598
Making Key Strategic Decisions
She also finds that ACME’s customers are retail distributors of its prod-
ucts and the company does not have any significant customer concentration.
Generally, relationships with customers have been long term.
The company currently has numerous products in the adhesives and
sealants area. ACME has several trademarks and several products that are well
recognized as well as ACME’s name. Victoria determines through her research
that the risk of product obsolescence or replacements by new products is a
minimal risk to ACME.
ACME has conducted research and development activities and the costs
range from $250,000 to $500,000 per year over the past five years. Manage-
ment does not expect any significant product developments in the near future.
Victoria’s financial analysis examines the dividend paying capacity of
ACME. Because the company is closely held, special analysis of the compensa-
tion paid to family members and perquisites is necessary. Victoria determines
that officers’ compensation, shareholder distributions, and perquisites over the
past five years have been as follows:
Officers’ Compensation, Perquisites,
and Shareholder Distributions
Year $ Million
2000 $7.7
1999 5.5
1998 8.2
1997 6.3
1996 6.5
Closely held businesses are frequently operated to minimize taxable in-
come. Publicly held companies, in contrast, are operated to maximize earnings
for the benefit of the shareholders and public markets. A financial analysis of a
closely held company should make adjustments so that revenues and expenses
are “normalized.” In this particular case, Victoria determines the amount of

ness operations. If a company has had high growth in recent years, that may in-
dicate significant growth potential in the future. If past earnings have been
volatile, this is an indication of increased financial risk for a buyer of the busi-
ness. While an analysis of the financial statements is important, the process
does not stop with looking at the company’s past performance. The ultimate
goal of the quantitative analysis is estimating the future profitability of the
business since that is what a prospective buyer is looking to receive. Future
earnings may or may not be similar to the past.
Balance Sheet Analysis
Victoria prepares Exhibit 18.1 that presents ACME’s historic balance sheets in
condensed form for the most recent five years. She finds that total assets grew
an average of 15% per year over the five years and a similar amount in the most
recent year. The current assets consist primarily of accounts receivable and in-
ventory. Fixed assets primarily consist of land, buildings, and improvements,
machinery and equipment, factory construction in progress, and transportation
equipment. As of the most recent year’s end, ACME’s depreciable fixed assets
were depreciated to 69% of their original costs.
The most recent year reflects unamortized intangible assets, consisting
primarily of goodwill (that had been recorded in accordance with generally
accepted accounting principles) in connection with ACME’s acquisition of a
manufacturing facility.
Current liabilities consist of accounts payable and the amounts due within
the next 12 months on promissory notes and obligations under capital leases.
ACME is moderately leveraged. During the past five years, ACME’s in-
terest bearing debt (both current and noncurrent portions) increased from $6.6
600
EXHIBIT 18.1 ACME Manufacturing Inc.: Summa
ry of condensed balance sheets 1996 –2000.
($million)
Growth R

17.33 13.67 16.56 9.19 9.90
15.0
26.8%
Equity
11.39 11.25 8.42 9.01 6.69
14.2
1.3
Total liabilities and equity
$28.72 $24.92 $24.98 $18.20 $16.58
14.7%
15.3%
Common Size
2000 1999 1998 1997 1996
Assets
Current assets
40.7% 46.4% 49.5% 51.8% 55.3%
Fixed assets, net
48.3 41.6 37.5 42.0 41.0
Other assets
11.0 12.0 13.0 6.1 3.7
Total assets
100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities and Equity
Current liabilities
40.1% 25.7% 35.1% 23.9% 29.8%
Long-term liabilities
20.3 29.1 31.2 26.6 29.9
Total liabilities
60.3 54.9 66.3 50.5 59.7
Equity

decreased from 1.9 to 1.0 during the five-year period. Working capital also de-
creased from $4.2 million to $190,000 during the same five-year period. These
indicate the company has a greater risk in being able to pay its bills.
The activity ratios indicate how effectively a company is utilizing its as-
sets. The average number of days in ACME’s accounts receivable was similar
over the past five years at approximately 50 days. However, the average num-
ber of days inventory remained at the plant before being sold decreased from
58 days to 47 days. The average number of days of accounts payable was simi-
lar during the five-year period at 48 days.
The coverage ratios indicate a company’s ability to pay debt service. The
number of times interest was earned, as measured by earnings before interest
and taxes (EBIT) divided by interest expense, decreased from 8 to 7 times.
The leverage ratios generally indicate a company’s vulnerability to busi-
ness downturns. Highly leverage firms are more vulnerable to business down-
turns than those with lower debt-to-worth positions. ACME’s debt to tangible
worth increased in the past five years from 1.5 to 1.8. Fixed assets to tangible
worth increased from 1.0 to 1.5.
602
EXHIBIT 18.2 ACME Manufacturing Inc.: Summa
ry of condensed income statements 1996 –2000.
($million)
Growth R
ates
2000 1999 1998 1997 1996
1996–2000 1999–2000
Revenues
$50.29 $48.59 $40.85 $37.94 $33.02
11.1%
3.5%
Cost of goods sold

17.1
Interest expense
0.84 0.74 0.55 0.47 0.59
9.0
12.6
Pretax income
5.29 5.49 4.06 5.60 4.31
5.3
−3.6
Less: Income taxes*
—
— — — —
N/A
N/A
Net income
$ 5.29 $ 5.49 $ 4.06 $ 5.60 $ 4.31
5.3%
−3.6%
Common Size
2000 1999 1998 1997 1996
Revenues
100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold
69.2 69.9 69.6 66.6 68.5
Gross profit
30.8 30.1 30.3 33.4 31.5
Operating expenses
11.8 11.5 10.6 9.8 10.0
Officers’ compensation
6.7 5.9 8.6 8.0 6.8