Financial Analysis of Custom Snowboards Inc - Case Study Example

Task # 5 Financial Analysis of Custom Snowboards Inc. Write here September 18, Presentation to the CFO Financial Summary Custom Snowboards Inc. offers the most durable and reliable snowboard on the market. The company offers a 36-month guarantee against breakage with a free replacement warranty. The company showed growth in their 13th year with an increase in Sales Moreover, the administrative expenses of the company constitute less than 20% of sales showing that the company is operating efficiently and the selling expenses are also in the range of 10% of sales continuously during all these years. As we are aware that there has been an immense amount of economic turmoil all around the world. Custom Snowboards Inc. was also severely impacted as the customers decreased their expenditure on leisure and sports. However, the company did not have to suffer like other companies did and it suffered from a 4% decline in Sales. Horizontal Analysis An increase in Sales Expenses are fairly consistent Interest income increased by 28% and interest expense decreased by 5% Current assets increased by more than 100% and total assets by 3.6% whereas total current liabilities had no significant impact Retained Earnings increased by more than 70% Vertical Analysis Gross Profit is 30% of Sales General and admin expenses are less than 20% of sales on average during years 12, 13, & 14 On average, current assets constitute approx. 50% of the total assets Cash comprises of more than 15% of the total assets and has the highest constituency whereas receivable come second Current Liabilities are under 10% of the Total liabilities and equity Trend analysis - Trend analysis is the percentage changes in items of the financial statement during successive years. We can also call it an extension of the Horizontal Analysis and indicates the direction of change. The snapshot shows the sales trend during years 12, 13, & 14 respectively. Sales increased during the 13th year, however, as recession struck, they declined in the 14th year. The future trend analysis of the company sales show that the company would be able to improve its sales slowly and gradually during the next three years. Credit Risk The biggest risk that any bank faces in terms of lending is credit risk Loaned out funds wont be no longer available for operational and other bank use Risk of incorrect assessment of interest rate (Fitzsimmons,n.d.) The bank also looks at several other things in a companys financial statements. It also looks at the Debt-ratio, Interest Coverage ratio, current income status of the company as well as its credit history and overall stability of the Enterprise. Custom Snowboards Inc. Debt-ratio is currently 49%, which is less than its competitor. Moreover, another red flag comes when we look at the Financial Statements, specifically the Income Statement and see that Net Income has suffered a sharp decline by 74% due to a sharp decline in Sales. As the bank is concerned with the stability, the declining sales and income statement pose a risk to the lender in terms of ability of Custom Snowboards to cover its debt. Risk Mitigation Credit Risk is the major risk that banks are concerned with, The financial statements of Custom Snowboards Inc. show stability and gradual growth The trend analysis shows that the sales would grow gradually making sure that the company would be able to meet its obligations Horizontal and vertical analysis show that the company is not under huge current and long term liabilities and the expenses are not very high Custom Snowboards Inc. is a growing concern As far as the debt-ratio is concerned, a positive aspect is that although it is higher than the competitor, it has declined from last year. The companys Income Statement does not show a very positive picture, however, it is mainly due to the massive economic recession. Moreover, if we look at the Balance Sheet, we that the Working Capital is positive and the company has enough financial strength to meet its short term obligations and remain operational. Another positive that comes out from the three year comparative balance sheet is that the company has not taken any sort of short-term or long-term liabilities in the recent past and its current assets have increased by 22%. Ratio Analysis The snapshot shows the ratios of the company during year 13 & 14 and its comparison with their competitor Winter Sports during Year 14. Ratio Analysis Current Ratio and Quick Ratio show that the current assets of the company are more than its liabilities Although, the inventory turnover, which is a measure of inventory management of a firm is lower than Winter Sports but the difference is only of 3 days and it can be improved in the coming year. The average collection period is 11 days whereas it is 32 days for Winter Sports showing that Custom Snowboards is collecting its receivables sooner. Although the debt-ratio of the company is comparatively than Winter Sports showing Custom Snowboards Inc. finances 49% of its assets with debts, it has decreased from previous year showing that the company is keeping a check on its debt and managing it effectively. The Gross Profit and Operating Profit margin is currently 2% lower than Winter