Analysis under this model requires the examination of performance data over a specified accounting period (Marchetti, 2005). The paper analyses the performance of Competition Bikes and applies methods to pursue the same. This method relies on the final financial statements in the form of the balance sheet and the income statement. According to the returns of year 6 and 7, the revenue raised by 33% as contrasted by a year 7 and 8 net slump of 15%. This decline is a weakness. It is likely that during the second trading period; a recession had gripped the economy, thereby, reducing the returns. In addition to that, problem, the competitors such as Wheel Racing Inc could have caused the reduction in market share.
This is a major strength since in both periods, the decrease in selling expenses in both accounting periods’ shows that the company’s strategy of minimizing costs is effective. The company should continue implementing strategies that reduce the selling costs that sometimes take up a large proportion of the net earnings. An increase in general and administration costs in both accounting periods proves that the company has a major weakness in ensuring that the costs remain as low as possible. The company should come up with strategies that endeavour to reduce the general and administration costs.
Net earnings experienced an increase of 313% between year 6 and 7 and 81% between year 7 and 8. This is a major strength since the increases are attributable to sound selling strategies and competitive product placement in the market. It can also be attributed to commendable cost reduction strategies by the company, which have reduced the operating costs of the organization. The performance also shows that the organization has the capability to earn more than other companies do since it has a competitive advantage. The reduction in net earnings between the two periods can be attributed to the decline in sales reported at the end of year 8. It is also evident that Wheel Racing, Inc. offers stiff competition to Competition Bikes Ltd, and it could be one of the major reasons as to why the sales were less in the accounting period.
Horizontal analysis on the balance sheet provides a clear comparison between assets and the financial assets. A thorough analysis provides the change in financial position within the three years. The company had an increase of 34 percent in year 6 and 7, which shows that the company has adequate assets to cover the current liabilities. This is a major strength since the more the current assets in a company, the better, because the company can be able to cater for the short term, the company posted a 34% increase in current assets due to the 164% increase in accounts receivable. This performance was commendable. In addition, a 2% increase in total assets for the same accounting period. This company seems to place a lot of importance on the ability to meet short-term obligations. It aims to achieve that through accumulation of current assets.
There was a 122% increase in liabilities between year 6 and 7. This is a weakness since it translates to an ineffective utilisation strategy of assets to fund its projects. The increase can also be attributed to be as a result of large external borrowing by the company. Unfortunately, this tends to imply that the company is poor in generating internal funding. Therefore, the organization should ensure that it controls its amount of external borrowing in order to ensure that it does not fall into debt. In conclusion, horizontal analysis shows that the first accounting period posted better figures than the second period. Therefore, the company’s major strength lies in the large composition of assets. However, its weakness lies in large external borrowing. The organization should implement strategies that utilize assets efficiently while reducing external borrowing.
Vertical analysis concerns itself with the examination of crucial areas of the assets, liabilities, and capital structure. Each balance sheet item is analysed subject to assets while each income statement item is analysed subject to sales levels (Marchetti, 2005).
On a favourable note, the selling expenses maintained a steady 6.7% during the three-year period. The 6.7 percent shows that the company’s strategies of minimizing costs are very effective. Lower selling expenses usually reduce the operational expenses and as a result, lead to high profits due to low profits. The general and administration costs slumped slightly from 17% to 15% between year 6 and 7 but increased to 18% in year 8. Operating income for the three years was 2%, 5%, and 1% respectively. The administration cost is another weakness since it shows that the general and administration costs represent the most adverse cost unit. This should be reduced to enable the company to make profits. The company should concentrate on reducing this cost. The administration has to be downsized to enable the company benefit from the low cost of a lean structure.
The earnings before interest, taxes, and net earnings shows that the company performed better in year 7 compared other years. This is because there was a 3 percent increase in the earnings compared with other years, which had lower proportions. The decrease in the net earnings by 3 percent could have been as a result of the decrease in the sales recorded in the year. Competition Bikes should come up with effective strategies of increasing revenue and minimizing cost of production in order to increase the profits.
Current assets have maintained a steady rise from 24, 31, and finally 37% respectively in the three years. This is a major strength exhibited by the organization. The increase represents a commendable policy of increasing current assets to improve operating income. This also contributes at improving the financial position of the organization. At the same time, the company scaled down the current liabilities steadily at 2, 5 and 7%. This is a strength exhibited by the company. This is mainly because it has maintained a healthy current ratio of the business. The practise is good for the ability of the business to meet immediate obligations.
