Financial Analysis - Competition Bikes Inc - Case Study Example

Table of Contents Introduction 2 Horizontal Analysis 2 Vertical Analysis 4 Trend Analysis 5 Ratio Analysis 5 Analysis of Working Capital Requirements 9 Evaluation of Internal Control 9 Compliance with the Sarbanes-Oxley Requirements 11 Conclusion 11 References 12 Introduction Financial management is an aspect of business which will determine the long term success of the business as the ability of the business to manage the finances determines their long term success. This report analyzes the financial statement for Competition Bikes Inc by looking at different areas and factors so that a holistic view regarding the performance of the organization can be identified. This report will look to present the financial analysis which will cover the horizontal analysis, vertical analysis, trend analysis and ratio analysis where the performance will be evaluated and areas which need to be improved will be highlighted. The report will then analyze the working capital situation for Competition Bikes Inc by highlighting the areas they need to improve and the manner in which it will contribute towards the profit of the business. The report will then present the internal control system for Competition Bikes Inc and identify the manner in which the risk can be mitigated and better strategies for the long term success can be gathered. Finally, the report will highlight the manner in which Competition Bikes Inc complies with the Sarbanes-Oxley act and highlight the areas which need to be improved on. Overall, the analysis will analyze the financial statement and help to provide important directions which have to be improved so that the overall performance of the organization improves and the shareholders are provided with better return for the risk undertaken by them. Horizontal Analysis Horizontal analysis looks to compare the performance of the organization from one year to another based on absolute change in values along with percentage change. This thereby helps the user of the financial statement to understand the manner in which the organization performed as compared to the last year. A lot of financial and business decisions are based on it as comparing the performance from the last year helps to make decision regarding investment, new launches, and market share and so on. The horizontal analysis for Competition Bikes Inc shows that the performance had improved in year 7 as compared to year 6 but a dip is seen in the performance of year 8 as compared to year 7. This is an aspect which needs to be analyzed as the dip in performance for year 8 from year 7 could be due to different factors like recession, increase in competition, and some external factors which have a performance on the organization. This is an aspect which needs to be consulted while formulating business strategy so that the business is able to manage the financial better and make necessary arrangements so that better finance can be managed (Finance, 2011). Looking at the performance of Competition Bikes Inc in year 7 as compared to year 6 shows that sales have grown by more than 33% but the cost of goods hasn’t multiplied in the same proportion resulting in higher gross profits. This is further matched by the fact that selling expenses has grown in the same proportion showing a relation between sales and selling expenses but the general and administrative expenses hasn’t grown in the same proportion which has ensured that the net profit has grown by over 300% resulting in better performance. Looking at the performance of Competition Bikes Inc for year 8 as compared to year 7 shows that sales have decreased by 15% which has reduced in a proportionate decrease in selling expenses but the general and administrative expenses has increased by 1.2% showing that despite a decrease in sale the general expenses have increased. A breakdown of the general and administrative expenses shows a sharp increase in research & development expenses in 2007 and utilities in 2008 which has thereby made the expenses. Along with it year 7 has witnessed a growth in salary by 21%, executive compensation by 29% which has increased the overall cost for the business. This is an area of concern which Competition Bikes Inc needs to look as it would otherwise have an impact on the future performance and also shows that the business has spent more money than they actually should for the general and administrative purpose. This is an aspect which needs to be analyzed so that Competition Bikes Inc is able to improve the performance and ensure that better strategies are developed so that performance in year 9 improves. The overall analysis thereby shows the different areas of concern and requires formulating strategies which will help to ensure that the performance improves next year. The financial statement i.e. the Balance Sheet consistency in case of fixed assets like land, plant & machinery to remain the same and hasn’t changed. In a similar manner the long term liabilities have remained the same and haven’t changed showing proper management of resources. A drastic change on the other hand is witnessed with regard to cash and cash equivalent which decreased by 65% in year 7 and then increased by 350% in year 8. Accounts receivable also reduced by 164% in year 7 and decreased by 15% in year 8. In addition to it short term investment has increased by 10% in year 7 but hasn’t changed in year 8. Raw materials inventory have decreased by 15% in year 7 whereas has grown by 3.1% showing better management of inventory. Accounts receivable on the other hand has grown by 164% in year 7 and then a moderate decrease of 15% is seen in year 8. Accounts payable has grown by 200% in year 7 and then has an increase of 33% in year 8. Accrued expenses has increased by 14% in year 7 and then increased by 4% in year 8 showing changes overthe years. Vertical Analysis Vertical analysis looks to determine the expenses, profits and other aspect of the business based on the revenues which the business makes. To put is more clearly every financial head is based on revenues so that the users can understand the different percentage which is consumed from revenues The vertical analysis for three year i.e. year 6, year 7 and