Sports, Custom Snowboards plans to improve that by improve Sales gradually. Currently, the EPS of the company is also lower than its competitor but it is due to the decline in sales and recession. The companys EPS last year was 0.13, hence, as Sales improve, the EPS would also improve. Presentation to the CEO Historical Analysis If we look at the Income Statement of the company, we can see that the Sales accelerated during the 13th year by 0.5% and decelerated in the 14th year by 4%. The decline occurred due to the economic downturns. However, an interesting point here is that the selling expenses also declined by 4% during Year 14. A positive aspect for the company during all these years is consistency of expenses and their gradual decline. The expenses have not increased by more than 10% from the last year and in Year 14 they declined showing that Custom Snowboards is moving in the right direction and it is trying to attain operational efficiencies. The total operating expenses increased by 4% in the 13th year, which further declined to 2% increase in the following year. However, one level of concern is the Operating Income and Net Earnings which have been declining at a very sharp rate. During Year 13, Operating Income declined by 21% whereas during Year 14, they declined by 50%. Similarly, Net Earnings have also declined. Although, the company is not running in loss, but its performance from the past years has declined and one of the major reasons is the declining sales performance. The Balance Sheet shows a positive sign that Cash has increased by 100% during 13th year and increased by 13% during year 14. Another positive aspect is that the current and long-term liabilities have not increased significantly over the years. In fact, they declined during year 14 showing that the company did not take any significant debts or incur any liabilities during that year and it was able to reduce its obligations. The current and quick ratio are higher than Winter Sports showing that Custom Snowboards is more liquid than its competitor. It also has a better collection period days and a comparable inventory turnover. Similarly, the debt-ratio is higher than the competitor but the positive aspect is that it has declined from the past year. Implications for Future Performance For future implications, one ideal indicator is a trend analysis. A trend analysis is very similar to a horizontal analysis. It assumes one year as the base year and assesses performance in the latter years. A sales trend analysis of Custom Snowboards Inc. shows that the sales grew by 0.5% during the 13th year and declined by 4% during year 14. However, the sales trend analysis for future years shows that the company is going to be slow and steady. They would be able to grow their sales by 3% in the next year and then gradually keep it steady at that rate. A steady growth in sales is indicative of the fact that Custom Snowboards is moving in the right direction. Besides a trend analysis, we can also use historical performance to indicate future performance. Starting from the Income Statement, we see that the COGS have remained steady, which shows that if the company could reduce their other costs such as Selling and Administrative, they can reap in more profits. Another positive aspect is the availability of cash for future operations, which has increased by 13% and an 83% decline in short-term investment tells us that as the company has a long-term investment plan, they have halted all their short-term investments. The company can also rely on debts in the future as during the past three years, both their short-term and long-term liabilities have declined consistently giving Custom Snowboards Inc. the leeway to expand in the future with the help of debts. Cost Controls The most important element of costing is the method for overheads as well as other fixed costs. Operational efficiencies ensure that a company keeps a close check on these and other associated costs. As we know that the bottom line is equal to revenue minus expenses and hence, it is really important for a company to keep a close check on its expenses. The following is the budgeted Manufacturing Overhead and the budge of selling and administrative expenses. The company uses the traditional costing methodology for calculating the overhead and other costs. However, it is a well-acclaimed fact that Activity Based Costing is the most appropriate method for costing. Custom Snowboards Inc. would gain useful insight into the fastest-growing and least visible element of overhead costs. It would also help in improving the overall profitability as the company would be able to compare costs against the performance. The budgeting process would become more efficient and consequently, the planning and control would also become better. The most important advantage that results from moving to activity based costing approach is a betterment of the pricing decision as now the price would be based on product cost that results from the overall manufacturing process (Activity Based Costing System Benefits, 2011). Besides trying to make their cost controls and cost measuring procedures more accurate, we can see from the Vertical Analysis, that Selling and Administrative expenses comprise of more than 15% of the