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Financial StatementAnalysis and Controls

Prepared for Competitive Bikes, Inc.

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Horizontal Analysis

Using a horizontal analysis of the income statement for Competitive Bikes, several thingsstand out.

Years 6 and 7

Comparing Years 6 and 7, the company did very well. hey saw a !!" increase in netsales during Year 7, which gave them a !#.$" increase in cost of goods sold. %u&tractingthe dollar amounts of cost of goods sold from net sales yields an increase of !7.'" ingross profit for Year 7. (ncreasing profit is, of course, the main goal of a company, whichmade Competitive Bikes )uite successful in Year 7.

*erhaps part of the reason for the increase in profits was that Competitive Bikes increasedthe amount spent on advertising &y !7.'", and had an increase in research anddevelopment of !7.'". +s learned in the %upply Chain anagement class given &y

-estern overnor/s University, &oth an increase in advertising and in research anddevelopment will lead to an increase in profits.

-ith e0tra sales come e0tra e0penses. otal selling e0penses increased &y !!" andgeneral and admin e0penses increased &y !#.#". his is not a pro&lem, &ecause thecompany was still )uite profita&le. hese num&ers would only &e a concern if thecompany had not had such an impressive increase in net sales.

(n Year 7, Competitive Bikes saw their net earnings 1ump from 237,374 to 2#46,543,which figures out to a !#!.3" increase. his means that Competitive Bikes more thantripled their net earnings in Year 7. his was a very good year for the company.

he horizontal analysis of the &alance sheet for Years 6 and 7 shows that the total assetsfor the company increased &y 5.4" in Year 7. -hile this is not a large num&er, it is &etterthan a negative num&er and is not indicative of a pro&lem.

+t first, it can appear concerning that in Year 7, +ccounts and otes *aya&le increased &y#45", or 2#5$,$5. his is a pretty steep lia&ility, and one that is not favora&le for thecompany. +ccrued salaries decreased &y 5", &ut it still left the company with a #55.3"increase in total current lia&ilities. 8owever, lia&ilities are often turned into assets, and itcan &e surmised &y looking at the &alance sheet that this is what has happened here. (ndollar amounts, the total assets increased &y 2##4,4#3 and the total current lia&ilitiesincreased &y 2#5$,65.

otal long term lia&ilities decreased &y '.6", which is a good thing. his means that thecompany/s mortgage and other long term payments were made. his is possi&le &ecausethe company made enough gross profit to cover these payments.

9etained earnings increased 5" in Year 7. his is good for the company, &ecause it isinvesting that money in itself to increase its worth. he total stockholder/s e)uity is

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246,543, or an increase of 3.3". +n increase in stockholders e)uity is also a good thing&ecause it means that the net worth of the company has increased.

:verall, Competitive Bikes was a very successful company in Year 7, &ased on thehorizontal analysis of Years 6 and 7.

Year 7 and $

Year $ was rougher on the company, as the horizontal analysis &etween Years 7 and $shows.

(n Year $, net sales and cost of goods sold &oth decreased, which resulted in a #6.!"decrease of gross profits. his in turn leads to a decrease in operating e0penses.+ccording to the Competition Bikes %toryline, this decrease in sales is due to the pooreconomy. 9egardless of reason, a loss of profits is not a desira&le situation for thecompany.

+dvertising costs decreased &y #6.!" and research and development decreased &y#6.!". (t is unknown if these costs decreased simply &ecause money saving measureswere found, or if it was &ecause the company decided to cut money from these programs.(f the company did decide to cut money from these areas, this might account for some ofthe loss in sales.

-hile total operating e0penses declined, eneral and +dmin e0penses increased &y#.5". his is somewhat concerning, &ecause the ma1ority of the increase came fromUtilities. his could &e e0plained &y a couple of situations;

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again a&le to pay their mortgage and other long=term &ills. ot &eing a&le to pay thesewould spell &ad news for a company. +ll together, total lia&ilities decreased &y #.4",which makes that part of Year $ successful.

