Competition Bikes Inc. Storyline
Horizontal Analysis
In horizontal analysis, analyses of the performance of the company over a given duration of time is done. The intent of this paper is to analyze Competition bike's performance in the given period by using various methods. From the analysis of the financial statements of Competition Bikes Inc, there is a commendable performance in the company. Although there is a decrease in sales in the year 7 and the year 8 of 15 percent, a rise in the net sales is observed in the year 6 and 7, with an increase of 33 percent. This reduction in sales in the year 7 and 8 could have been contributed by an increase in competition for instance from Wheel Racing Inc, or general increase in the price level due to the inflation levels. This is an indication of a drastic change in the level of sales in year 7 and year 8 in the income statement. These changes in the sales level lead to changes of gross profit in the company’s income statement. This is evident by the decrease in gross profit in year 7 and 8 by 16.3 percent and a rise of 37.5 in year 6 and 7. The reduction of the gross profit level in the year 7 and 8 is contributed by a decrease in sales in the same period.
The company’s weakness to control general and administrative expenses was evident, as there was an increase in these costs in these respective periods. A 1 percent increase in these costs occurred in the year 7, and 8 and a 20 percent increase is also experienced in the year 6 and 7. This shows that the company is unable to maintain these costs as low as possible. The research and development cost incurred in year 8 lead to an increase in cost in the year. The provision for taxes and earning before interest and taxes has changed with the same proportion. The existing hostile competition has led to a decrease in sales.
The balance sheet horizontal analysis provides a clear comparison of the assets in the company. A change in the financial position is evident when a further analysis is done. The company shows that it has adequate assets to cover its current liabilities as there is an increase of assets by 34 percent in the year 6 and 7. This shows that the company is able to meet its current maturing obligations when they fall due for payment. The increase in the level of assets in the company can be contributed by the huge increase in the account receivable by 164 percent. This was a tremendous improvement that makes the company liquidity level improved. The total asset value increased in the year 6 and 7 by 2 percent despite a small decrease in the value of total assets was evidenced in the year 7 and 8. This shows that, the company strength lies in the composition of assets.
There was an increase in the liability levels in the year 6 and 7, by 122 percent. This is an indication that, the company does not fully utilize the available resources in its operations or funding its projects. The company has a huge external borrowing, which could have contributed to this increase in the liabilities level. The Competition Bikes Inc should finance its borrowing with an optimal debt to avoid the risk of indebtedness.
The performance of the company in the year 6 and 7 is better than the performance in year 7 and 8. This is obtained from the horizontal analysis done on the income statement and statement of financial position. The company has a tendency of financing its operations from external funds rather than internally generated funds. Therefore, the company should reduce the level of borrowing, as well as the cost of borrowing.
Vertical analysis results
Vertical analysis involves analysis of three financial components, which are basically assets, liabilities and equity. The balanced sheet is expressed in terms of assets, and the income statement is expressed in terms of sales. The assets and sales are used a basis of evaluation. This makes organizations have an elaborate view of progress in the financial performance.
The cost of goods is 73 percent of the total sales of Competition bikes Inc. This shows that, the sales level has an impact on the gross profit earned by the organization. On average, 27 percent of the accounting profit is recorded by the company in the three periods. The management of competition bikes Inc needs to develop strategies to reduce its operational costs. This will lead to an increase in profits as there will be a reduction in cost of sales. The company average gross profit is 27 percent. For the achievement of higher profits, the company should reduce its costs or increase its unit selling price. The proportion of administrative costs and operational costs tends to equalize in the three periods. These costs in year 6 is 17 percent, 15 percent in the year 7 and 18 percent in the year 8. From these analyses, the year 7 seems to have a better performance than the year 6 and 8.
The same trend is followed by the earnings before interest and taxes. There was a better performance of the company in year 7 as compared to the year 6 and the year 8. This was as a result of 3 percent increase in earnings when compared with the other years. The decrease in earnings levels could have been contributed by the sales level in the same period. The sales level has a direct relationship with the earning levels in the company. For Competition Bikes Inc to increase its profit level, it needs to develop strategies that increase its sales revenue, as well as reduce the cost of production.
