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Mergers and acquisitions: a retail business case-study
MBA, UoPeople
BUS 5110 - Managerial Accounting
Dr. Seval Ozbalci
20/05/2023
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Mergers and acquisitions: a retail business case-study
A raw reading of a company’s financial statements allows a user to get as much information as
they can get for evaluating a company’s financial health. However, to compare multiple companies
for use cases such as mergers and acquisitions, supplier, or client evaluations, we need financial
ratios. Indeed, the ratios will summarize the financial information and give us comparable metrics
for decision-making. What are the important ratios and how are they used for decision-making?
Discussion
As a case study, we’ll be considering a company looking to acquire one of two retail businesses.
We have their income statements and balance sheets at our disposal. We’ll be calculating ratios to
compare their profitability, their short-term and long-term liquidity measures. We’ll define and
calculate all ratios then evaluate the big picture. First, we calculate the profit margin ratio, which
indicates how much of its revenue translates to profits, and the return on assets, which measures
income generated by the average assets invested (Heisinger & Hoyle, n.d).
Profit margin ratio = Net income / Net sales
For Fashion Forward: 136,500 / 2,500,000 = 5.46%
For Dream Designs: 212,500 / 5,400,000 = 3.94%
Industry average (2018) = 2.2% (Ready Ratios, 2023)
Return on assets = Net income / Average total assets
For Fashion Forward: 136,500 / ((2,747,000 + 2,805,000)/2) = 4.92%
For Dream Designs: 212,500 / ((4,381,250 + 4,450,000)/2) = 4.81%
Industry average (2018 ) = 3.2% (Ready Ratios, 2023)
Both companies are above industry average in both ratios, with Fashion Forward 1.5 points ahead
of Dream Designs in the profit margin ratio. Their similar return on assets shows that both
companies are good with generating revenue, with Fashion Forward being a little more efficient.
For short-term liquidity measures, we compute the current ratio, which measures the company’s
ability to cover its current liabilities with its current assets, and the quick ratio, which measures a
company’s ability to cover its current liabilities with its liquid assets (Heisinger & Hoyle, n.d).
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Current ratio = Current assets/ Current liabilities
For Fashion Forward: 1,170,000 / 1,297,000 = 1.11
For Dream Designs: 1,625,750 / 2,280,500 = 1.40
Industry average (2018) = 1.21 (Ready Ratios, 2023)
Quick ratio = (Cash + Marketable securities + Short -term receivables) / Current liabilities
For Fashion Forward: (950,000 + 200,000 + 35,000) / 1,170,000 = 1.01
For Dream Designs: (1,710, 000 + 250,000 + 120,500) / 1,625,750 = 1.28
Industry average (2018) = 0.44 (Ready Ratios, 2023)
Fashion Forward’s current ratio is below industry average, while Dream Designs’ is higher. Both
are greater than 1 which means both can pay their current liabilities without long-term leveraging.
This could indicate that Fashion Forward is slightly more leveraged than Dream Designs. This
distinction is similar in the quick ratio, but both companies are higher than the industry average –
more importantly, both companies have a quick ratio higher than 1 which is healthy.
We calculate the accounts receivables turnover ratio, which quantifies a company’s effectiveness
in collecting receivables (Murphy, 2023). This allows us to compute the average collection period,
which displays the number of days it takes to collect on credit sales (Heisinger & Hoyle, n.d).
Receivables turnover ratio = Credit sales / Average account s receivable
For Fashion Forward: 2,000,000 / ((200,000 + 150,000)/2) = 11.43
For Dream Designs: 4,320,000 / ((250,000 + 275,000)/2) = 16.46
Industry average (2018) = 40.55 (Ready Ratios, 2023)
Average collection period = 365 days / Receivables turnover ratio
For Fashion Forward: 365 / 11.43 = 31.94
For Dream Designs: 365 / 16.46 = 22.18
Industry average (2018) = 9 (Ready Ratios, 2023)
This time, both companies are way lower than the industry average in receivables turnover ratio,
which could indicate slow or inefficient collection processes and credit policies (Fernando, 2023a).
