Horizontal analysis allows side by side comparisons on a year to year basis to determine the performance from one year to the next. The company decides on standards to compare the results of the analysis. Standards are researched by checking competitors, internet research of general industry guidelines or standards created from past experience in the company. The Company states in the summary that they attribute the net sales decrease in sales to the economy. The primary buyers of the bikes are professional bikers and with the sponsors of these professionals backing off the sales for this company took a direct hit. Competition Bikes Inc, also decreased advertising between years 7 and 8. This looks as though the company is marketing to a specific audience and when that audience dried up so did the sales of the bike. The company needs to put money to the Research and Development department to search for a new audience or try to create a new version of their product and market it to a broader audience.
Revenue is the cost of goods sold subtracted from the net sales. In Years 6 and 7 the competition Bike Company had a 37.5 % increase in revenue. However, in years 7 and 8 the company had a 16.3% decrease in revenue. Competition Bikes has a decline in sales that is directly related to the decline in the economy. Even though the sales are expected to increase they are still not projected to meet the initial level of sales the company experienced. The use of more marketing may increase sales. The labor and inventory have not increased but utilities have increased, this may be due to an increase of energy costs. After reviewing the General and Administrative Expenses I have noted the increase in the first year by 21% and 1.2% between years 7 and 8. Administrative salaries were increased by 21% between years 6 and 7. This needs investigated as the sales have decreased, where are the additional costs of administrative expenses originating? The increase even in as little as 1.2% in Administrative salary seems to be a poor decision in a tough economic time.
Cash on hand has increased due to accounts carried over from year 7. Inventory and Production remained stable but receivables dropped. Inventory should be reduced to mirror the drop in sales and reduce overhead and reduce costs in inventory and production. This organization has not adjusted to the drop in sales. The total selling expenses for years 6 through 8 have increased from 299,220 in year 6 to 397,960 in year 7 and then 338, 748 in year 8. A review and an adjustment to the operating income will reduce overall expenses. Unfortunately another option for Competition Bikes is to reduce labor and production costs by offering early retirements or issuing layoffs. With high expenses the company gets less profit.
Vertical analysis is a method of financial statement analysis in which assets, liabilities and equities in a balance sheet are listed as a proportion of the total account. The main advantage of vertical analysis is that the balance sheets of any business can be compared. It is easy to see a relative annual change within one business with a vertical analysis. A decrease in % seen on the vertical analysis is a loss and an increase in % is a gain. Net sales have decreased in year 8 compared to year 7, while gross profits have dipped from 27.4 to 27%. Selling expense has remained the same through years 6, 7 and 8. It would not be recommended to increase selling price as this may lead to further decreases in sales and overall profits will decrease more. As net sales have declined and Operating Expenses as remained the same, it is clear Competition Bikes must trim operating income. General Administration expenses have increased form 15.5% in year 7 to 18.4% in year 8.
Utilities and Executive compensation being the two key areas of impact to the Total General and Administration Expense increase in year 8. This signals some work on cost cutting and compensation evaluations are needed to stay on budget. Competition Bikes Net Income has decreased from 2.8% in year 7 to 0.6% in year 8. This will influence companies lending money to Competition Bikes should the need arise to repay future debts. The Total Current Assets for Competition Bikes is 36.8% in year 8 up from 31.5%, showing that the company has enough funds to settle current debt. Specifically Works in Process Inventory and Raw Materials Inventory remains unchanged from year 7 to 8, this shows that even with a decrease in sales the company is slow moving and has not adjusted inventory to sales. The company has accrued more debt from year 7 to year 8 seeing an increase of Total Current Liabilities moving from 5.4% to 7.0%.
Trend Analysis is attempting to spot a pattern in information that is collected. Trend analysis is mostly used to predict future events, although another good use is to review and estimate the situation of past events.