The ratio between the current assets and the total assets of the company was 24 percent in the year 6, 31 percent and 37 percent in the year 7 and 8 respectively. This contributes to the increase in the financial performance of the company in these three years. This is an indication that, the company is using measures of improving its asset base as time progresses. On the other hand, the level of current liabilities is changing but with a lesser magnitude than the current assets. It is evident that, the current liabilities ratio in the year 6 was 2 percent, 5 percent and 7 percent respectively in the years 7 and 8. This shows that, as the level of current liabilities increased the level of current assets increased but with a bigger magnitude. It is recommended that the company should maintain a low level of liabilities to maintain its liquidity position. (Atrill, Jenner, & Silvester, 2003)
The company’s capital structure is made of debt as one of its components. The ratios of the debt level in the three years were 45 percent in year 6, 41 percent in year 7 and in the year 8, it was 38 percent. A lower level of borrowing was done in year 8 as compared to the other years. This can be as a result of increase in the equity level in the year 8 whereby the equity level was 54 percent. The level of equity in the other years was 53 percent in year 7 and 52 percent in the year 6. Therefore, the company has an ability of reducing the debt level which increases the gearing level of a company.
The outcome of trend analysis
Trend analyses involve analysis of the performance of the company through an assessment of its financial outcomes. Competition Bikes Inc is showing a commendable performance as indicated by the projected and historical trend analysis. This is also evidenced by an increase of 133 percent in the year 7. There is an increase in the sale, as well as a reduction in costs in the same period. There were high net earnings realized in the period. Year 8 income was different from year 7 income due to a drastic decrease in the sales level. This lead to unpleasant performance in the period. For Competition Bikes Inc to gain competitive advantage, it needs to set strategies of sales margin improvement.
There is a projection of sales increase by 3.2 percent in year 2009 and 4 percent in the year 2010. This is an indication of expected improved performance in the years 2009 and 2010. The company forecasts to fully implement its sales strategy by the eleventh year. This shows that the company is able to increase its sales without an actual increase in the cost of production. This is an indication that the company is striving to achieve its objectives within the stipulated period of time that is the year 2011.
Ratio analysis
The performance of Competition Bikes Inc can also be analyzed using ratios. The company’s current ratio in the year 7 and 8 is 5.5 while that of Wheels Racing Inc is 4.2. This shows that the company has a high liquidity position than its competitors. This is an indication that the company is able to meet maturing obligations as and when they fall due for payment. From the acid test ratio of 4.5, the company current assets are 4.5 times more than its current liabilities.
The company has been able to meet its outstanding obligations in due time better than their rivals. It has been indicating a very high average collection period of 43.8 days whereas its competitors average collection period is 32.5 days. This shows that the Competition Bikes takes a longer period to receive payment from their debtors than their competitors do.
The credit policy of Competition Bikes Inc is an average collection period of 43.8 days. When compared to the company’s competitor, Wheel Racing Inc, the competitor has a better collection period of 32.5 days than that of the company. This shows that, the average time taken by a debtor in a competitor company to pay is less than a debtor of the company. A low collection time is recommended thus the competitor is better than the company. The opportunity cost incurred for holding the money by the debtor is more to the company than the competitor. This shows that, the company should review its credit policies to match with the competitors trend. The company has high chances of incurring liquidity problem if the cash held by the competitors is huge. On the other hand, the debt ratio of the company competitor is lower than that of the company, an indication that the competitors depend on its owners' equity more than the company. This means that, the gearing level of the competitor is higher than that of the company hence improved value in its capital structure.
When the profit margins levels of the two companies are compared, Two Wheel Racing Inc shows a higher margin than the Competition Bikes Inc. This is an indication that the performance of the competitor is higher that that of the company in terms of the profit making. The company is supposed to devise strategies to improve its margin level to prevent the competitor from snatching its market share. The competitor trend should warn the Competition Bikes Inc managers on how to face the challenge. In the stock market, the Two Wheels Racing Inc performs better than the Competation Bikes Inc. This is evidenced from the earning per share of the two companies. The Two Wheels Racing Inc has a 0.08 earning per share while the Competition Bikes Inc has 0.04. This shows that the company should develop measures to improve its performance to attract investors into the company.
Part B
Cash flow improved techniques
Competition Bikes, Inc. has an average collection period of 44 days. This implies that it has a good credit policy. Nonetheless, Competition Bikes should attempt to reduce the number of days it takes to collect the receipts from debtors. The reduction in the number of days of the collection is instrumental as it ensures that the company invests in profitable ventures. In addition, the company has an acid test ratio of 4.5 and a current ratio of 5.5. These ratios imply that the company can be able to furnish its short term obligations when they mature. Competition Bikes Inc has an operating profit margin of 1.9 percent, a gross profit margin of 27 percent and net profit margin of 0.7 percent. These ratios are low, and the company needs to improve on the cash flow techniques so as to increase its earnings. The low turnover ratios were mostly caused by the decrease in sales from 5,980,000 in year 7 to 5,083,000 in the year 8.