Year $ only saw 2!6,#, or a !.#" increase, put into retained earnings. his is

significantly less than the previous year, &ut still not &ad. his added a #.6" increase tostockholder/s e)uity. he stockholders were likely not over=the=moon e0cited a&out this,&ut at least it wasn/t a loss? :verall, the total >ia&ilities plus

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+ vertical analysis of the &alance sheet can tell many things a&out a company. orstarters, Competitive Bikes total current assets are 53.'" AYear 6, !#.4" AYear 7, and!7.5" AYear $. + typical company has current assets of appro0imately !" A8orngrenet al., 54, so Competitive Bikes is in a good position. et *roperty and

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to forecast sales &ased on many years worth of history. +dditionally, the company has noguarantee that the economy will improve, which could skew their forecast.

Eespite that, it is still possi&le for the company to achieve the forecasted sales. hecompany has some strengths that will allow for these sales to happen, so long as the

weaknesses are taken care of.

he ma1or strength of the trend forecast is that the pro1ections are not so large that theyare unattaina&le. he num&ers are realistic and not inflated.

+lso in the strength category is that the company has a good )uality product that isindividually customized for the customer. heir product is dura&le and relia&le, and theirresearch and development team has made some vast improvements on the product. heseare all strengths for the company, and will allow for the pro1ected sales to &e attained.

atio Analysis

Current 9atio

he current ratio tells if a company is a&le to pay off its lia&ilities. he higher the ratio,the &etter a&le a company is to pay off the lia&ilities with assets A8orngren et al., 54.Competitive Bikes had a current ratio of '.4 for Year 7 and '.!' for Year $. +lthoughthis num&er did decrease in Year $, it is still a very strong num&er. (f the current ratio istoo low, then Competitive Bikes would not &e a&le to pay off their lia&ilities with assets,and if it were too high, it would &e indicative of assets that were too li)uid A8orngren etal., 54. Competitive Bikes has enough assets to pay off lia&ilities.

Competitive Bikes competitor, wo -heel 9acing, has a current ratio of 3.5 for Year $.-hile this is also a strong num&er, it is not as strong as that of Competitive Bikes.

+cid=est 9atio

he acid=test ratio is a way to determine if a company could pay off all its currentlia&ilities if they &ecame due immediately. or this ratio, a company should strive tohave as high of a num&er as possi&le. + #. is considered a FsafeG num&er A8orngren etal., 54.

Competitive Bikes scored a 3.'5 in Year 7 and a 3.5' in Year $. +lthough they had aslight decrease on the acid=test ratio in Year $, &oth years are still very strong. hismeans that the company could pay off all its current lia&ilities if they needed to.

wo -heel 9acing shows an acid=test ratio of !.3 for Year $. his places themsignificantly &elow Competitive Bikes, although they are still in a good position.

(nventory urnover

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he inventory turnover ratio is a measure of how many times a company sells its averageinventory per year. + higher num&er is &etter for a company, &ecause it means that theycan easily sell their inventory A8orngren et al., 54.

Competitive Bikes did not have an inventory turnover ratio, &ecause they sell their items

as soon as they are made. his means that the company keeps no inventory. hecompetitor, wo -heel 9acing, has an inventory ratio of !.3 in Year $, which means thatthey sell their average amount of inventory a little over three times a year. his is a prettygood num&er, &ut Competitive Bikes has the advantage, &ecause they have no inventory,thus reducing inventory costs.

+verage Collection *eriod

he average collection period ratio tells how many days it takes the company to collecton receiva&les. he smaller the num&er is, the fewer days it takes for the company to get

their cash A8orngren et al., 54.

or &oth Years 7 and $, Competitive Bikes had an average collection period of 3!.$. wo-heel 9acing had a num&er of !5.' in Year $. his means that wo -heel 9acing has astronger average collection period and gets access to their cash soon than CompetitiveBikes does.

Ee&t 9atio

he de&t ratio is a measure of a company/s a&ility to pay off its de&ts. or this ratio, thelower the num&er is, the &etter of a position the company is in A8orngren et al., 54. (nYear 7, Competitive Bikes had a de&t ratio of 36.7". Year $ saw a de&t ratio of 3'.4".

