Analysis of Company Audit-Risk Using Financial Analysis Tools
Audit risk occurs when an auditor makes an unqualified report of the company’s state of affairs. This results when he or she omits information that is significant in the procedure. An individual could make an error or fraud, thus causing the misstatement (DiGabriele, 2010). These threats are categorized into inherent, detection and control risks.
Financial analysis is the process of collecting, selecting, evaluating, and interpreting financial information of a company. This is significant in making investment and financial conclusions (Lanier & Saini, 2008). The analyzed data are used for internal activities of the organization such as appraising employee performance. Subsequently, the effectiveness of operations and credit policies are also determined. A firm uses this information to choose prospective investments and value the credit ability of debtors (Lau, 2010). An auditor obtains data from the different company statements, such as annual reports and financial disclosures; these include balance sheet, income statement, and cash flow reports.
Balance Sheet
Michael Kors Limited has more assets as compared to Ralph Lauren Corporation. This shows that the former is a larger company because of its own, as the organization’s equity and liability are higher than Ralph company.
Income Statement
Michael Kors has a greater sales volume than that of its competitor, which could be because of a wide market access for the firm. Their sales figures, however, are reasonably close. Its earnings are more than Ralph’s Corporation over the financial period, meaning that its operations and productions are efficient. This leads to an increase in income to the firm, and hence the profit earned is higher. The costs of operations for the Ralph Lauren company are less than the Kors limited as shown by the expenses incurred by both organizations (SEC, 2014).
Financial Ratios
Financial ratios provide mathematical relationships that exist in fiscal information; they have different characteristics and classifications. These include coverage, return, turnover, liquidity, profitability, financial advantage, and return on investment ratios. This report will provide financial comparisons between two competing corporations through ratio analysis of their balance sheets and income statements. Their financial positions and key variances in their annual reports will be determined. This includes Michael Kors Limited and a competing firm which are the Ralph Lauren Corporation. The financial information for the latter were obtained from an internet source.
Liquidity ratios
These ratios indicate the ability of a firm to use its liquid assets to meet its short-term obligations. They include
Current ratio
Current ratios = Current Assets/Current Liabilities
A ratio indicating a value less than 1 shows that a firm may be experiencing liquidity problems. Surplus cash in the business is illustrated by a very high current ratio. The effective and significant value should be between 1.2 and 2.0.
Quick ratio/Acid test ratio
This ratio establishes whether a company meets its liabilities without the sale of its stock: the recommended ratio is about 1:1.
Quick Ratio= Cash + Marketable Securities/Current liabilities.
Leverage ratios
Debt to Equity Ratio: It shows the ratio of capital borrowed from a firm to its funds.
Interest coverage
The ratio shows whether a firm can pay its interest on the loan using its revenue. An effective ratio should be over 1.5.
=EBITDA interest/Expense
Inventory turnover
It shows the number of days it takes for inventory to be converted into sales. A high ratio shows that there is efficiency in buying and selling of products. On the contrary, a low value indicates the existence of obsolete and surplus commodities.
=Cost of Sales/Average inventory
Total asset turnover
= Revenue/ total assets
It indicates the amount of income earned from company assets.
Accounts receivable turnover
=Net Sales/Average Accounts Receivable
This ratio shows the number of times debtors pay for the credit facilities offered by the company. They have weak liquidity positions as compared to the average in the industry. Both firms have a close value of current assets and current liabilities that illustrate this. The profit figures between the two companies differ because firm B is expected to be efficient in its operations; therefore, auditing of the two companies will involve the use of different financial information.
References
DiGabriele, J. (2010). Applying forensic skepticism to lost profits valuations. Journal of Accountancy, 209(4), 32-38.
Lanier, C. D. Jr. & Saini, A. (2008). Understanding consumer privacy: A review and future directions. Academy of Marketing Science Review, 12(2), 1-45.
Lau, C. (2010). A step forward: Ethics education matters! Journal of Business Ethics, 92(4), 565-584.
Securities and Exchange Commission [SEC] (2014). Michael Kors Holdings Limited. United States Securities and Exchange Commission. Retrieved from http://www.sec.gov/Archives/edgar/data/1530721/000119312513239625/d494652d10k.htm