tear 8 for Competition Bikes Inc shows that majority of the expenses is direct cost which is incurred on cost of goods sold and accounts nearly around 73% which makes the gross profit to be 27%. In a similar manner there is consistency in the selling expenses which is 6.7% of the total revenues showing a proper relation between the revenues and selling expenses showing that the business has developed a plan where the look match the revenues with the expenses. The area of concern for Competition Bikes Inc is the general and administrative expenses which show that there is inconsistency which has made the general and administrative expenses to fluctuate. This shows that the management hasn’t been able to control the indirect expenses which should have shown a better relationship with the revenues is an area which the management needs to work on. This would thereby require that the management looks to develop better relationship of revenues with general and administrative expenses so that control can be exercised and the business is able to ensure consistency in the bottom line. This will help to improve the financial aspect and will ensure better control of the different finance. The analysis also highlight the manner in cash and cash equivalent has grown ensure sufficient liquidity but has also increased the credit in the market through a growth in receivable which needs to be monitored and controlled. The fixed expenses are kept the same ensuring better use of resources to generate extra income but have also resulted in an increased in debt from the market especially the short term debt. A look at the balance sheet shows a growth in cash and cash equivalent in year 7 and year 8 showing more liquidity. The long term liabilities have decreased as it reduced to 41.6% in year 7 and then 39.2% in year 8 showing effectiveness in managing the long term business needs. The shareholders equity has grown which is due to an increase in retained earnings which haven’t been distributed among the shareholders. Accounts receivable has grown and comprises of 14% of the total base in year 8 and 17% in year 7 showing very high investment in current assets. Further, manufacturing plant and equipment shows a very high percentage and is around 47% showing high dependence on machinery. In the same manner non manufacturing assets and furniture stands at 19% and 12% which results in high asset. The liabilities show that mortgage payable is very high and stands at 40% showing very high debt component. At the same time equity has been maintained at the same level of 23% which thereby shows no money is raised from the market further. Trend Analysis The trend analysis which looks to find out the manner in which the business for an organization will grow is based on different dimensions and areas like economic growth rate, organization growth rate, competition and so on. This helps to facilitate a process through which the organization is able to make necessary arrangements for the required resources so that the business demands can be met. The trend analysis has been based on a moderate growth rate of around 3 to 4 percent but the different reason for it has been clearly stated. Despite it Competition Bikes Inc can look towards a moderate growth rate based on different dimensions like economic growth rate, degree of competition, inflation and so on (Padachi, 2006). These are some of the factors which have been identified but haven’t been provided clear information and are an area which could result in fluctuation in the forecasted demand. This is an area which needs to be identified and worked on so that the overall framework through which business will be able to prepare for the necessary resources can be identified. The trend analysis figures shows an increase in sale of around 3 to 4 percent in the next few years which has been developed keeping in mind a nominal growth rate which the business is expected to achieve. The growth in sales has been based on the change in demand and is based on the historical performance which will help to make necessary arrangements for the required resources. The market dynamics and the manner in which the economy is performing shows an scope for further development of business. The trend can also be adjudged on the basis of inflation regarding the manner in which price changes will be achieved and will thereby help to bring a transformation in the working style. Ratio Analysis Financial statement at their own doesn’t provide any information and are mere numbers which have to be interpreted and analyzed. Ratio analysis helps to interpret and analyze the different financial data based on which different important business decisions can be taken. Ratio analysis looks at measuring the different financials on different dimensions through which an analysis is developed so that the user of the financial statement are able to understand the performance of the organization better and based on it are able to take decisions which will help to reduce risk and maximize gains. The detailed analysis of the financial statement through ratio analysis for Competition Bikes Inc is as Profitability Ratios: This ratio helps to understand the manner in which the business is able to improve its bottom line by carrying out its daily operations. This ratio are of prime importance to the shareholders, investors, employees, suppliers and others associated with the business as it helps to understand the manner in which the business was able to perform in the year and using the different resources were able to generate the required returns (Eljelly, 2004). The gross profit margin for both the year i.e. year 7 and 8 shows consistency which states that despite a decrease in sales the direct cost associated with the business has reduced highlighting the fact that the business has a direct relation with the inputs and output. The area of concern for Competition Bikes Inc is the operating profit margin and the net profit margin which has decreased considerably. The operating profit margin has decreased to 1.9% in year 8 from 5.3% in year 7 whereas the net profit margin has decreased to 0.6% in year 8 as compared to 2.8% in year 7 showing an increase in expenses. A more detailed analysis shows that indirect