Competitive Bikes has a very good de&t ratio, as anything under 6" is considered goodA8orngren et al., 54. +dditionally, they managed to lower their de&t ratio for Year $,which means they have improved.

wo -heel 9acing has a de&t ratio of !$" in Year $. his num&er is considera&ly &etterthan Competitive Bike/s ratio, and put the competitor at the advantage.

ross *rofit arginhe gross profit margin is a very important num&er for a company to keep an eye on. +nincrease in this num&er means that the company has had an increase in profits, while adecrease could signal pro&lems within the company A8orngren et al., 54.

or Year 7, Competitive Bikes had a gross profit percentage of 57.3". (n Year $, theysaw a decrease to 57". he decrease in this num&er is &ecause Year 7 saw really highsales and profits in the company, and Year $ didn/t fare as well.

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he competitor, wo -heel 9acing, had a gross profit percentage of !5.#" in Year $.his num&er is higher than Competitive Bikes, which puts the competition in a &etterposition.

:perating *rofit argin

he operating profit margin shows how much a company earns in operating income per2# of sales. + higher num&er means that the company is making more money per sale, soa higher num&er is prefera&le A8orngren et al., 54.

Competitive Bikes had an operating profit margin of '.!" in Year 7 and #.4" in Year $.his means that Year 7 saw operating income of 2.'! per dollar in sales and Year $ saw2.#4 of operating income per dollar of sales. his is a significant drop in Year $, andcan &e e0plained &y the drop in sales for Year $.

wo -heels 9acing has a operating profit margin of '.5". Competitive Bikes camenowhere near this num&er in Year $, which is a concern. Based on the trend analysis andfuture forecasts, Year 7 had an a&normally large amount of sales. his num&er of largesales lead to Competitive Bikes having an operating profit margin of '.!" for Year 7. (fhaving an e0ceptional year is the only way they are going to meet the competition/soperating profit margin, Competitive Bikes is going to remain &ehind wo -heel 9acingin this area.

et *rofit argin

he net profit margin tells how much of the revenues a company gets to keep after allcosts are taken out A8orngren et al., 54.

or Year 7, Competitive Bikes had a net profit margin of !.!" and of .7" in Year $.either of these num&ers are very high, &ut Year 7 is particularly low. he net profitmargin of .7" means that Competitive Bikes only kept .7" of their revenues afterta0es. his is not a lot of money.

he competition, wo -heels 9acing, had a Year $ net profit margin of '.#3". hismeans that wo -heels 9acing is keeping more of their revenues as profits. CompetitiveBikes should strive to increase their net profit margin in order to keep up with theircompetition.

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or Year 7, Competitive Bikes had an earning per share ratio of .5, and for Year $ itwas .3. his is the opposite of what a company wants to happen. 9ather than have thisnum&er decrease, Competitive Bikes should aim to increase it each year. (ncreasing theirprofit in Year 4 will help them achieve a higher earnings per share.

(n comparison to the competitor, Competitive Bikes fell &ehind in Year $. wo -heels9acing has an earnings per share ratio of .$. his means that the competitor wasearning more income for each share of outstanding common stock.

9eturn on otal +ssets

he return on total assets tells if a company is using their assets to earn a profit or not.or this num&er, it is ideal to have a larger num&er than the industry average A8orngren etal., 54.

Competitive Bikes had a return on total assets of 3.'" in Year 7 and .$" in Year $. hisis another significant decline for the company, once again a result of Year $ notperforming as well as Year 7.

wo -heels 9acing has a return on total assets of 3.$" in Year $. his num&er tellsthat Competitive Bikes has not met the return on total assets of their competitors in thepast year, and should work harder to use their assets to return a profit.