The income over the last three years has been fluctuating.. This tells us the company has an initial growth period. Sales also drop between years 7 and 8 and the gross profit margin decreased as well. This may be due to operating expenses. This leads to the prospect of stable future sales. The stakeholders are continuing to back the company and the company does predict sales will remain stable. The modest increase in sales does not show enough to recover without making adjustments to free capital. Using year 8 as a starting point when forecasting 9-11 years, the company has modest increases, but not enough to commit to a huge recovery. The forecast never reaches the largest increase of 133% seen in year 7.
Ratio analysis is a quantitative analysis of a company’s financial statements. Ratios are calculated from current year numbers and are then compared to previous years. They may also be compared to other companies in the industry and may even be compared to the economy.
Earnings Per Share Ratio, which is on the income statement, shows viability and profitability. The EPS ratio is the earning potential of the company and is used to compare the company to its competitors. Fast growing companies will have a higher ratio compared to slower growing companies. The EPS for Competition Bikes is 0.03 for year 8 and 0.02 for year 7, with Two Wheel Racing at a 0.08 EPS Ratio. Current Ratio is the ratio of current assets to current liabilities. In year 7 the Current ratio is 5.79 and drops slightly to 5.25 in year 8. Competition Bikes is able to meet its debt obligations 5.25 times. The company has been good at maintaining a high ratio even with the decrease in sales in year 8. Looking Two Wheel Racing’s Current Debt Ratio at 4.2, shows Competition Bikes has been better at maintain a high ratio than the compotator. Acid Test Ratio tells whether the company can pay all its liabilities if they were due immediately. This ratio actually takes the inventory the company has into consideration. Ideally the industry standard is a ratio of 1:1, showing a company is solvent. Competition Bikes is at 4.14 in its most current year 8. This shows the company can pay off all liabilities immediately. Competition Bike’s acid ratio is slightly higher than Two Wheel Racing, whose Acid Ratio is 3.4.
The Debt ratio compares debt capital to total assets. Excessive debt leads to paying interest with higher payments on principal. Competition Bikes Debt Ratio is 47% in year 7 and 46.2% in year 8. Two Wheel racing is at 38%. Competition bikes must continue to balance debt and equity and obtain a more optimal Debt Ratio. The Times Interest ratio shows how a company can pay the interest payments. TIE Ratio in year 7 was 5.27 and decreased to 1.77 in year 8 for Competition Bikes. To improve this ratio Competition Bikes must collect debts more effectively as well as increase sales and stay within budgeted operating expenses. The Price/Earnings Ratio shows the market price per share of common stock to the company’s earnings per share of stock. This will estimate the value the market will set for the business. The P/E Ratio for Competition Bikes in year 7 was 49.67 and in year 8 was 96.61. This indicates the company is a good investment especially if you compare it to Two Wheel Racing whose P/E Ratio is 29. Investors will buy Competition Bike stock over Two Wheel Racing stock. Strengths:
•Equity is being internally generated instead of externally produced. •Net sales are expected to climb.
•Assets have grown showing increased liquidity.
•Inventory is minimal as shipping occurs as ordered.
•There is a better credit risk than competitors.
•Decrease in gross profit.
•Decrease in property, plant and equipment assets.
•Profitability is decreasing- operating profit margin is 1.9%.
Comparison to Two Wheel Racing:
•Competition Bike has more quick assets that enable payment of current liabilities making a better credit risk. •Competition Bikes keeps fewer inventories on hand- creating less overhead. •Competition Bikes has a longer collection on accounts receivable. •Competition Bikes has a larger debt ratio making them less appealing for long term liabilities. •Competition Bikes has a lower gross margin profit. Two Wheels can make more money on every bike they sell.