total revenues. The company can try and reduce this percentage by a detailed audit of the operations and other procedures and try to reduce these expenses. A place to start the audit from comes from the Horizontal Analysis of the Income Statement where we see that the Administrative Salaries and Executive Compensation have been increasing each year with a rapid increase of more than 10% during the year of recession. Custom Snowboards Inc. can work towards finding out the reason of these costs and look to reduce them. Merger, Acquisition or licensing In terms of expansion to the European Market, Custom Snowboards Inc. has three options available to them: they can merge with European SnowFun Inc. and build a production plant, they can also acquire European SnowFun Inc. or license their technology. If Custom Snowboards Inc. decide to merge with European SnowFun Inc. the Earning Per Share of the company would rise from $ 0.66 to $ 0.79, which is a very positive sign for the company. Hence, the merger seems to have a positive potential. Moreover, a merger would allow the company a larger geographic coverage. The company would also be able to achieve economies of scale. The acquisition option is not feasible as the NPV comes out to be negative when we subtract the outflow from the NPV of acquisition. The final option available is of licensing, which is a profitable option as the income increases because of it. However, we cannot choose the option as in case of licensing, a company would associate its name with the product of the other and they would have little or no control over their product. They might earn a bad reputation. Therefore, in the light of the above discussion, merger seems the most feasible option. Following are the calculations and comparisons for the three options: Risks & Risk Mitigation Although, the merger seems as the most feasible option, it has a number of risks involved. First of all, Custom Snowboards Inc. might plan to finance the merger with debt in hope that the profits from the merger would help it in paying it back. This expectation has a major loophole, the hope that the company would as profitable as expected might be a false believe resulting in loss for the buying company. A clash in the cultural environment of both the companies might create serious operational problems as the employees might not feel comfortable working in the new organization. The final risk is loss of control resulting in a compromise of procedures and quality hampering overall company performance. A major strategy to reduce the above-mentioned risks is to conduct a thorough analysis of the company and find out as much information as possible. The decision should be finalized after an in-depth analysis and several meetings so that whatever method the company decides to choose for financing the merger, it should not have to suffer from a loss. Moreover, the future profitability and sales growth after the merger should be calculated with as much accuracy as possible. Regarding the cultural synchronization, the company should make several visits to the organization and try to find any traditional practices, and information on the people of the organization. Financing Options Available The company has two options available: Lease or Buy. Both options have certain advantages and disadvantages. However, choosing the right option is necessary as it also has an impact on the Working Capital of the company. Hence, the company needs to choose the less costly option. The following calculations provides in-depth analysis of the cash outflows in case of both the options. The after-tax outlays are the total cash outflows minus the tax savings. The present value of outflows is the annual cash outflows multiplied by the time value of money factor that has been chosen. The final line is the total net present value of both the options for the next five years. As we are looking at total cash outflows for both the options, we would choose the option that has a lesser NPV. For Custom Snowboards Inc., the NPV of leasing is -653,355 whereas for purchasing it is -659,426. Hence, leasing the investment is the more feasible option for Custom Snowboards Inc. The company also needs to identify a capital structure that would prove to be most feasible for it. It has a number of options available. We have calculated the Earning per Share in case of adopting each of the option. Following is a snapshot of the calculations: As it is clear from the calculations above, the EPS is most when the company takes no debt but due to non tax deductible nature of equity, we cannot adopt a capital structure with 100% equity. 30% debt and 70% equity is the second best option in terms of EPS. This option is also less risky as compared to other options that are either to keep all in debt, 80% of debt or no debt. Although, the no debt option is least risky, but it is also the most expensive as the interest expense is tax deductible and has an impact on the bottom line. Hence, we would adopt the 30% debt and 70% equity option. References Activity Based Costing System Benefits (2011). Activity Based Costing (ABC): Drucker Tells Why. Retrieved on September 18, 2011 from Fitzsimmons, Collin (n.d.). Risks of Bank Loans. Retrieved on September 18, 2011 from Read More