9eturn on Common

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of action, as market prices of shares are not controlled &y the company A8orngren et al.,54.

he priceHearnings ration for Competitive Bikes in Year 7 was 34.67, and was $!.7! inYear $. his increase is good, &ecause it means in Year $, the company/s stock was

selling for $!.7! times the company earnings. his indicates that investors are willing topay so much &ecause they have high hopes for the company/s future.

he priceHearnings ratio of wo -heels 9acing in Year $ was 54. his num&er showsthat investors are more willing to spend more money on Competitive Bikes than they areon wo -heels 9acing.

imes (nterest

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out employee &onuses. (t could &e used to &uy more e)uipment, land, or other itemsneeded for their company. (deally, since Competitive Bikes currently has limitedadvertising, the e0cess working capital should &e put towards promoting and advertisingtheir &ikes. (nvesting the e0cess working capital &ack into the company will increaseprofits in the long run.

(mproving working capital in future years will allow for Competitive Bikes to have moremoney to grow their company. here are several ways to increase working capital. heidea is to either increase assets, lower lia&ilities, or &oth. herefore, the following willresult in an increase in the working capital.

Increase #et Profits. ore net profits will increase assets A+nderson,

5#.

Increase Sales. ore sales lead to more profit, which is an asset

A+nderson, 5#.

ed$ce Costs. Costs are a lia&ility, so they should &e reduced as much as

possi&le Awithout comprising the )uality of the product. his can &eachieved &y getting rid of unnecessary e0penses or temporarilysuspending an e0pense A+nderson, 5#.

%liminate &ns$ccessf$l Prod$cts. (f a company has a product that is not

selling well, the company should eliminate that product in order torelocate those resources to a successful product. his will ideally lead toan increase in sales and profit A+nderson, 5#.

Increase Cas' Flo(. (ncreasing the cash flow will keep money coming

into the &usiness. he company should take steps to ensure that paymentsare &eing made in a timely manner, &oth to and from the companyA+nderson, 5#.

Internal Controls

(nternal controls are the measures that are set into place in order to protect a company/sassets, to encourage employees to follow the company policies, to encourage efficiencyin operations, and to ensure accurate accounting records. +ll pu&lic companies arere)uired to have and to follow a set of internal controls A8orngren et al., 54

Corrective +ction

Competitive Bikes has some corrective action they need to take to improve their internalcontrols in the purchasing system.

he pro&lem with the purchasing system is that the purchasing department has too muchpower. he purchasing department is responsi&le for sending the purchase order to thesupplier, choosing the lowest &idder to &e the supplier, sending the purchase order, andthen sending the invoice to accounting. his places the purchasing department within

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each step of the purchasing process. -hile this may seem like the logical thing to do, itopens the company up for risk.

he whole purchasing process needs to &e redesigned to lower the risks to the company.o &egin with, the monthly &udget pro1ections should not &e completed &y the purchasing

department. anagement, or a small &udgeting team, would &e &etter suited to thisresponsi&ility.

+fter this step is completed, the purchasing department can retain the responsi&ility ofselecting the supplier. 8owever, they should have someone who oversees this selection.he company should appoint a manager or other higher=level employee to ensure that thecorrect supplier has &een chosen on the )ualifications that are specified. or CompetitiveBikes, those )ualifications are Flowest &idderG and Fsimilar )uality productsG &etween thesuppliers.

he supplies should not &e delivered to the purchasing department. 9ather, they should

&e sent to a receiving department for check=in and delivery to the production line. +t theend of the month, when the e0tra supplies are sent to raw materials inventory, theinventory management department should &e responsi&le.

>astly, the invoices should not &e sent to the purchasing department. hey should &e sentstraight to the accounting department, where they will get recorded. hey should also &esent to the finance department, who will make payment on the invoice.

9isks

he current pro&lems with internal controls within Competitive Bikes purchasingprocedures strongly increase the risk of theft, collusion, and unethical &ehavior.

he purchasing department should not &e in charge of the monthly pro1ected &udget.his could allow for the purchasing department and the supplier to work together in away that would &enefit them &oth, instead of the company.

his is also why the purchasing department needs to have someone who oversees thedecision of what supplier to use. (f a supplier were a good friend of an employee, or evenoffered that employee some kick&acks, the purchasing department could easily choosethat supplier over another, even if they do not meet the company/s criteria.

