Case Study of Diamond Gem Cleaning and Maintenance Company

Abstract

This paper will provide a financial ratio analysis of the company using: (1) Gross profit margin, (2) Current ratio, and (3) Debt ratio derived from the provided data. This paper will provide a narrative about, and observations of, significant lines from the statements. This paper will provide conclusions that are supported with research, data and logic. And finally this paper will provide a brief discussion of what limitations exist with the informational material provided.

 

Keywords: gross profit margin, current ratio, debt ratio

 

 

 

 

 

 

 

 

 

 

 

Gross Profit Margin – Gross profit Margin is used to measure company’s financial health as it reveals the amount of money left from revenues after the expenses for cost of goods sold (Investopedia, n.d.). The formula to measure gross profit margin is –

Gross profit Margin = (Revenue – Cost of goods sold)/Revenue

In case of “Diamond Gem Cleaning and Maintenance Company”

Contract Revenues – 5,146,862

Contract Cost – 4,532,519

So gross profit margin = (5146862 – 4532519)/5146862 = .12 or 12%

Current Ratio – shows if a company has enough cash or cash equivalent which is included in current asset to cover current debts or liabilities (liabilities to be addressed / paid back in 1 year).

In this case current assets = 893868

Current liabilities = 571697

Current ratio = Current assets / Current liabilities=893868/571697 = 1.56 or 15.6%

 Debt ratio tells us how leveraged a company actually is, higher the debt ratio, higher the outgoing cash flow towards debt interest and principle payment (Investopedia, n.d.).

For this company Total Long term Debt = 172467

Total Short Term Debt = 571697

Total Assets = 1180660

Debt Ratio = (Total Long term Debt + Total Short Term Debt) / Total Assets =744164/1180660

=.63

Let us find out the Common side analysis of balance sheet and income statement –

Common-Size Balance Sheet Analysis
ASSETS        
         
CURRENT ASSETS        
         
Cash   225,971   19.14%
Contracts receivables   505,050   42.78%
Other assets   162,847   13.79%
         
Total current assets   893,868   75.71%
         
LONG TERM ASSETS        
         
Equipment   286,792   24.29%
         
TOTAL ASSETS   1,180,660   100.00%
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
         
CURRENT LIABILITIES        
         
Accounts payable   257,335   21.80%
Line of credit   85,000   7.20%
Accrued expenses   72,495   6.14%
Income tax payable   46,660   3.95%
Current portion of notes payable   31,747   2.69%
Deferred income taxes   78,460   6.65%
         
Total current liabilities   571,697   48.42%
         
LONG TERM LIABILITIES        
Notes payable (long term)   172,467   14.61%
         
TOTAL LIABILITIES   744,164   0.00%
         
STOCKHOLDERS’ EQUITY        
         
Common stock 62,000     0.00%
Additional paid-in capital 63,862     5.41%
         
Retained Earnings 310,634     26.31%
         
Total stockholders’ equity   436,496   36.97%
         
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY   1,180,660   100.00%
         

 

Common-Size Income Statement Analysis
     
Contract Revenues 5,146,862 100%
     
Contract Costs 4,532,519 88.06%
     
Gross Profit 614,343 11.94%
     
General and Administrative Expenses 322,356 6.26%
     
Operating Income 291,987 5.67%
     
Other Expense 25,770 0.50%
     
Income Before Provision for Income Taxes 266,217 5.17%
     
Provision for Income Taxes 115,450 2.24%
     
Net Income 150,767 2.93%
     
     
Retained Earnings, Beginning Balance 159,867 3.11%
     
Net Income 150,767 2.93%
     
Retained Earnings, Ending Balance 310,634 6.04%

 

From Balance Sheet, the significant line items are the “Total Current Asset” and “Total long term assets” which gives us “total assets”. Current assets are cash or cash equivalent, usually current asset is used to cover current liabilities or short term commitments.

Next are “Total current liabilities”, “Long Term Liabilities” those give us “total liabilities”. Current liability is a commitment to be fulfilled in a year, payment to vendors, or repaying some debt etc. and long term liability is usually long term debt or commitment those have to be paid off in more than a year.

Retained earnings is also important because it shows the amount that was not paid out as dividends (Investopedia, n.d.) and is reported under shareholder equity. And a positive retained earning implies the company made a profit and reinvesting in business to grow the business.

From Income Statement, “Contract Revenues”, “Contract Cost”, “Net income” are important. Contract revenues gives us the amount company has made from sales and contract cost gives us the cost of contract sold.

And another important point we see that “Retained Earnings, Beginning Balance” was 159867 and “Retained Earnings, Ending Balance” is 310,634, so the company is making profit, and of course we can see the net income which is 150,767.

 

 

 

With all the data discussed above we can calculate following too –

Profitability Measures

Gross margin ratio = Gross margin / Net sales = 11.94%

Profit margin ratio = Net income/ Net sales = 2.93%

Profit margin is pretty low, because of high debt.

Return on assets = Net income Average/ total assets = 150,767 /1,180,660 = 12.77%

The company is making $12.77 on every $100 of asset

Return of equity =       Net income / Shareholder’s Equity = 150,767 / 436,496=34.54%

The company is making $34.54 on every $100 of equity.

Short-Term Liquidity Ratios

Current ratio = Current assets / Current liabilities=893868/571697 = 1.56

The company has $1.56 of cash or cash equivalent for every $1 of current liability, so it has enough money to cover in short term.

Long-Term Solvency Ratios

Debt to assets = Total liabilities /Total assets = =744164/1180660 =0 .63

This shows for every $0.63 of debt (including current and long term) the company has $1 of asset

Debt to equity = Total liabilities /Total shareholders’ equity = 744164/436496=1.7

This shows the company has way too much liability than equity. For every $1.7 of liability the company has only $1 of equity.

Conclusion- The Company is leveraged although it has enough asset to cover it’s short term current liabilities. But due to high debt the company’s profit is low. The company is a profit making company and makes money, but if interest rate raises or sales drop in that case it might find it difficult to pay back its long term liabilities.

 

Limitation of the data – The limitation is mainly regarding trend analysis. We have balance sheet and income statement of only one year / quarter. So we do not really know if the company is doing better or worse from previous year / quarter. And due to lack of data we do not know if it is doing better than its peer company or doing worse, we cannot do any comparison.

 

 

 

 

 

 

 

 

References

Retrieved on 3/20/2018. Retrieved from https://www.investopedia.com/terms/r/returnonequity.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/terms/g/gross_profit_margin.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/university/ratios/debt/ratio2.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/terms/r/retainedearnings.asp

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