Competition Bikes Analysis - Case Study Example

COMPETITION BIKES SUMMARY REPORT Table of Contents Table of Contents 2 Task A 3 Task A.2. 8 Task A.3. 10 Task A.4. 12 References 14 Task A Competition Bikes, Inc. is engaged in the business of manufacturing bicycles which are meant for professionals who use them for racing purposes. The company was established in the year 2001 and has been successfully running its business since then. It is headquartered at San Diego, California, United States. Larry Ferguson is the CEO of the company and holds 40% of the shares with himself. The financial statements of the company are available for the past three years of its operations, which is for the years 2006, 2007 and 2008. There are various techniques which can be utilized to evaluate the information present in the financial statements of a company. Some of the commonly used techniques are horizontal analysis, vertical analysis, trend analysis and ratio analysis. All these analyses have been performed for the Competition Bikes, Inc. taking into account the income statements and the balance sheets of the company for the past three years. Horizontal analysis of the financial statements is generally done to compare the performance levels within the company for a given period of time (Weygandt, Kimmel, & Kieso, 2009, p. 647). Horizontal analysis of Competition Bikes, Inc. that has been presented in the case would facilitate comparative analysis of the amounts as well as percentage increase or decrease of each of the related items in its income statements and balance sheets (Warren, 2008, p. 306). It would thus help to identify and understand the operational weaknesses and strengths of the company. As evident from the horizontal analysis of the income statements of Competition Bikes, Inc., there has been an 81.6% decline in its net income in the year 2008 as compared to 2007 which is quite significant. This decline in net earnings of the company is mostly attributed towards the 15% decline in its net sales in 2008 as compared to 2007 because of the current economic scenario which is going through a downturn. A 15% decline in sales value implies that the cost of goods sold and the variable expenses directly related to the sales output would also decline correspondingly. This fact is evident from the 15% decline in the selling expense items like sales commissions, distribution network and transportation out. However, in spite of the reduction in sales, the utilities expenses of the company increased by $15,000 in 2008 which is around 11.1% rise when compared with the year 2007. In the year 2007, when the net sales of the company increased by 33.3%, the corresponding increase in its utilities expense was only 3.8% as compared to 2006. Hence, this is a major area of concern and a potential weakness of the company of not being able to cut down on its utility expenses even with the reduction in sales volume. However, the company managed to reduce its research and development costs by 16.3% in the year 2008. This can be regarded as one of the potential strength of the company of being able to reduce its operational costs related to its research and development activities significantly in the year 2008. As regards the general and administration costs incurred by the company, it did not manage to reduce it in spite of the decline in sales value in 2009. These facts suggest that the company management was inefficient in managing its resources effectively and efficiently to help in bringing down its operational costs significantly to compensate for the decline in sales because of the recent downturn in the economy. Next, if we look at the horizontal analysis of the balance sheets of the company for the past three years, it is observable that the current assets of the company in the form of cash and cash equivalents increased by around 275.4% in 2008 as compared to the year 2007 which is quite significant. The work in process remained same for the year 2008 when compared to 2007. It is noteworthy mentioning the fact that previously the work in process inventory increased by 31.8% in 2007 as compared to 2006. These facts signify that the company managed to utilize its available resources well and must have relied more on cash sales rather than credit sales in the year 2008; this rationale is explained by the 15% decline in the accounts receivables of the company. The increase in cash and cash equivalents was determined by the decrease in accounts receivable and by the increase in liabilities for the same period. In what concerns the PP&E assets, these have declined by 7.8% for the year 2008 as compared to 2007 because some of the PP&Es benefits have been used up, their cost should be expensed, by recognizing accumulated depreciation. The company had a treasury stock amounting to $100,000 in the year 2007 which is missing for the year 2008. It implies that the company managed to sell all its treasury stock in 2008 to generate cash revenues and thus have contributed significantly towards the rise of cash balances in 2008. Vertical analysis of the financial statements of the company has also been performed. Vertical Analysis is sometimes known common-size analysis and is a technique utilized to analyze the information present in the financial statements of a company where each of the items are expressed as percentage of a certain base item. In the case of vertical analysis of Competition Bikes, Inc. the sales figure and total assets and total liabilities and equities figures have been considered to be the base for analyzing its income statements and balance sheets respectively. It can be observed from the vertical analysis of the income statements of the company that except for some of the items the company managed to keep most of the items related to its operational expenses as fixed percentage of the sales value for the past three years. The administrative salaries expense is found to be amounting to around 3.3% of its net sales in the year 2008. The corresponding figure for the year 2007 was 2.8% of its net sales in that year. This implies that the company has not managed to reduce this expense in spite of the significant reduction in the sales volume in 2008. Its executive compensation is also found to amount around 4.3% of its sales which was around 2.8% of its sales in 2007. It implies that the company did not manage to utilize its human resources effectively and efficiently in 2008 to generate higher amount of revenues for the company. This can be considered to be one of the weaknesses of the company management. The balance sheet figure shows that there has been a significant increase in the assets of the company in the form of cash in the year 2008. The accounts payable also forms a significant portion of the total liabilities and equity balances of the company for the year 2008. It indicates that the company might have increased its credit purchases more in 2008, thereby increasing its available cash levels. The company also maintains a liability in the form of treasury stock owned by them which was not present in the year 2006. Next, if we look at the trend