expenses have increased despite a reduction in revenues showing inefficiency on the part of the management to control the indirect cost. This is an area of concern and the management of Competition Bikes Inc needs to cut down the unnecessary cost and look toward improving their operational efficiency so that business performs better. While comparing the same with another competitor named Two Wheel Racing Competition Bikes Inc has a lower gross profit margin, net profit margin and operating profit margin. This shows that Competition Bikes Inc has more direct and indirect cost compared with its competitor which is an area that needs to be worked on. Competition Bikes Inc needs to use other players and industry as a standard and needs to work in such a manner that they are able to achieve better effectiveness and are able to ensure that the bottom line improves. The same has been reflected through the return on assets and equity which shows a dip due to the fact that the profits have decreased and is an area which Competition Bikes Inc need to focus on for the future. Liquidity Ratios: This ratio helps to understand the financial health of the organization by looking at the liquidity condition of the organization. This thereby helps the business to ensure that strategies are developed which will look to use the finance in a better manner and ensure that they don’t get engulfed in a liquidity trap as it helps the business to plan the money they will receive and pay within a short period of time which is normally one year (Gandy, 2011). The performance of Competition Bikes Inc for year 7 and year 8 shows that they have more liquidity than required which shows that the business hasn’t been able to use the finances properly. The ratio for the two years shows that liquidity has decreased as the current ratio has moved from 5.79 in year 7 to 5.25 in year 8 and the acid test ratio has moved from 4.41 in year 7 to 4.14 in year 8. The management needs to work on similar lines and need to reduce their current investment so that better efficiency is achieved and the finance is used in the correct direction. Comparing the ratio to the competitor Two Wheel racing also shows very high liquidity content requiring the development of immediate strategies which will reduce liquidity and provide better use of resources. While comparing the current and the acid test ratio it is witnessed that Competition Bikes Inc has little inventories which is a good sign as it will ensure limited chances of the inventory becoming obsolete but the other concern for Competition Bikes Inc is that they should ensure that they have sufficient inventory so that the daily operation of the business doesn’t comes to a halt. This thereby requires careful planning and developing a method through which Competition Bikes Inc will be able to use its short term finances in a better manner. Efficiency Ratios: Efficiency ratios look to evaluate the manner in which the different assets and liabilities are used by the business to carry out their operations and earn profits for the business. The average collection ratio shows consistency for year 7 and 8 as in both the year the money is collected within 44 days whereas the competitors collect the money in 33 days. This increases the risk for Competition Bikes Inc as they need to look at collecting the money quickly which will help to further improve the current ratio and also ensure that the chances of bad debts reduce (Lyroudi & Lazaridis, 2000). This would also help Competition Bikes Inc to use the excess funds in a different direction and is an area to work on. Long Term Capital Ratios: The long term capital ratio helps to understand the manner in which the business raises capital and the different component which provides the required finance for the business. The debt ratio shows consistency and nearly accounts for 50% of the total capital whereas the competitor Two Wheel Racing has around 32% which means less than one third of the total component. Competition Bikes Inc needs to reduce the debt component as it is an area of concern and has resulted in the business to pay interest on the borrowed funds which is an expense for the business and could have easily attributed to the shareholders (Antony, 2004). This will help to ensure that the shareholders will be better compensated for the risk undertaken by them and will help to ensure better effectiveness in managing the capital. Market Performance Ratios: These ratios determine the performance of the organization based on different parameters and helps to understand the sentiments of the people towards the organization. The price earnings ratio shows a dip in year 8 as compared to year 7 which is an area of concern and needs to improve so that the shareholders are properly compensated. One of the prime reasons for a dip has been the decrease in bottom line which needs to be improved for better performance. The overall strategies should look towards being competitive and need to improve as the times interest earned have also dipped due to lower profits. Competition Bikes Inc needs to focus on improving both the ratios and identifying the different areas and parameters through which the performance will improve will help to ensure better returns for the shareholders. Analysis of Working Capital Requirements The working capital requirements for Competition Bikes Inc show that the organization has more liquidity than required. This has resulted in the fact that unnecessary investments are being made in short term assets. The comparison of the working capital against the competitor Two Wheel Racing also shows a very high liquidity. Competition Bikes Inc needs to develop strategies where they reduce investment in cash and cash equivalents as it has grown tremendously (Deloof, 2003). This has resulted in having more cash and cash equivalent then required and can be used by the business in different areas through which the overall profit can be improved. Competition Bikes Inc can look to improve the working capital but cutting and reducing investment in those areas which are unnecessary. Competition Bikes Inc can aim to reduce the cash and cash equivalent as it has increased considerably and has thereby impacted the overall working capital