Total liabilities reduced from 45%, 41% to 38% over the same period. Conversely, equity increased from 52, 53 to 54% over the same period. The comparison shows that the company yearns to decrease its gearing. The main area of concern for the company is the amount of borrowing which increase the level of gearing in the company. The total stockholders’ equity in year 6 was 52 percent, 53 percent in year 7, and 54 percent in year 8. This implies that Competition Bikes maintained the same level of capital in all the three years.
Under the trend analysis, historical data shows a potential for exponential growth. From the analysis, the best performing year for the company is year 7. This is mainly because the company recorded a good increase in revenue and profit from year 6 to year 7. This is mainly because there is a 33% increase in revenue from year 6 to year 7. The increase of sales figures by a third of base year figures in one year is a healthy spike. This could be attributed to policies geared towards reducing cost of operation and increase in sales volume. The trend analysis also showed stagnation in the two year immediately following the base year. The company does not maintain its strategy well enough by this analysis. This is mainly because the company reports its worst performance during year 8. This could be explained by the tough economic times. In addition, the company might be losing its customers to competitors leading to the decrease in sales and revenue.
Projected sales traversed from 3.2% to 7.2% higher than 2008 in the year 2009 and 2010 indicate that the company yearns to increase its earnings steadily over time. This is a strength that that has been displayed by the organization. In the same vein, the company targets to maintain costs at manageable levels or reduce the same. This manifests that the company intends to minimise costs by putting mechanisms and policies in place to maintain the costs. The intention of the company to boost its sales every year point to the existence of a strategy that is healthy for its growth.
The trend forecasting is extremely modest for such a company. This is a weakness that has been noted with regard to the organization. The company should review its budgeting policies with a view to revising them upwards. For example, the forecasted net sales in the company’s budget indicate that from year 2008 to 2009 there would be an increase in 3.2%. This is a modest value for the organization since it can be able to aim for a higher value of increase in net sales. This is mainly because from 2009 to 2010 a further 10% is projected. The forecasted trend analysis implies that the company has the potential to increase its sales as well as revenue from year 8 to year 11.
Ratio analysis analyses the comparative performance indicators. Current ratio was 5.5 in year 7 and 8. This is a major strength of the organization mainly because its main competitor Two Wheels Racing has a current ratio of 4.2. Comparing these two figures, it is evident that the company has a favourable ratio. This indicates that the organization has an excellent liquidity and it can be able to handle short-term obligations.
Acid test results show a result of 4.5 which is higher than the competitors. The figure implies that the company’s assets are 4.5 times the liabilities it has. This is an advantage since these figures prove that the company has a better operating position that the competitor. This is mainly because it indicates that the organization enjoys a favourable position when it comes to meeting any short-term obligations that may arise.
The organization has a collection period of 43.5. This shows that the organization has an excellent credit policy. However, a collection period of 43.5 against Two Wheel Racing 32.5 days is adverse and is a weakness of the organization. This means the operating assets of the company are held up in accounts receivables. This means that current assets do not circulate and generate profits as efficiently as possible. This is unfavourable because decreases earnings and return on capital employed. It is important to ensure that the collection period is reduced to ensure that the organization does not undergo opportunity cost when it comes to investments. The organization also faces the risk of liquidity due to large amounts being held by debtors.
A 46% debt ratio is worse than Two Wheel racing 38%. This is a weakness exhibited by the organization since it indicates that the organization obtains 54% of its funding from external funding. As discussed earlier, the organization should ensure that it controls its amount of external borrowing in order to ensure that it does not fall into debt. The debt ration exhibited by Two Wheel racing indicates that the competitor has better internal revenue generation policies.
Further, the 27% gross profit margin as compared to the competitor’s 32% is adverse. This shows that the competitor is more efficient than Competition Bikes. This indicates that Two Wheels has more effective operating activities than Competition Bikes. The net profit and gross profit disparity shows that the expenses are exorbitant. The gross profit margin that was reported was 27%. Comparing this to its competitor, it is evident that it has been outperformed. This is mainly because Two Wheels Racing reported a 32% gross profit margin. The company should streamline its production and check unnecessary expenditure to maximise profitability. The increase in price-earnings ratio and a corresponding decrease in return on equity indicate a high gearing ratio. High gearing ratios are detrimental to the performance of a company.
