Ace Company is seeking a $3 million loan with a 10-year term. They will use this financing to buy manufacturing equipment and create supporting software. Management must assess Ace Company’s Account Receivable Collections, average inventory turnover rate in comparison to the industry average, and short-term and long-term creditworthiness to determine loan approval.
Accounts Receivable Collections
The accounts receivable account on Ace Company’s Balance Sheet has shown consistent growth over time. In 2016, the accounts receivable turnover was 4.68, and in 2017, it increased to 5.06. Accounts Receivable is the result of providers offering goods and services on credit, enabling customers to delay payment until a later time (Murphy, 2023). Based on the firm statistics, all consumer sales are made on credit. This method might be risky when customers are unable to settle the debt completely. Cash and accounts receivable are components of working capital that affect the speed at which cash and accounts receivable are managed (Murphy, 2023). In 2016, the company collected its accounts receivable an average of 4.68 times per year, increasing to an average of 5.06 times per year in 2017. Consumers are paying off their debts more often while the amount they owe continues to rise. The corporation is improving its debt collection rate, leading to an annual increase in cash flow.
Inventory Turnover Rate
Inventory turnover rate (ITR) is a ratio that measures how many times the inventory was utilized in relation to the budgeted money in the preparations. Thus, it demonstrates the speed at which a corporation is able to sell its goods after acquiring it. A higher figure indicates a greater rate of inventory turnover for the firm. The surplus of merchandise being acquired might have a significant impact on this if the firm gets a discount for buying a larger quantity of merchandise. When a corporation overbuys, the ratio will be lower compared to not overbuying. The industry average turnover ratio is 10. Ace Company had an average turnover of 1.94 in 2016 and 1.82 in 2017. This does not indicate cash flow but rather the efficiency of inventory management.
Short-Term and Long-Term Creditworthiness
To assess a company’s creditworthiness, management must analyze the company’s credit score, outstanding debt, and capacity to repay the loans (Dhir, 2019). Various financial measures may help assess a company’s capacity to pay its debts, with the total debt-to-equity ratio being a key indicator. A lower ratio indicates a stronger capacity to repay. Ace Company had a debt-to-equity ratio of 3.78 in 2016 and 2.49 in 2017. As the ratio decreases, they are settling their existing debt. Their debt is diminishing annually. Next, we will assess the interest earned ratio. This ratio indicates the capacity to repay the loan using their present income. Ace Company’s interest earned ratio was 8 in 2016 and 10.2 in 2017. This indicates that Ace Companies can cover a larger portion of their interest obligations. As the ratio rises, their capacity to cover the interest payments grows (Dhir, 2019). The last ratio to assess is the present ratio. The current ratio assesses a company’s capacity to transform its current assets into cash in order to settle its short-term obligations. Ace Company had a current ratio of 1.53 in 2016 and 1.79 in 2017. The growing ratio indicates that the company’s current assets have grown while its current liabilities have stayed constant. This enhances Ace Company’s capacity to settle their immediate debts.
Recommendation
The analysis of Ace Company’s financial statements and financial ratios supports the approval of the $3 million 10-year loan request. Their improved capacity to settle existing debts demonstrates their capability to handle any new commitments assumed by Ace Company. Ace Company’s gross profit percentage rose from 47.2% in 2016 to 50% in 2017. They have expanded their firm by boosting their earnings and reducing their existing liabilities. The inventory turnover rate may still be a cause for worry.
Nevertheless, it is important to note that this reduced pricing may be attributed to buying products in large quantities to benefit from a volume discount. Ace Company is well deserving of the loan extension. They have good credit, and their income is always growing. By sanctioning the loan, Ace Company will enhance its capacity to increase income.
References
Dhir, R. (2019). Creditworthiness. Investopedia. https://www.investopedia.com/terms/c/credit-worthiness.asp
Murphy, C. (2023, May 24). Receivables Turnover Ratio Defined: Formula, Importance, Examples, Limitations. Investopedia. https://www.investopedia.com/terms/r/receivableturnoverratio.asp
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