Subject: Financial Statement Analysis – Task 1
Competition Bikes Inc.
A1.a. Horizontal Analysis Results
Horizontal analysis is the financial statement analysis where line items are compared over time.
The net sales and gross profit of Competition Bikes Inc have fallen drastically in the current period (years 7 and 8) when compared to the previous period (years 6 and 7). This is mainly due to the current economy and due to that fact that some of the sponsors for the professional riders have cut back on funding. The sales forecast for the next few years shows that the current decrease in sales can be recovered partly but would stay under the peak sales figure of 4000 which was seen in 2007.
Even with a decrease in sales, the percentage of Cost of Goods sold to Net Sales has stayed around 73%. This implies that the material and labor cost has remained constant as well. The advertising budget was cut 16.3% in the current period due to low sales and the economy. Advertising budgets are cut whenever the sales are low or the economy is bad. However, this is not good, as it makes it much harder to get the sales. The selling expenses have all reducing in the current period compared to the previous period.
The general and admin expenses have stayed fairly constant compared to the previous period. Utilities has seen a huge change from 3.8% to 11.1%. This might be due to higher energy costs. R&D has seen a decrease of -16.3%. This might have been due to reduced investment in this category in the bad economy. The labor figures remain fairly constant across the periods. The company should cut back on labor and hours as appropriate based on the sales and production needed so that it can save on these expenses. Operating Income has fallen 69.1% which sales have only fallen 15%. This is due to fixed overhead, salaries, utilities and other expenses which are incurred irrespective of any sales. The operating income decline carries over to the net earnings which has fallen 84.1% from the previous period. The company should look at overhead expenses which are being incurred and bring them in line with sales and production needed.
On the balance sheet, cash has increased to 348.2% from -64.6%. Receivables have decreased to -15.0% due to the decline in sales. Raw materials inventory has increased a little bit from the previous period. Competition should lower its raw materials and work in process inventory and bring on par with the projected lower sales. This would free up cash and inventory which would take longer to liquidate. Current Assets have risen 16.5% in the previous period which is a good sign that the money is managed well. The total assets show a 0.2% decline attributable to the declining economy and sales.
On the liabilities side, the accounts payable increased by 33.3% in the last period. Competition should honor its payments on time and to avoid penalties and interest. Current liabilities are up by 28.5%. Total liabilities are down 1.9% and the total liabilities and equity is down by only 0.2%. This is not on par with sales as the liabilities should have reduced more on par with the downward economy. Competition should look at its liabilities and inventory and reduce them as needed.
A1.b. Vertical Analysis
Vertical Analysis is a proportional analysis of financial statement in which each line item is listed as a percentage of another item. Every line item on an income statement is shown as a percentage of sales and every line item on a balance sheet is shown as a percentage of total assets. With this you can see the relative proportions of all items and you can also do a comparative analysis over time.
The income statement analysis of Competition Bikes shows that the gross profit has remained fairly close over the three years, within a 1% difference. Operating expenses did not change over the three years, staying at a constant 6.7%.
General and Admin Expenses increase from 15.5% in year 7 to 18.4% in the year 8. Competition should look at this area and cut costs where it can. The areas it should look at to cost cut are administrative and executive salaries, utilities and other general expenses.
The net earnings have fallen 2.8% in year 7 to 0.6% in the year 8. This would be of concern to lenders and competition’s ability to meet debt obligations.
The balance sheet analysis of Competition shows that the Total Current Assets increased considerably from year 6 to year 7 (24.5% to 31.5%) and from year 7 to year 8 (31.5% to 36.8%). This shows the strength of competition in its liquefiable assets and its ability to repay debt. Under current assets, Accounts Receivables went down from year 7 to year 8 (16.7% to 14.2%), showing that the company is getting its payments sooner. The cash and cash equivalents showed a major increase from year 7 to year 8 (2.2% to 9.7%). Competition should evaluate to see how much current assets it needs to meet its debt obligations and distribute the remaining cash assets to its stockholders or invest elsewhere wisely. The raw materials and work in process inventory have remained fairly constant, but they should be cut down on par with the sales and economy to free up the capital.
Under current liabilities, Accounts and notes payables has increased from 4.6% in year 7 to 6.1% in the year 8. Competition should make sure it pays its accounts on time so that it can avoid penalties, interest and maintain goodwill.
Long term liabilities have decreased over the 3 years, which is a good sign of decreasing debt. Total Stockholders’ equity has increased slightly by 1% over the 3 years.
A1.c. Trend Analysis
Trend Analysis collects past data and predicts the future movement of a stock with the past data. It shows how a company performs over time.
The historical Trend Analysis of Competition Bikes shows a big jump in percentage from year 6 to year 7 (100% to 133.3%). However, in the year 8 it fell back to 113.3% , which is an increase of 13.3% from the base year (year 6), but fell by 20% from the year 7. This is attributable to the bad economy.
The forecasted trend analysis, with year 8 as the base, shows moderate growth from years 9 to 11, but it still doesn’t reach the peak growth of 133% seen in the year 7. This is good for the current economic situation, but Competition should closely monitor its costs, inventory and capital to return to the peak sales seen in the year 7 as expected by investors and lenders.
A1.d. Ratio Analysis
Ratio Analysis calculates the company’s financial data into ratios which can be used to measure a company’s health and can be compared against its competitors, previous years and the economy. There are several kinds of ratios that can be looked at to perform this analysis.
Liquidity Ratios measure the company’s ability to meet its short term debt obligations. They are also called short term solvency ratios as they measure the ability of the company to be solvent in the short term.
1) Current Ratio
It is the ratio of current assets to current liabilities and measures the ability of a company to pay its debt using current assets. The higher the ratio, the better the company is to meet its debt obligations.
Current Ratio = Current Assets / Current Liabilities
The current ratio of Competition is 5.25:1 in year 8 and 5.79:1 in year 7. The ideal value of current ratio is 2:1, as that would allow a company to still pay its short term debt, even if the assets are cut by half. Competition is well above this value and can meet its short term debt obligations and withstand any crisis. Two wheel racing’s current ratio is 4.20:1, which shows that Competition is better placed in terms of its current assets and is fairly ahead of its competitors.
If the company’s composition of current assets has a lot of slow moving assets, then it is tough to convert them quickly into cash to meet its debt. To avoid this, the acid test ratio should be considered.
2) Acid Test Ratio
Acid test ratio measures the company’s ability to pay its short term debt using its quick assets. Quick Assets can be defined as cash, short term investments and accounts receivables. These assets are very liquid and can be quickly converted to cash to meet any short term debt. The higher the ratio, the better the company is to meet its debt obligations.
Acid Test Ratio = (Cash+short term investements+Accounts receivables) /Current Liabilities
The Competition’s Acid Test ratio is 4.14:1 in year 8 and 4.41:1 in year 7. The recommended value for this ratio is 1:1, as that would give a company enough cash to meet its short term debt. The competition’s acid ratio is well over this ideal and is more than Two Wheel Racing’s acid ratio of 3.40. As the acid ratio looks only at quick assets, the company should take a look at how long the collection period of its accounts receivables and accounts payables and should take corrective me