The earnings per share of 0.04 of Competition Bikes are lower than Two Wheels at 0.04. This a weakness exhibited by Competition Bikes. This means that investors are likely to be attracted by the competitor (Rees, 1995). At earnings per share (EPS) of 0.04, Competition Bikes has worse returns on investment than Two Wheels at EPS of 0.08. This is worse than Two Wheels especially considering that the company has a superior price earnings ratio of 83. The ability to service external debt for Two Wheels is 4.24 as compared to 1.77 for Competition Bikes. This is another weakness. A higher interest earned ratio is good for a company since it indicates that the company can be able to generate enough funds to pay interest. The company has to reduce its liabilities to decrease gearing. This will also free up returns to service owners’ equity. On the other hand, Competition Bikes has a price earnings ratio of 83, which is superior to the Two Wheels Inc. This is a strength since it evidently shows that the company stock is highly attractive to shareholders and investors.
Ways of improving cash flow:
One of the ways through which the company can increase cash flow is by increasing its sales volume for each year. This can be achieved by reaching out to more clients. This can be achieved through the utilization of marketing campaigns that markets the organization’s products to consumers. The company could utilize the internet to market itself. Nowadays social media offers a cheap and quick way to reach out to a large number of consumers as well as potential customers. By improving its customer base, the organization will be able to improve its revenue as well as sales.
The company should also seek to reduce production costs. Production factors such as energy, economic infrastructure (for instance, transportation and communication), labour, as well as raw materials are crucial factors in improving sales volume. Low costs are an encouragement to production in the market. This will also lead to the organization being able to operate under the current market prices. This will help the organization target price conscious consumers thus improving its cash flow.
Ways of using excess working capital:
The company should decrease its working capital current ratio. This is mainly because it has an excess working capital since it has a current asset ratio of 5.4 in year 7. In year 8, the current asset ratio continued to increase to 5.9 by decreasing the working capital it would be able to generate more income. The reduction of the credit collection period for instance would boost turnover figures. The maintenance of a healthy ratio will enable it meet its financial obligations in commendable time. Non-essential expenses should be done away. The payment period for supplies should be reduced to enable the company address the working capital shortfalls. Competition Bikes has a lot of idle working capital tied up in accounts receivable. These should be realised to enable the firm pirate n the short term. Reduction of the repayment period will facilitate a growth that is required in the current reserves. Meeting the working capital needs is paramount to success (Rees, 1995). The organization can also invest the excess working capital in a website that will help it market itself as well as sell its products.
Internal control system:
The company has a formidable internal control system.
1. Only the purchase department is involved in the process of acquiring raw materials. No other department is involved in the purchase process. This ensures that there is no teeming and lading or fraud.
2. The order of raw materials is made on the projection of the first month instead of market prices or historical trends.
3. The company compares information from three sources before making a decision to purchase raw materials.
4. The purchasing department is responsible for writing pay checks for suppliers.
5. All unused raw material is kept at the end of the month. This is an excellent, however, there is a need to record this raw material.
1. The purchasing department should not order raw materials based on the monthly projections rather it should be based on historical projections.
2. The company should ensure that all transactions are recorded. This can be achieved by ensuring that all goods received have a delivery note and it sends out a receive note to the supplier.
3. The company should have internal checks that will ensure that the goods received (stated on the delivery note) are the goods that were ordered.
4. The purchase department should be scaled down to prevent any form of fraud. Currently the department orders material, invoices and pays for the materials. This should be broken down to different departments.
5. The organization should not just compare three sources with the same quality. This could lead to receiving poor quality goods.
6. All unused raw materials at the end of the month should be recorded and documented for further accountability.
Risks and how to mitigate them:
The company faces the risk of being defrauded by the purchasing department. This is mainly because the purchasing department is tasked with the ordering raw materials, invoicing and paying the suppliers. This risk can be mitigated by ensuring that the tasks are separated into different departments. Different departments will ensure that the organization has more control over the ordering, invoicing and payment of suppliers.
The company also faces a business risk of receiving substandard raw materials from suppliers. The organization only relies on only three suppliers. The number of suppliers to the organization should be boosted to increase competitive bidding between suppliers. There should be an allocation for increasing the number of suppliers. By having a large number of suppliers, the organization evades the risk of receiving substandard raw materials. In addition, the company should have a quality control department that is tasked with checking and determining the quality of the material received from the suppliers in order to ensure that the products received are of a certain standard.
Analyzing compliance with Sarbanes Oxley Compliance:
Competition Bikes does not comply with Sarbanes Oxley act. On assessment of the internal Control System under section 404 requires the management to review the control procedures of a company (Marchetti, 2005). In this respect, the company reports that it has strong internal control, however, this is not the case. There are issues that the company needs to address.
The company should adopt the recommended corrective measures, which will ensure that its internal control measures are effective. The company should also ensure that it comes up with new ways of keeping records at the company in order to ensure Sarbanes Oxley compliance.
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