analysis of the company it can be found that both historical and forecasted trend percentages of sales figures of the company has been calculated. The historical sales trend of the company for the last three years indicates that its net sales have increased from the year 2006 to 2007, but have again declined in the year 2008. This indicates that the current economic downturn had an impact on the sales of the company, which is a weakness for the company because its sales are volatile to the overall economic environment. The forecasted sales trend for the forthcoming years indicate that the company is expecting to recover its recent decline in its sales value in the forthcoming three years between the years 2009 and 2013. It is expected a 6% increase over the five years forecast of the net sales, which is strength of the company because its operations would improve, without being overoptimistic over the company’s earnings. This forecasted result could also deliver a good signal to the market and boost the stock price because the management’s confidence in the future earnings of the company. Considering the forecasted cash-flows, these are very important when considering a trend analysis and also the implications for the company’s operations, the compound growth rate1 over the five years period is 8%. This result suggests strength for the company, because it has the ability to increase its cash, but keeping it in appropriate limits because in theory is considered that too much cash-flow gives the possibility to managers to spend it on perks (Ross et al., 2009). A ratio analysis has also been performed for the company. Ratio analysis is an important tool of analyzing the financial statements of a company which is utilized to gather useful information related to the financial condition and operational performance of the organization (Brigham, & Ehrhardt, 2010, p. 108). The current ratio of the company has been calculated as 5.35 for the year 2008. This is a fraction lower than the corresponding figures for the year 2007, but is significantly higher than the industry standards which are around 4.2. It implies that the liquidity position of the company is very good with enough cash available to it to cover up its existing current obligations. The acid test ratio of the company has also been calculated to be significantly higher than the industry standards. It indicates that the company as enough liquid money available with them to fulfill its current debt obligations. Hence, strong liquidity position of the company can be considered to be one of the potential strength of the company. The average collection period of the company remained same at 43.8 days in 2008 as compared to 2007. However, it is significantly higher than the industry standards of 32.5 days. It implies that the company has not managed to collect its receivables efficiently in 2008. This is another weakness of the company. The gross profit margin of the company has remained almost same but its net profit margin has reduced significantly to 0.7% in 2008 which was 3.3% in the year 2007. It indicates that the company has incurred huge amount of operational costs in 2008. Hence the companys operational efficiency is not good. The reduced operating margin of the company is also another indicator of the operational inefficiency of the company. Thus, the profitability position of the company has suffered a lot in 2008 mainly due to its high operational costs. The company did not manage to efficiently utilize its resources as well to generate profit which is indicated through its significant decline in its return on assets ratio which stands at 0.8% as compared to the industry standards of 4.8%. The debt ratio of the company has declined a little in 2008 but is significantly higher than the industry standards. It indicates that the company is greatly leveraged and has significantly higher proportion of debt in its capital structure. The companys inability to generate significant amount of profits in the year 2008 is reflected through its low return on common equity ratio as well. The interest coverage ratio of the company has declined significantly in 2008 amounting to 1.77 which was 5.27 in the year 2007. It is significantly lower than the industry standards as well. It indicates that the company has not managed to reduce its debt obligations even with the significant decline in its revenues. However, the price/earnings ratio is quite high. It implies that the shareholders of the company expect that it would improve upon its performance significantly in the forthcoming years. Hence this is one of the strengths of the company management to be able to maintain a good reputation in the market. Task A.2. Working capital of a company comprises of the current assets that the company has in excess of its existing current liabilities. Working capital is required by the company to finance its daily operational activities and thereby helping it to have a sustainable business. Cash is one of the important constituent of the current assets possessed by a company and thereby forms a part of the working capital of the company. It is necessary for a company to have enough cash available with it to ensure fulfillment of funding requirements to carry on its daily operations and smooth running of the position. Efficient working capital management can help a company to improve its liquidity position along with the increase in profitability of the company. The company should be careful about not having excessive working capital in the form of cash available with them as well. It is so because the excess working capital unless utilized by the company for carrying on its operational activities would not help the company to increase its profitability position. In case of Competition Bikes, Inc. it can improve upon its working capital through various ways. First of all it needs to decrease its average collection period which has been calculated as 43.8 days. This is mainly attributed towards the credit sales performed by the company. The company sends invoices to its distributors on a monthly basis. This results in the delay of collection of its receivables thereby delaying the availability of cash with the company. Hence, the company can think of reviewing its credit policy and implement ways to collect its receivables in quicker time so that it is able to generate more cash for itself thereby improving its working capital. The other measure which the company can take to improve its working capital is by delaying the payment made to its suppliers for the raw materials purchased. Currently the company pays its suppliers every 15 days. This should be extended so that the company can hold cash with them for a longer time. As regards its inventory, the company can further reduce its average inventory days below 25 days. All these factors would result in increasing liquidity of the company thereby improving its working capital. The excess working capital can be utilized by Competition Bikes Inc. to improve upon its profitability position through various means. The company already has a significant amount of cash