needs (Filbeck & Krueger, 2005). The extra money can be used to pay off the short term debts as accounts payable have increased which will help to further improve the brand image. The organization also has to reduce the inventory, accounts receivable and develop a cycle where inventories are properly rotated and money form the debtors is collected on time and also paid to the creditors. This has to be followed by the fact that accounts payable needs to be paid off so that the debt burden of the firm reduces and better efficiency is garnered in managing the different assets. Evaluation of Internal Control The present internal control system used by Competition Bikes Inc is one where based on the future projections and needs order are placed and goods are received. The present internal control system used by shows the following weakness Competition Bikes Inc needs to follow a complete process where the entire purchasing process, including bidding, purchasing, receiving, and invoice processing is necessary to be looked and developed so that the different gaps which are present can be fixed. Competition Bikes Inc needs to ensure that while purchasing the product price is matched with quality as it will have an impact on the final output. Identifying the match between quality and price will help Competition Bikes Inc to purchase goods from the correct bidder and ensure maximum effectiveness in purchasing goods (Saleem & Rehman, 2011) The department also lacks personal verification of the goods which has been purchased. The department should compare the goods received with the one ordered so that when the payment is made it is correct and for the goods which have been purchased. The goods should match with the business requirements and should be capable of enhancing the business performance The different gaps provide different risk for Competition Bikes Inc which has to be dealt with and are as Misuse of inventory which would mean loss for the business as people could use the goods for other purpose than stated Mismanagement of finance as the business could pay for the goods which are not received Chances of theft and lack of proper verification and monitoring of the entire process Competition Bikes Inc needs to develop their internal control system where they ensure the use of entire purchasing process, including bidding, purchasing, receiving, and invoice processing along with proper monitoring, verification and continuous development of the internal control process so that effectiveness is gained. This will be achieved through Use the services of auditor to verify the physical inventory with the book inventory so that differences can be found and people found objectionable are dealt strictly Ensure that products are procured from suppliers who are genuine and provides correct products and while looking to do so steps have to be taken to ensure that price and other details are obtained from different suppliers Provide training and ensure that people have proper knowledge and understanding regarding the manner inventory has to be managed. Properly check the materials against different dimensions and specification so that quality standards are met and correct products is received This will help to exercise better control and will ensure that the business will be able to use the resources in a better way. The entire purchase process needs to undergo certain changes and based on the needs and requirements of the organization ramification for better performance have to be developed. Compliance with the Sarbanes-Oxley Requirements Competition Bikes Inc complies with the Sarbanes Oxley Act by disclosing all the accounting principles, internal control system and disclosure in the financial statement. This can be seen from the statement which has been provided where every detail regarding the internal control system and process is provided. This will ensure that there is no mismanagement of finance with regard to inventory in the financial statement and will just require to work on certain areas like better monitoring and verification of inventories so that complete justice can be provided. The only concern with this regard is the manner in which the different gaps like bidding, purchasing, receiving, and invoice processing is missing in certain parts needs to be developed so that the internal control system becomes better and stronger. Competition Bikes Inc needs to aim at improving the process of providing details regarding the inventories and have to ensure that all the information supplied is correct and true. Along with it detailed regarding the different disclosures and accounting policies are clearly provided. The company needs to revive the entire purchasing process, including bidding, purchasing, receiving, and invoice processing is necessarily developed so that the internal control complies with the SOX requirements. This has to be matched by the fact that the overall process should be such that it aims towards maximizing the gains and ensure better control over the use of resources. The financial statement needs to further follow the principle of disclosure and provide complete details regarding the manner in which internal controls are being provided. Conclusion This report presents the financial analysis which covers the horizontal analysis, vertical analysis, trend analysis and ratio analysis where the performance will be evaluated and areas which need to be improved will be highlighted. The report will then analyze the working capital situation for Competition Bikes Inc by highlighting the areas they need to improve and the manner in which it will contribute towards the profit of the business. The report will then present the internal control system for Competition Bikes Inc and identify the manner in which the risk can be mitigated and better strategies for the long term success can be gathered. Finally, the report will highlight the manner in which Competition Bikes Inc complies with the Sarbanes-Oxley act and highlight the areas which need to be improved on. Thus, an overall analysis of the financial statement based on different areas and directions have been provided which will help to develop strategies for the future. 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