Avery Products Case Study

Avery Products

(Financial Analysis)

Robert Eng, vice president and loan officer of the First National Bank of Cincinnati, was recently alerted to the deteriorating financial position of one of his clients, Avery Products, Inc., by his bank's newly instituted computer loan analysis program. The bank requires quarterly financial statements balance sheets and income statements from each of its major loan customers. This information is punched on cards and fed into the computer, which then calculates the key ratios for each customer, charts trends in these ratios, and compares the statistics of each company with the average ratios and trends of other firms in the same industry. If any ratio of any company is significantly poorer than the industry average, the computer output makes note of this fact. If the terms of a loan require that certain ratios be maintained at specified minimum levels, and these minimums are not being met by a company, the computer output notes the deficiency.

When an analysis had been run on Avery Products three months earlier, Eng had noticed that some of the company's ratios were showing downward trends, dipping below the averages for the jewelry manufacturing industry. Eng had sent a copy of the computer output, together with a note voicing his concern, to John Avery, president of Avery Products. Although Avery had acknowledged receipt of the material, he had taken no action to correct the situation.

The first financial analysis indicated that some problems were developing, but no ratio was below the level specified in the loan agreement between the bank and Avery Products. However, the second analysis, which was based on the data given in Tables 1, 2, and 3, showed that the current ratio was below the 2.0 times specified in the loan agreement. According to the loan agreement, the Cincinnati Bank could legally call upon the company for immediate payment of the entire bank loan, and if payment was not forthcoming within 10 days, the bank could force Avery Products into bankruptcy. Eng had no intention of actually enforcing the contract to the full extent that he could legally, but he did intend to use the loan agreement provision to prompt Avery Products to take some decisive action to improve its financial picture.

Avery Products is a company that manufactures a complete line of costume jewelry products. In addition to its regular merchandise, Avery creates special holiday items for the Christmas season. Seasonal working capital needs have been financed primarily by loans from the Cincinnati Bank, and the current line of credit permits the company to borrow up to $300,000. In accordance with standard banking practices, however, the loan agreement requires that the bank loan be repaid in full at some time during the year, in this case by February 1999.

TABLE 1

AVERY PRODUCTS, INC.

BALANCE SHEET

YEAR ENDED DECEMBER 31

1988 1994 1995 1996

Cash $ 41,000 $ 61,000 $ 28,600 $ 20,400

Accounts receivable 163,000 245,000 277,400 388,000

Inventory 204,000 306,000 510,000 826,200

Total current assets $408,000 $612,000 $ 816,000 $1,234,600

Land and building 61,000 49,000 130,600 122,400

Machinery 81,600 151,000 118,300 102,000

Other fixed assets 49,000 28,600 8,200 6,100

Total assets $599,600 $840,600 $1,073,100 $1,465,100

Notes payable, bank 102,000 286,000

Accounts and notes payable 90,000 98,000 155,000 306,000

Accruals 40,800 49,000 57,000 77,500

Total current liabilities $130,800 $147,000 $ 314,000 $ 669,500

Mortgage 61,000 45,000 40,800 36,700

Common