The average collection period is high, with Fashion Forward noticeably higher than its competitor.
This means Fashion Forward has trouble collecting payments (Kenton, 2023).
To evaluate a company’s efficient use of its inventory, we can calculate the inventory turnover
ratio (Fernando, 2023a). This ratio can be converted to the average sale period, indicating the time
it takes to sell the inventory (Heisinger & Hoyle, n.d).
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Inventory turnover ratio = Cost of goods sold / Average inventory
For Fashion Forward: 1,400,000 / ((112,000+105,000) / 2) = 12.90
For Dream Designs: 3,250,000 / ((200,000+215,000) / 2) = 15.66
Industry average (2018) = 52 (Ready Ratios, 2023)
Average sale period = 365 days / Inventory turnover ratio
For Fashion Forward: 365 / 12.9 = 28.29
For Dream Designs: 365 / 15.66 = 23.30
Industry average (2018) = 7 (Ready Ratios, 2023)
Both companies have a lower inventory turnover ratio and higher average sale period than the
industry averages, which could signal excess inventory or diminishing demand (Fernando, 2023a).
Given that we are in the retail business, it could be that both manufacturers have yet unsold winter
clothing at year’s end in December. Finally, we calculate the Debt-to-Equity ratio which is a long-
term solvency measure to evaluate a company’s financial leverage between shareholders’ equity
(Fernando, 2023b).
Debt-to-Equity ratio = Total liabilities / Total shareholders ’ equity
For Fashion Forward: 1,345,000 / 1,402,000 = 96%
For Dream Designs: 1,901,250 / 2,480,000 = 77%
Industry average (2018) = 92% (Ready Ratios, 2023)
Dream Designs’ lower than average Debt-to-equity ratio means that the company is relatively
safer, but also a potential sign the company is not taking advantage of debt to grow. To make our
decision, special care must be taken, as both companies’ stocks are not worth the same. Dream
Designs is worth 1,139,500$ in preferred stocks while Fashion Forward is only worth 650,000$.
In addition, both companies’ stock price have decreased between 2017 and 2018, which may be
a dangerous indication. Qualitative factors can be factored in as well, such as a risk analysis of
whether the companies’ brands are exposed to controversies or legal liabilities. In view of these
ratios and the income statement, we suggest acquiring Dream Designs. Not only does it have
higher revenue with a higher profit margin ratio than the industry average, its low Debt-to-Equity
ratio and higher current and quick ratios mean that it has the cash to cover its liabilities and will
be a net positive and robust addition to our portfolio.
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Conclusion
We’ve seen the application of the various ratios in a mergers and acquisition case study, while
comparing to the industry average. With the data we had, we recommended buying Dream Design,
as its Debt-to-Equity, current and quick ratios indicate a robust business both short and long term,
with a high profit margin ratio and high revenue indicating strong quantitative returns.
References
Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for managers. Accounting for Managers - Table
of Contents. https://2012books.lardbucket.org/books/accounting-for-managers/index.html
Murphy, C. B. (2023, January 13). Receivables turnover ratio defined: Formula, importance,
examples, limitations. Investopedia.
https://www.investopedia.com/terms/r/receivableturnoverratio.asp
Ready Ratios. (2023). Retail Trade: average industry financial ratios for U.S. listed companies.
Retail trade: Industry financial ratios benchmarking.
https://www.readyratios.com/sec/industry/G/
Fernando, J. (2023a, March 27). Inventory turnover ratio: What it is, how it works, and Formula.
Investopedia. https://www.investopedia.com/terms/i/inventoryturnover.asp
Fernando, J. (2023b, April 5). Debt-to-equity (D/E) ratio formula and how to interpret it.
Investopedia. https://www.investopedia.com/terms/d/debtequityratio.asp
Kenton, W. (2023b, April 21). Average collection period formula, how it works, example.
Investopedia. https://www.investopedia.com/terms/a/average_collection_period.asp
