Sparklin Automotive Company spark plug manufacturing and market strategy 1930

SAC

This memo will discuss the financial condition of Sparklin Automotive Company (SAC) for the years 2005-2006. Sparklin produces spark plugs for the original equipment market (OEM) for automotive manufacturers, as well as for the automotive aftermarket. The company has recently introduced a new spark plug that offers superior performance. The content of this memo will include both a ratio analysis and other forms of financial analysis. At the conclusion of this memo will be recommendations for the company to improve its financial performance. These recommendations will be based on the financial analysis contained in the memo.

Financial analysis involves analyzing a company's financial statements to determine the health of the company. There are a number of different types of analysis, including ratio analysis and trend analysis. The former involves calculating financial ratios in order to better understand the firm's financial performance. Ratio analysis tends to use the same sets of ratios for each company in order to allow for better comparison between companies, but also within the same company over time. There are a number of different types of ratios that are calculated, each relating to a different component of financial performance. These include liquidity ratios, profitability ratios, debt ratios, operating performance ratios and investment valuation ratios (Loth, 2011).

Part III.

The three main liquidity ratios are the current ratio, the quick ratio and the cash ratio. The current ratio is the current assets / current liabilities. The quick ratio is (current assets -- inventories) / current liabilities and the cash ratio is cash / current liabilities. The current ratio for SAC is 1.40, compared with 1.47 in 2005. The quick ratio in 2006 is 0.64 and in 2005 it was 0.95. The cash ratio in 2006 is 0.45, compared with 0.78 in 2005.

The three main profitability ratios are the gross margin, the operating margin and the net margin. The gross margin is calculated as the gross income / revenue. The operating margin is calculated as the operating income / revenue. The net margin is calculated as the net income / revenue. The gross margin for 2006 was 40.7%, compared to 49% in 2005. The operating margin was 37.9%, compared to 44.2%. The net margin in 2006 was 17.6%, compared to 20.4%.

The debt ratios to be studied are the debt ratio and the debt-to-equity ratio. The debt ratio is the debt / assets. The debt/equity ratio is self-evident. The debt ratio for 2006 is 30.6%, compared to 31% in 2005. The debt-to-equity ratio in 2006 was 44%, compared to 44.9% in 2005.

The three main operating performance indicators are the accounts receivable turnover, the inventory turnover and the asset turnover. The accounts receivable turnover is calculated as the net income / accounts receivable. Inventory turnover is calculated as the cost of goods sold / inventory. Asset turnover is calculated as the net income / total assets. The A/R turnover for SAC in 2006 was 3.2 times, compared with 3.7 times in 2005. Inventory turnover was 2.7 times in 2006, compared with 3.1 times in 2005. Total asset turnover was 0.18 times in 2006, compared with 0.2 times in 2005.

Part IV.

While there has only been a slight deterioration in the current ratio in 2006, the quick and cash ratios have declined sharply. This is the result of a dramatic increase in inventories, which has come at the expense of cash. This could potentially indicate that the company has seen its sales slow, affecting the cash conversion cycle and leaving more of its assets in inventories. That sales increased at a slower rate than the cost of goods sold would seem to support this contention.

The profitability ratios indicate that the company's financial performance has deteriorated in the past year. Each ratio decline significantly. The biggest decline was in the gross margin, which in part can be attributed to the buildup in inventory that the company experienced. The company actually cut its other expense categories. There was a substantial decline of 63% in selling expenses, which may be related to the buildup in inventory.

The debt and debt-to-equity ratios remained little changed. The company added a small amount of debt, while its equity remained at the same level. The overall size of the company was virtually unchanged in 2006. Put together, the company saw a slight shift upwards in indebtedness, but not much. The current capital structure is reasonable and adequate, and its stability is indicative of a healthy company.

The operating performance ratios also indicate a decline in the performance of SAC in 2006. Each ratio was weaker in 2006 than it was in 2005. There was a significant decline in the inventory turnover ratio, which is related to the higher rate of inventory at the end of the year. Accounts receivable turnover was also lower, which reflects the combination of lower net income and higher accounts receivable. This is not related to the inventory problem but reflects the inability of the company to collect from customers. Combined, the inventory and A/R turnover issues point to a year in which demand slumped, causing inventory to go unsold and more customers to stretch their payment cycle with SAC.

When the ratios are taken together, the performance of SAC declined in almost all categories in 2006. The company is healthy in general, and remains profitable, but it saw inventories spike. There were other signs of pending distress, including the fact that cost of goods sold grew at a faster rate than revenues. This could be related to the inventory buildup but may also reflect an operating environment where the firm's purchasing pricing power is declining, and it is unable to pass those costs onto the customers. It may have tried to pass the costs along, resulting in the reduced inventory turnover.

Part V. A trend analysis is another way of analyzing financial statements. The ratios already tell a strong story about the firm's past year, but the trend analysis can help to fill in some of the information gaps. For example, it is evident that the company is faced with rapidly rising cost of goods sold, and this is affecting profitability. The company was able to maintain its net margin at a relatively healthy level because it cut its costs significantly. However, the cuts to the sales force may have contributed to the increased unsold inventory. Although the company is healthy, the fact that there was no change in the firm's equity is cause for concern, especially as it was forced to increase (slightly) its long-term borrowing.

Part VI. There are a number of recommendations that I would make to SAC. The first recommendation is that the company should hire back some of its sales force. There is a buildup of inventory that is a drag on the firm's financial performance, and this may be related to the decline in sales expense. The reduction appears not to be paying for itself, so should be reversed.