Strategies that lead to an increase in sales levels also lead to an increase in cash flow. For the Competitive Bikes Inc to increase its cash flow levels, it must develop strategies to increase its sales. The company can advertise its products, carry out product promotion, as well as diversification of its operations as strategies of increasing its sales level. This will improve its competitive advantage over its competitors. This can also be done through upgrading of its technology in production to ensure an efficient, as well as effective production means. The reduced cost of production can also be achieved through the choice of a supplier who allows a quantity discount. This will lead to reduced cost of production thus an increase in the cash inflow levels in the company.
Methods of utilizing surplus working capital
The company has excess working capital as indicated by the acid test ratio of 4.5 and a current ratio of 5.5. This excess working capital can be used by the company to increase its investment level of bikes. Another kind of investment that can be made using this excess working capital is upgrading the company's technology level to match with the changing world. This, in turn, will lead to an improved competitive power over its rivals. Investment in production machinery will also lead to an improved performance of the company. An increase in the quality of bikes will make the firm sales level increase thus high earnings.
Part c
Competition Bikes Internal controls
i. The acquisition of raw materials is made by the purchasing department. Collusion among the working group may result due this thus subjecting the company to some risks.
ii. Historical or market prices should be used to make acquisition of goods, but the company uses the first month projection.
iii. The company should consider recording the unutilized raw materials since failure to record may lead to inaccurate information about the inventory level.
iv. The company only uses three sources in making its decisions. It ignores other available sources.
The corrective measures
I. The acquisition of raw materials and payment for the raw material should be handled by different departments such that the purchasing department should be concerned by purchasing of raw materials and payment should be made by the cashier. This is to reduce collusion among workers.
II. Monthly projections should not be used to make acquisitions, but use of historical prices, as well as market prices, should be used while making purchasing decisions.
III. There should be a system for recording the raw materials purchased, the remaining stock and the amount of sales. This is to ensure that there exists accurate information for making production purposes. Therefore, a proper accounting procedure would be instrumental.
IV. The company in searching for the best supplier should consider the quality of the materials but not the prices of the raw materials. This is because the company may buy substandard quality. Therefore, to avoid buying substandard materials, the company should consider quality and other sources of supply.
The risks facing the company and how they can be mitigated
Competition Bikes faces a high risk of being insolvent. This is because there is no documentation of the transactions undertaken by the company. It is evident that the company does not keep a record of the unused stock at the end of each month. This is precarious as it may lead to lack of proper usage of the raw materials due to wastage and pilferage. In order to mitigate against this, Competition Bikes should implement bookkeeping policies in order to ensure that all transactions are documented.
Competition Bikes faces a risk of purchasing low quality raw materials in every purchase. The risk is likely to occur due to the fact that the company compares three sources only while making a decision on whether to buy raw materials or not. In order to ensure that the company does not purchase substandard raw materials, it should put in place quality checks and ensure that it evaluates as many suppliers as possible. The evaluation of many suppliers ensures that the company chooses the supplier with quality raw materials.
Another risk facing the company is that of being defrauded its cash by the purchasing department. This is because the department is responsible for various tasks that should be handled by different departments. The risk of being defrauded can be mitigated by ensuring that the purchasing department is responsible for ordering raw materials while the cashier is responsible for paying out the suppliers.
Analyzing compliance with Sarbanes–Oxley requirements
The Sarbanes Oxley Act states that the management should ensure that there are sufficient internal controls so as to reduce the chances of having misstatements being recorded in the financial reports. However, it is obvious that Competition Bikes does not comply with Sarbanes-Oxley requirements. The company’s report given at the end of the year states that Competition Bikes has a strong internal control system while, in the real sense, it has a weak controls. It is evident that the company has a weak internal control system due to the fact that the purchasing department handles multiple tasks which is precarious for the company. In addition, the company does not keep any records which is a sign of a weak internal control system. Therefore, as much as the report filed may indicate that there are strong controls, the company does not comply with the Sarbanes-Oxley requirements.
Corrective actions
The company should put into practice new ways of keeping records in a manner that ensures accountability and transparency. This can be done by implementing accounting procedures and policies to be followed by the accountants. Furthermore, the internal auditor should regularly check whether the internal controls are strictly followed in the execution of tasks in the company. Finally, there should be a semiannual report written by both internal and external auditors meant to ensure that everything is in compliance with the Sarbanes-Oxley requirements.
References
Atrill, P., Jenner, M., & Silvester, M. (2003). Accounting: An Introduction (2 ed.). New Jersey: Prentice Hall.
Koch, & Wüstemann. ( 2010). Accounting & Risk. 1-17.
Mills, D., Call, W., & Drew, A. (2000). Foundations of Accounting. Paddington, : UNSW Press.
Walton, P., Haller, A., & Raffournier, B. (2003). International Accounting (2, illustrated ed.). London: Cengage Learning EMEA.
