the times interestearned ratio. This ratio relates earnings before interest and taxes—a measure of profitability and oflong-term viability—to the interest expense—a measure of the level of debt.Earnings before interest and taxesInterest expense4.
SciTronics’ earnings before interest and taxes (operating income) were $_____ in2008 and its interest charges were $_____. Its times interest earned was _____times. This represented an improvement/deterioration from the 2005 level of_____ times.
A fifth and final leverage ratio is the number of days of payables. This ratio measures the averagenumber of days that the company is taking to pay its suppliers of raw materials and components. Itis calculated by dividing annual purchases by 365 days to determine average purchases per day:Annual purchases365 daysAccounts payable are then divided by average purchases per day:Accounts payableAverage purchases per dayto determine the number of days purchases that are still unpaid.It is often difficult to determine the purchases of a firm. Instead, the income statement shows costof goods sold, a figure that includes not only raw materials but also labor and overhead. Thus, itoften is only possible to gain a rough idea as to whether or not a firm is becoming more or lessdependent on its suppliers for finance. This can be done by tracking the pattern over time ofaccounts payable as a percent of cost of goods sold.Accounts payableCost of goods sold5.
SciTronics owed its suppliers $_____ at year end 2008. This represented _____%of cost of goods sold and was an increase/decrease from _____% at year end 2005.The company appears to be more/less prompt in paying its suppliers in 2008 thanit was in 2005.
6.
The financial riskiness of SciTronics increased/decreased between 2005 and 2008.
Liquidity Ratios: How Liquid is the Company?The fourth basic type of financial ratio is the liquidity ratio. These ratios measure a company’sability to meet financial obligations as they become current. The current ratio, defined as currentassets divided by current liabilities, assumes that current assets are much more readily and certainlyconvertible into cash than other assets. It relates these fairly liquid assets to claims that are duewithin one year—the current liabilities.
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Assessing a Company’s Future Financial Health
Current assetsCurrent liabilities1.
SciTronics held $_____ of current assets at year-end 2008 and owed $_____ tocreditors due to be paid within one year. Its current ratio was _____, anincrease/decrease from the ratio of _____ at year-end 2005.
The quick ratio or acid test is similar to the current ratio but excludes inventory from the currentassets:Current assets InventoryCurrent liabilitiesInventory is excluded because it is often difficult to convert into cash (at least at book value) if thecompany is struck by adversity.2.
The quick ratio for SciTronics at year-end 2008 was _____, an increase/decreasefrom the ratio of _____ at year-end 2005.
Profitability RevisitedManagement can “improve” its return on equity by improving its return on sales and/or its assetturnover and/or by increa…

  

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