Introduction

The Exceptional Service Grading Company (ESGC) provides grading, certification, and encapsulation for collectors’ comic books to protect their investments. Due to the high record trends in the industry, the company is having a great success. The success pushes ESGC to expand to assessing other publication formats, such as magazines and movie posters. However, the company should look at its financial ratios and evaluates whether the company has financial strength to do the expansion projects.

This article will look into ESGC’s financial statements through 2017 to 2018 and evaluate the financial ratios. Then the paper will provide recommendation for ESGC based on the insights. The balance sheet and the income statements of ESGC can be downloaded from this link.

Approach and Answers to the Problem

Financial ratios are effective tools to measure a firm’s financial performance because of a common basis for evaluation provided by the analysis (Dauderis et al., 2021). The approach will start by defining the ratio that will be observed, explaining the importance and the limitation of the ratios, calculating it and comparing it with industry benchmark, before extracting insight from the result.

The Exceptional Service Grading Company Financial Ratios

Gross Profit Margin

The gross profit margin usually provided as the percentage of sales after deducting cost of goods sold, that is left to cover operating expenses, creditor interest, and income taxes (Dauderis et al., 2021). It is calculated gross profit margin divided by revenues.

  20182017
Service Contract Revenues= a$ 9,200,000$ 6,595,400
Service Contract Costs= b$ 6,503,100$ 4,957,800
Gross Profit Margin= a-b$ 2,696,900$ 1,637,600
Gross Profit Margin Percentage= (a-b)/a29.31%24.83%
Gross profit margin for The Exceptional Service Grading Company

The percentage increases from 24.83% at the end of 2017 to 29.31% at the end of 2018. It can indicate that the company has improved in its service operation efficiency. However, the benchmark of gross margin ratio for service company is 49.1% to 50.1% in 2017 and 2018 (Services: Industry Financial Ratios Benchmarking, n.d.). The value for ESGC is far lower than the benchmark. The company should consider rising the service price or improving the service costs efficiency.

Current Ratio

Current ratio indicates how many current asset are available to pay current liabilities at a time (Dauderis et al., 2021), calculated by dividing current assets by current liabilities.

  20182017
Current Assets= a$ 5,652,200$ 4,576,900
Current Liabilities= b$ 3,325,950$ 3,292,850
Current Ratio= a/b1.70 : 11.39 : 1
Current ratio for The Exceptional Service Grading Company

The calculation above shows that at the end of 2018, $1.70 of current assets exist to pay each $1 of current liabilities, better than $1.39 : $1 in 2017. The current ratio benchmark for service company is 1.22 in 2018 (Services: Industry Financial Ratios Benchmarking, n.d.), thus, ESGC already has higher current ratio than industry average. The increasing current ratio can be a good sign of the company’s financial strength to pay its liabilities.

Debt Ratio

The debt ratio is the percentage of total assets financed by debt, calculated by dividing total liabilities by total assets (Dauderis et al., 2021). The debt ratio benchmark for service company is 67% in 2018 (Services: Industry Financial Ratios Benchmarking, n.d.)

  20182017
Total Liabilities= a$ 4,170,300$ 4,067,900
Total Assets= b$ 7,007,800$ 5,875,400
Debt Ratio= a/b0.595 : 1 or 59.5%0.692 : 1 or 69.2%
Debt ratio of The Exceptional Service Grading Company

The debt ratio for ESGC has improved compared to industry benchmark, from 69.2% in 2017 to 59.5% in 2018. This is also due to no dividend paid in 2018.

Net Profit Ratio

The net profit ratio is a broad measure of profitability (Garrison et al., 2018). ESGC has a relatively low gross profit margin percentage, and so, it is important to calculate another ratio that will better explain the company’s profitability.

  20182017
Net Income= a$ 1,330,000$    454,500
Total Revenues= b$ 9,200,000$ 6,595,400
Net Profit Ratio= a/b6.89%14.46%
Net profit ratio of The Exceptional Service Grading Company

The net income ratio benchmark for service company is 1.4% to 2.9% in 2017 and 2018 (Services: Industry Financial Ratios Benchmarking, n.d.). Even though ESGC has relatively low gross margin percentage, it still has higher Net Profit Ratio. It shows that ESGC still has good profitability.

Debt-to-Equity Ratio

ESGC has an average debt ratio compared to industry benchmark. Since principal and interest payments are part of debt financing, the higher the financing from debt, the greater the risk (Dauderis et al., 2021). To better evaluate the company’s ability to finance new projects, the company should evaluate its leverage, by evaluating debt-to-equity ratio.

  20182017
Total Liabilities= a$ 4,170,300$ 4,067,900
Stockholders’ Equity= b$ 3,137,500$ 1,807,500
Debt-to-Equity Ratio= a/b1.33 : 12.52 : 1
Debt-to-Equity ratio of The Exceptional Service Grading Company

The debt-to-equity ratio benchmark for service company is 0.49 to 0.52 in 2017 and 2018 (Services: Industry Financial Ratios Benchmarking, n.d.). ESGC has improved its debt-to-equity ratio, but it’s still far higher than industry benchmark. Although an improving debt-to-equity ratio indicates that a company is improving its financial leverage (Garrison et al., 2018), the company still needs to lower the risk by decreasing the financing from debts.

Analysis: The Exceptional Service Grading Company Case Study Answers

The viability for new projects should be evaluated on whether the company use financing from debt or equity. The company has high debt to equity ratio, 1.33 in 2018, which means that the company uses more debt than equity to fund its asset. Creditors would prefer less debt and more equity, since equity provide buffers as protection. If the company use more equity to fund the new projects, than it is more viable for the company to move forward for the new projects.

All ratios evaluated above showed that the company has improved its financial position through 2017 to 2018. The company has more profitability and more leverage. The company also did not pay any dividend in 2018, which means it has more equity and more cash. All of those are some reasons of how the company’s asset increasing through the year.

The ratios above also have limitations. Financial ratios should not be treated as the ending analysis, but rather as a starting point (Garrison et al., 2018). The ratios would raise questions and opportunities for further analysis. For instance, comparing data with industry benchmark should also be analyzed whether the comparation is

The follow up questions for the company would be how it would fund the new projects, and how is the viability of the new projects from other factors, such as employees readiness, industry and customer perspective, and technology availability.

Conclusion and Recommendation

The first recommendation of the paper is for ESGC to answer the follow up questions. In addition to the ratios, ESGC should consider various internal factors, like employee learning and growth, customer satisfaction, or business process performance, as well as external aspects, such as industry trends, technological changes, changes in customers behavior, and changes in broad economic indicators (Garrison et al., 2018). While ESGC has a significant financial improvement, the company has relatively high debt-to-equity ratio. The second recommendation is to fund the next project using the stockholder’s equity to lower the risk and strengthen credit point of the company.

References

Dauderis, H., Annand, D., & Jensen, T. (2021). Introduction to Financial Accounting. Lyryx Learning Inc. Licensed under Creative Commons BY-NC-SA 3.0. 

Garrison, R., Noreen, E., & Brewer, P. (2018). Managerial Accounting (16th ed.). McGraw-Hill Education.

Services: industry financial ratios benchmarking. (n.d.). Ready Ratios. Retrieved June 21, 2022, from https://www.readyratios.com/sec/industry/I/

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