%upplies should not &e sent to the purchasing department, &ecause it gives employees theopportunity to steal supplies, especially if they have access to an invoice and can changethe num&ers. %ending the supplies to the receiving department will lessen the chances fortheft to go unnoticed. +t the end of the month, having an inventory managementdepartment handle the goods &eing transported to raw materials inventory will also helplessen the possi&ility of unnoticed theft.

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Currently, the purchasing department is not only placing the order, they are receiving theinvoice. (f an employee from the purchasing department felt so inclined, it would &e asimple matter for them to steal a product and then alter the invoice. (t would also allowfor purchasing employees to change the amount on an invoice to Fhelp outG a supplierwho might also &e a friend. his is why Competitive Bikes needs to have their supplier

invoices sent directly to the accounting and finance departments.

he finance department, who should also receive the invoice, will &e a&le to pay for thesupplies. his will prevent accounting from altering num&ers on the payout to &enefitthem or the supplier. +ccounting should record the amount of the invoice in their &ooks,and if a pro&lem does occur, management will &e a&le to compare the records fromaccounting and finance to see who was responsi&le for the transgression.

(mproving the internal controls within Competitive Bikes will lessen all the possi&le risksto the company. (nternal control is a&out keeping responsi&ilities and departmentsseparate, to lessen the chance of the company e0periencing pro&lems. (f Competitive

Bikes implements the suggested actions, their company will &e much safer from theft,collusion, and unethical &ehavior.

Sar)anes*+ley

he %ar&anes=:0ley act was created in 55 as a way to ensure that companies areaccurately reporting their finances. his act set out guidelines for internal and e0ternalauditing of a company/s financial documents A8ilton, 5##.

Compliance

+ material weakness is what happens when a company/s internal controls fail, making itpossi&le for that company/s financial reports to &e inaccurate AIaterial weakness,I5##. he letter from Competitive Bikes that will accompany the financial statements isan inaccurate letter, &ecause a material weakness is present within the company. hematerial weakness present, discussed a&ove in the F(nternal Controls; Corrective +ctionGsection, is that of the purchasing department having the a&ility to alter invoices fromsuppliers. (f these invoices were to &e altered, it would make for flawed financialreporting. (n order to &e in compliance with the %ar&anes=:0ley +ct, Competitive Bikesneeds to develop a &etter system of internal controls, &ecause the one they have nowpresents unreasona&le risks for the company.

Corrective +ctions

Competitive Bikes is currently non=compliant with the %ar&anes=:0ley +ct. here are acouple of things that need to &e done in order to comply.

irst, the company mustdevelop a &etter set of internal controls for their purchasingdepartment. his needs to &e done in order to prevent theft of products, fraud, or evencover=ups of mistakes.

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%econdly, Competitive Bikes needs to &ring in an e0ternal auditor to evaluate thecompany/s internal controls. his will ensure that the company is in compliance with thatportion of the %ar&anes=:0ley +ct &y having a non=partial entity review the internalcontrols.

(t is not &elieved that Competitive Bikes was intentionally incorrect with their statement.9ather, the company did not realize that the internal controls it has in place areineffective. Changing the internal controls and having someone from the outside accessthem will provide the company with a strong set of internal controls that will &oth protectthe company and &ring it into compliance with the %ar&anes=:0ley +ct.

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!orks Cited

+nderson. A5#, +ugust 7.How to increase your working capital. 9etrieved fromhttp;HHwww.onlinecheck.comH&logHworking=capitalHhow=to=increase=your=working=capitalH

8ilton, 9. A5##.Managerial accounting: Creating value in a dynamic businessenvironment A4th ed.. craw=8ill.

8orngren, C., 8arrison, -., D :liver, . A54.AccountingA$th ed.. *rentice 8all.(%B #!675476.

Material weakness. A5##. 9etrieved fromhttp;HHwww.investopedia.comHtermsHmHmaterialweakness.asp