Dividing current assets by current liabilities will give the Working Capital for Competition Bikes. Current Assets – Current Liabilities = Working Capital
YearCurrent AssetsCurrent LiabilitiesWorking Capital
Working capital increased $152,287 from year 7 to year 8. Even though the company has the ability to expand due to a positive cash flow the drastic decline of sales should be evaluated over the next year and inventory monitored to reflect. With a steady increase of working capital the company can increase advertising, improve operations, expand production and pay down debt. The collection process for Competition Bikes is an area that needs improvement as it currently mails invoices on a 30 day term. Charging interest on past due accounts or giving discounts for accounts paid in full can increase working capital.
Evaluation of Internal Controls
Internal controls are set in place to monitor the processes and procedures of the company. This determines which area needs to be reviewed, updated and possibly more closely supervised.
Review of Internal Controls
Competition Bikes does not have procedures in place to address the flow of materials through the entire process of production. Material flow from ordering, receiving, invoicing, payment, reorder, usage and left over materials are accounted for in the company process. There are a few processes that should be addressed and possibly updated:
1. Receiving three bids for materials every time an order is received may be a lengthy process. Creating a contract with a vendor may save time and help monitor inventory. Shipping and handling prices may also be able to be negotiated with a vendor. Inventory that is can also have a specific drop date for receiving and possibly a payment plan in place as well. This will establish “known” processes for inventory.
2. Separation of the accounting process can delay payments and hinder the supply chain process. Use of accounting software could streamline this process for the company, possibly reduce an employee position and more closely monitored accounts payable and receivable for Competition Bikes.
3. Using a common courier for all shipping is another area to review as well as shipping schedules for sales in the Canadian market. Competition Bikes may benefit from varying the use of shipping and creating ship dates with vendors.
4. Each bike made at Competition Bikes is checked individually. While this is a good marketing tool, I question the process for time management purposes. Each bike is created based on a specific customer measurement, this individual process can only check for specific mechanical defects. I would like to see a QA on the bikes returned due to incorrect measurements as this process is performed at individual locations and the measurements are sent to the manufacturing company to build the bikes. This quality control is not mentioned in the Internal Control process.
5. The operating cycle also poses a question concerning the ability to accurately capture the remaining inventory in a timely manner prior to the next order of materials. This process would be monitored in a more timely and accurate process if governed by an inventory system. The inventory and accounting systems could be linked as well.
Risk is any threat to a company for existing business problems. Profit margin compared to competition is a strong way to asses risk. Review of Internal Controls to assure the compliance to policy and procedure is another strong assessment of risk. The lack of a receiving department is a large risk for this company.
There should be receiving department that will receive the materials, send an invoice to the accounting department, a separate step to match the purchase order to the packing slip, once accomplished the next step to have an authorization of payment sent for payments from bank accounts. Without this process there is no way to track materials and payments of materials. Holes in the purchasing process can lead to material waste, overpayment for materials not received, losses, misstatements of inventory levels, embezzlement, etc.
Simple software programs for inventory management and purchasing as well as establishment of a receiving department can help the company streamline processes. The receiving position will match invoices to purchase orders. After verification of all orders, an accounting officer will then make all financial transactions. Internal audit processes to review and approve invoices will reduce the risk of embezzlement. Tying the purchasing system to an inventory control system will also decrease order errors, allow for historical data to drive timelines relating them directly to production time lines. Competition Bikes needs to define and carry out internal controls.
Sarbanes Oxley is defined as the company’s responsibility to establish an Internal Control Process, maintain the process and assess the process for its effectiveness The Internal Control process must also be reported yearly. Competition Bikes is not following the SOX Act as listed below: Section 302 of the SOX Act requires officers to sign off on the company’s financial reports. This ensures the effectiveness of the company’s internal controls over the financial reporting. Section 404 requires businesses to publish information relating to the adequacy and effectiveness of the internal control procedures for financial reporting.
A registered accounting firm must also attest to the report and assess the effectiveness of the internal controls. There are discrepancies in the Competition Bikes reporting system and there is no outside auditor verifying financial findings. Competition Bikes needs to include an internal control report in its annual report and hire an outside auditor to evaluate internal controls.