Harrods sporting goods case study

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Harrod’s Sporting Goods

In January of 2016, Becky, who served as the company’s chief financial officer, walked into Jim’s office and said, “I’ve

had it with the First National Bank of Omaha. It is willing to renew our loan and line of credit, but the bank wants to

charge us 2½ percentage points over prime.” The prime rate is the rate at which banks make loans to their most

creditworthy customers. It was 4.75 percent at the time Becky had visited the bank, so that the total rate on the loan

would be 7.25 percent. It was not so much the total rate that Becky objected to, as the fact that Harrod’s was being

asked to pay 2½ percent over prime. She felt that Harrod’s was a strong enough company that one percent over prime

should be all that the bank required. Her banker told her he would review the firm’s financial statements with her next

week and reconsider the premium Harrod’s was being asked to pay over prime.

While Becky knew the bank “crunched all the numbers,” she decided to do some additional financial analysis on her

own. She had a bachelor’s degree in finance with a 3.3 GPA. She began by examining Figures 1, 2, and 3 below.

Figure 1

Harrod’s Sporting Goods

Income Statement

(2013-2015)

2013 2014 2015

Sales

.............................................................

$4,269,871 $4,483,360 $5,021,643

Cost of goods

sold

.............................................................

2,991,821 2,981,434 3,242,120

Gross

Profit

.............................................................

$1,278,050 $1,501,926 $1,779,523

Selling and administrative

expense

.............................................................

865,450 1,004,846 1,175,100

Operating

profit

.............................................................

$412,600 $497,080 $604,423

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Interest

expense

.............................................................

115,300 122,680 126,241

Extraordinary

loss

.............................................................

__ __ 170,000

Net income before

taxes

.............................................................

297,300 374,400 308,182

Taxes

.............................................................

104,100 131,300 107,864

Net

income

.............................................................

$ 193,200 $ 243,100 $ 200,318

Figure 2

Harrod’s Sporting Goods

Balance Sheet

(2013-2015)

2013 2014 2015

Cash

...............................................................

$ 121,328 $ 125,789 $ 99,670

Marketable

securities

...............................................................

56,142 66,231 144,090

Accounts

receivable

...............................................................

341,525 216,240 398,200

Inventory

...............................................................

972,456 1,250,110 1,057,008

Total current

assets

...............................................................

$1,491,451 $1,658,370 $1,698,968

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Net plant and

equipment

...............................................................

1,678,749 1,702,280 1,811,142

Total

assets

...............................................................

$3,170,200 $3,360,650 $3,510,110

Liabilities and Stockholders’ Equity

Accounts

payable

...............................................................

$ 539,788 $ 576,910 $ 601,000

Notes

payable

...............................................................

160,540 180,090 203,070

Total current

liabilities

...............................................................

$700,328 $757,000 $804,070

Long-term

liabilities

...............................................................

1,265,272 1,292,995 1,372,240

Total

liabilities

...............................................................

$1,965,600 $2,049,995 $2,176,310

Common

stock

...............................................................

367,400 368,000 368,000

Retained

earnings1

...............................................................

837,200 942,665 965,800

Total Stockholders’

equity

...............................................................

1,204,600 1,310,655 1,333,800

Total liabilities and stockholders’

equity

...............................................................

$3,170,200 $3,360,650 $3,510,110

1 Withdrawal of funds in the form of dividends or other means makes the increase in retained earnings less than net income.

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Figure 3

Harrod’s Sporting Goods

Selected Industry Ratios for 2015

1. Net income/Sales 4.51%

2a. Net income/Total Assets 5.10%

2b. Sales/Total Assets 1.33 x

3a. Net income/Stockholder’s Equity 9.80%

3b. Debt/Total Assets 0.48

4. Sales/Receivables 5.75 x

5. Sales/Inventory 3.01 x

6. Sales/Fixed Assets 3.20 x

+

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Required Activities:

1. Calculate the profitability ratios for all three years using the formulas provided in section “A. Profitability Ratios”

within Chapter 3:

1. Profit margin

2. Return on assets (a and b)

3. Return on equity ( a and b)

2. Write a one-paragraph description of any trends that appear to have taken place over the three-year time

period.

3. Examine the income statement in Figure 1 above. Note that there was an extraordinary loss of $170,000 in

2015. This might have represented uninsured losses from a fire, a lawsuit settlement, etc. It probably does not

represent a recurring event or affect the earnings capability of the firm. For that reason, the astute financial

analyst might add back in the extraordinary loss to gauge the true operating earnings of the firm. Since it was a

tax-deductible item, we must first multiply by (1-tax rate) before adding it back in.* The tax rate was 35 percent

for the year.

$170,000 Extraordinary loss

_____.65_ (1-tax rate)

$110,500 After-tax addition to profits from eliminating the extraordinary loss

from net income

The more representative net income number for 2015 would now be:

Initially reported (Figure 1 above) $200,318

Adjustment for extraordinary loss being eliminated +110,500_

Adjusted net income $310,818

Note: This adjustment was made because the $170,000 deduction saved 35 percent of this amount in taxes. If we eliminate the $170,000, the tax benefit would also be eliminated. Thus, the firm would only benefit by 65 percent of $170,000, based on a 35 percent tax rate. The after-tax benefit of the tax adjustment for the extraordinary loss is $110,500.

A. Recompute the same ratios for 2015 using the adjusted net income figure of $310,818.

4. Write a one-paragraph description of trends that appear to have taken place over the three-year time period

(Refer to question 1 above for 2013 and 2014 data and question 3 above for the adjusted net income numbers

for 2015).

5. Write a one-paragraph analysis of the company’s profitability ratios compared to the industry ratios (Figure 3

above) using the revised ratios for 2015 from question 3 above. Include asset turnover and debt to total assets

as supplemental material in your analysis.

6. Calculate the Asset Utilization ratios for 2015 using the formulas provided in section “B. Asset Utilization Ratios”

within Chapter 3:

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1. Receivable turnover (Note: For the Receivables turnover ratio, only half the sales are on credit

terms.)

2. Inventory turnover

3. Fixed Asset turnover

7. Write a brief one-paragraph description of any trends that appear to have taken place. Compare Harrod’s sales

to total assets ratio to the industry in your description.

8. Write a one-paragraph conclusion that provides analysis of your answers to questions 4 and 5 above.

a. Include your opinion on whether or not Becky Harrod has a legitimate complaint about being charged

2½ percent, instead of 1 percent over prime.