Integrative Case 2
- Track Software, Inc. |
Seven years ago,
after 15 years in public accounting, Stanley Booker, CPA, resigned
his position as manager of cost systems for Davis, Cohen, and
OAc€?cBrien Public Accountants and started Track Software, Inc. In the
2 years preceding his departure from Davis, Cohen, and OAc€?cBrien,
Stanley had spent nights and weekends developing a sophisticated
cost-accounting software program that became TrackAc€?cs initial
product offering. As the firm grew, Stanley planned to develop and
expand the software product offerings, all of which would be
related to streamlining the accounting processes of medium- to
large-sized manufacturers. |
Although Track
experienced losses during its first 2 years of operationAc€??2009 and
2010Ac€??its profit has increased steadily from 2011 to the present
XXXXXXXXXXThe firmAc€?cs profit history, including dividend payments and
contributions to retained earnings, is summarized in Table 1. |
Stanley started
the firm with a $100,000 investment: his savings of $50,000 as
equity and a $50,000 long-term loan from the bank. He had hoped to
maintain his initial 100 percent ownership in the corporation, but
after experiencing a $50,000 loss during the first year of
operation (2009), he sold 60 percent of the stock to a group of
investors to obtain needed funds. Since then, no other stock
transactions have taken place. Although he owns only 40 percent of
the firm, Stanley actively manages all aspects of its activities;
the other stockholders are not active in management of the firm.
The firmAc€?cs stock was valued at $4.50 per share in 2014 and at $5.28
per share in 2015. |
TABLE 1 |
Track Software, Inc., |
Profit, Dividends, and Retained Earnings,
2009Ac€?o2015 |
Net profits |
Dividends |
Contribution to |
after taxes |
paid |
retained earnings |
Year |
(1) |
(2) |
[ XXXXXXXXXX)] = (3) |
2009 |
($50,000) |
$0 |
($50,000) |
2010 |
(20,000) |
0 |
(20,000) |
2011 |
15,000 |
0 |
15,000 |
2012 |
35,000 |
0 |
35,000 |
2013 |
40,000 |
1,000 |
39,000 |
2014 |
43,000 |
3,000 |
40,000 |
2015 |
48,000 |
5,000 |
43,000 |
Stanley has just
prepared the firmAc€?cs 2015 income statement, balance sheet, and
statement of retained earnings, shown in Tables 2, 3, and 4, along
with the 2014 balance sheet. In addition, he has compiled the 2014
ratio values and industry average ratio values for 2015, which are
applicable to both 2014 and 2015 and are summarized in Table 5. He
is quite pleased to have achieved record earnings of $48,000 in
2015, but he is concerned about the firmAc€?cs cash flows.
Specifically, he is finding it more and more difficult to pay the
firmAc€?cs bills in a timely manner and generate cash flows to
investors, both creditors and owners. To gain insight into these
cash flow problems, Stanley is planning to determine the firmAc€?cs
2015 operating cash flow (OCF) and free cash flow (FCF). |
Stanley is
further frustrated by the firmAc€?cs inability to afford to hire a
software developer to complete development of a cost estimation
package that is believed to have Ac€A?blockbusterAc€?? sales potential.
Stanley began development of this package 2 years ago, but the
firmAc€?cs growing complexity has forced him to devote more of his time
to administrative duties, thereby halting the development of this
product. |
StanleyAc€?cs
reluctance to fill this position stems from his concern that the
added $80,000 per year in salary and benefits for the position
would certainly lower the firmAc€?cs earnings per share (EPS) over the
next couple of years. Although the projectAc€?cs success is in no way
guaranteed, Stanley believes that if the money were spent to hire
the software developer, the firmAc€?cs sales and earnings would
significantly rise once the 2- to 3-year development, production,
and marketing process was completed. |
With all these
concerns in mind, Stanley set out to review the various data to
develop strategies that would help ensure a bright future for Track
Software. Stanley believed that as part of this process, a thorough
ratio analysis of the firmAc€?cs 2015 results would provide important
additional insights. |
TABLE 2 |
Track Software, Inc., Income Statement ($000) |
for the Year Ended December 31, 2015 |
Sales revenue |
$1,550 |
Less: Cost of goods sold |
$1,030 |
Gross profits |
$520 |
Less: Operating expenses |
Selling expense |
$150 |
General and administrative expenses |
270 |
Depreciation expense |
11 |
Total operating expense |
431 |
Operating profits (EBIT) |
$89 |
Less: Interest expense |
29 |
Net profits before taxes |
$60 |
Less: Taxes (20%) |
12 |
Net profits after taxes |
$48 |
TABLE 3 |
Track Software, Inc., Balance Sheet ($000) |
  December 31   |
Assets |
2015 |
2014 |
Cash |
$12 |
$31 |
Marketable securities |
66 |
82 |
Accounts receivable |
152 |
104 |
Inventories |
191 |
145 |
Total current assets |
$421 |
$362 |
Gross fixed assets |
$195 |
$180 |
Less: Accumulated depreciation |
63 |
52 |
Net fixed assets |
$132 |
$128 |
Total assets |
$553 |
$490 |
Liabilities and stockholdersAc€?c equity |
Accounts payable |
$136 |
$126 |
Notes payable |
200 |
190 |
Accruals |
27 |
25 |
Total current liabilities |
$363 |
$341 |
Long-term debt |
$38 |
$40 |
Total liabilities |
$401 |
$381 |
Common stock (50,000 shares outstanding |
at $0.40 par value) |
$20 |
$20 |
Paid-in capital in excess of par |
30 |
30 |
Retained earnings |
102 |
59 |
Total stockholdersAc€?c equity |
$152 |
$109 |
Total liabilities and stockholdersAc€?c equity |
$553 |
$490 |
TABLE 4 |
Track Software, Inc., |
Statement of Retained Earnings ($000) |
for the Year Ended December 31, 2015 |
Retained earnings balance (January 1, 2015) |
$59 |
Plus: Net profits after taxes (for 2015) |
48 |
Less: Cash dividends on common stock (paid during
2015) |
5 |
Retained earnings balance (December 31, 2015) |
$102 |
TABLE 5 |
Industrial |
Actual |
Average |
Ratio |
2014 |
2015 |
Current ratio |
1.06 |
1.82 |
Quick ratio |
0.63 |
1.1 |
Inventory turnover |
10.4 |
12.45 |
Average collection period (days) |
29.6 |
20.2 |
Total asset turnover |
2.66 |
3.92 |
Debt ratio |
0.78 |
0.55 |
Times interest earned ratio |
3 |
5.6 |
Gross profit margin |
32.1% |
42.3% |
Operating profit margin |
5.5% |
12.4% |
Net profit margin |
3.0% |
4.0% |
Return on total assets (ROA) |
8.0% |
15.6% |
Return on common equity (ROE) |
36.4% |
34.7% |
Price/earnings (P/E) ratio |
5.2 |
7.1 |
Market/book (M/B) ratio |
2.1 |
2.2 |
TO DO |
a.  (1) On what
financial goal does Stanley seem to be focusing? |
Is it the correct goal? Why or
why not? |
(2) Could a potential agency
problem exist in this firm? |
Explain. |
b. Calculate the firmAc€?cs
earnings per share (EPS) for each year, |
recognizing that the number of
shares of common stock outstanding |
has remained unchanged since
the firmAc€?cs inception. |
Comment on the EPS performance
in view of your response in part a. |
c. Use the financial data
presented to determine TrackAc€?cs operating cash flow (OCF) |
and free cash flow (FCF) in
2015. |
Evaluate your findings in
light of TrackAc€?cs current cash flow difficulties. |