balance available with it which is indicated through its balance sheet. This excess working capital in the form of cash can generate significant amount of profit for the company if it is utilized in some operational activities of the company which could reduce its operating expenses. As for example the company can think of buying trucks itself to facilitate delivering its products. It could help the company to significantly reduce its operating costs in the form of transportation out expenses. The company can also think of setting up its own distribution channel which could result in significant reduction in the operating expenses in the form of distribution network support. The company can also utilize its available cash to pay off its long term debts which will in turn reduce its interest expenses thereby increasing its net earnings. Moreover, the company can also utilize its cash in some short term investment activities which could help them generate positive returns. These are some of the ways in which the company can utilize its excess working capital efficiently to improve its profitability position without increasing its current sales level that is very much unlikely in the present economic scenario. Task A.3. Based on the excerpt from the operating manual of the company as presented in the case it can be found that the company prepares its purchase order on a monthly basis and the quantity ordered is based on the monthly budget figures prepared by the organization. One of the major weaknesses that can be observed in its purchasing system is the timing of placing the order on the first of every projected month. Hence, the company would not be able to receive the ordered goods from its suppliers at the beginning of the month as it would require additional order processing time to get it completed. It is suggested that that the purchase order is placed with the supplier well before the projected month after measuring the average lead time of delivery so that goods are available with the company on time to carry on its operating activities. Another weakness that can be observed is in the inventory management system followed by the company. It is suggested that the company should manage its inventory well and there should be a system where minimum re-ordering level would be set by the company. When the inventory goes down to the minimum ordering level that is when the next order should be placed. It is risky for the company to order the goods on the first day of each projected month. It may so happen that the company might have used up all its goods in the manufacturing process by the first of the projected. It would mean that the company has no goods to manufacture until it receives the raw materials from its suppliers. Another area of concern for the purchasing department is regarding the process of choosing its suppliers. It can be risky for the company because of frequent changes in its suppliers. The company would not be able to build up a strong relationship with its suppliers which are essential for the smooth running of any business. Another thing which the company can do is to increase the frequency of its orders. It would help the company to manage its inventory well and reduce the costs associated with holding the inventory for longer time. Another issue related to internal controls is to ensure that the company states procedures for handling each area i.e. no financial transaction is handled by only one person from beginning to end. This segregation of duties is necessary in order to have an efficient internal controls system. So, the company analyzed should take this into consideration, and should ensure that has sufficient personnel to overlook all activities. Moreover, a weakness of the internal control system of this company is that it does not take into account modifications at a macro and micro level. In this matter, considering the financial crisis it should have been taken measures in the internal control system in order to meet the changes or the bad outcomes from the market. As well as purchases shortage risk and the vendor relationship weaknesses, risks such as errors in the company’s procedures and faults in the financial statements disclosed by the company should be considered. The most appropriate corrective measure in this area would to be considering the audit of an external company, because in this way the control system would be more efficient. So, the employees of this company should ensure that the financial information is reliable, assets and records of the organization are appropriate considered, and the organization’s policies are respected. All these compliances would help the company to mitigate the risks that appear in its internal control system. Task A.4. The main purpose of Sarbanes-Oxley (SOX) is to ensure protection to the investors of a company by presenting them with more reliable and accurate information regarding the company operations. It mainly deals the compliance of a company with respect to the internal control mechanisms followed by them. In case of Competition Bikes Inc. there are some areas which seem to be not compliant with the SOX requirements. First of all the company do not have any internal auditors. It is suggested that internal audits should be performed by the company periodically 3 to 4 times a year to effectively monitoring its internal control system. Independent auditors should be appointed by the company to be more compliant with SOX requirements. Next regarding the accounting of purchases made by the company it seems to be non-compliant with the SOX requirements because the purchases are not accounted for at the moment when it gets accrued. Thus the company should account for its purchases as and when it is accrued by the company. Next regarding its suppliers, the company should identify its suppliers and record the same. The other non-compliant area that can be identified is regarding the assessment of its internal control mechanisms which is done at the end of the financial year. It should be done at least 90 days in advance before the end of the financial year end so that effective measures could be taken for the non-compliant areas before the financial reporting is done at the end of the financial year. Thus, in a nutshell, Competition Bikes Inc. should have a strong and effective internal control mechanism in place which would include efficient employees of the organization who would have the responsibilities to monitor the controls of its raw material acquisitions, purchases, inventories and the year ending financial reports prepared by the organization. References Brigham, E, F., & Ehrhardt, M. C. (2010). Financial Management Theory and Practice. (13th ed.). Connecticut: Cengage Learning. Warren, C. S. (2008). Survey of Accounting. (4th ed.). Connecticut: Cengage Learning. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2009). Managerial Accounting: Tools for Business Decision Making. (5th ed.). New Jersey: John Wiley & Sons. Ross, S., Westerfield, R. & Jordan, B. (2009). Fundamentals of Corporate Finance. (9th ed.). New York: McGraw-Hill/Irwin. Read More