Enron’s Demise- Were There Warning Signs?

Enron’s Demise- Were There Warning Signs?

• Evaluate Enron’s profit, leverage, and cash flow performance during the period 1998-2000.

Profitability

In the year 2000, the firm realized growth in revenue by 151.27%. This rate is similar to that of growth in income within the same period. However, the expenses have also grown at almost a similar rate, and this stands at 151.43%, with the net income only growing by 9.63%. A critical analysis of this shows that there are some flaws in the financial reporting by the firm. Enron has experienced diminished margins between 1998 and 2000, and this could be due to the decreased trading growth. For instance, putting into consideration the return on equity between 1998 and 2000, it is noted that this has declined from 9.33% to 8.54%. The case is the same for the return on asset ratio within the same period, which has declined from 2.68% to 1.49%. Besides, the net profit for the company has also reduced from 2.23% to 0.97% between 1998 and 2000.

Leverage.

The year 2000 experienced an increment in the short term and long-term debts. This implies that the company has been highly leveraged. The percentage increase in these debts stood at 165.68%. Besides, there has been an increase in debt to equity ratio from 1.45 in the year 1999 to 3.22 in the year 2000. The implication of this is that Enron is not strong in its solvency.

Cash flow performance

The trade receivable has shown a significant increment between the years 1999 and 2000. The account payables have also increased, and this is a positive indicator for the company. The implication of having increased account payables is that the company has been delaying making payments to its suppliers and this positively affects its operating cashflow

• Evaluate Enron’s long-run financial performance. Does the data reflect Enron’s transformation from a pipeline company to a trading company?

An analysis of the balance sheet and statement of cash flow by Enron shows that its assets and liabilities have been increasing. The increase in assets is one of the desirable conditions of any firm. However, the increase in liabilities is one of the aspects that any firm wants to avoid. Given this case whereby the assets and liabilities are both increasing, this serves as a serious warning sign to the demise of Enron. As a result of this kind of trend in its data shows that the firm has transformed from a traditional pipeline company to a trading company.

• What is your assessment of Enron’s earnings quality?

My assessment for the earnings quality of Enron is that the firm is weak, and this is based on the fact that the firm has been experiencing diminished margins between 1998 and 2000. The earning’s quality can also be based on its balance between the incomes and expenses, whereby it is evident that both increase at an almost similar rate. The quality of the earnings could have been desirable if there could be a declining expense with an increasing income.

• Evaluate Enron’s financial leverage at the end of 2000.

At the end of 2000, the firm recorded an increase in its long term and short-term debts. This increment was so as to make the firm a going concern despite the fact that it was on the verge of shutdown. Many firms are known to survive in debts, and this can either be short term or long-term debts. Apart from the long term and short-term debts by the firm, the other aspect that is relevant in the evaluation of financial leverage for the firm is the interest coverage ratio. There has also been a decline in the interest coverage ratio. The implication of this is that the firm has sufficient operating income to service the interest outstanding on long term debts.

• Enron’s stock price traded around $62.72 per share at the end of April 2001. Do you think Enron was worth that much?

At the end of April, the stock price for the company traded at approximately $62.72. This was too low for the firm, with this low price being set on the verge of bankruptcy. The reason as to why the firm had to lower the prices of its stocks is so as to make it attractive to invest in it.  This was one of the desperate moves by the firm to be able to raise funds to sustain it. I believe that the firm is worth more than that but had no option but to set low stock prices as a result of bankruptcy.