Over the last two weeks we have looked at Acme’s cash flow and short-term liquidity, and the results are not good. Even though Acme has shown an excellent profit on sales over the last two years in the midst of a 17% drop in sales during the recession, it is in serious short-term danger.
The good news is that Acme has no long-term debt to worry about. A measure of a company’s long-term solvency is the long-term debt/long-term debt plus equity ratio. In this case it is zero. The stockholders equity in this company is $38 million so Acme can look for some long-term debt structure to help ease the short-term liquidity it has gotten itself into. Taking out a mortgage on its buildings and land currently valued at $21 million would ease the short-term problems.
For their $38 million investment, the stockholders are getting a dividend of 5.3% in 2008.
The biggest problem with Acme, like many manufacturing concerns, is inventory control. During the downturn in orders, Acme kept the shop busy making parts for inventory instead of laying off employees. If the company was saddled with debt, this could have been a fatal decision since they wouldn’t likely have access to additional capital. The company must also address the situation with its vendors because vendor delivery is most likely already a problem.
This exercise over the last few weeks has shown us why as managers we must look beyond the monthly Income Statement if we want to really understand what is happening in our company. Just because we show profit, that doesn’t necessarily mean all is well.