Competition Bikes Inc is a bicycle manufacturing company, which was established in 2001 by an avid rider called Lary Ferguson. The company specializes in sporting bikes for new entrants and existing sportsmen. So far, the company has been successful and among the world’s largest sporting bile sellers despite its short history. This paper evaluates the company’s financial operations.
Operational strengths and weaknesses
To evaluate the company’s operational strengths and weaknesses, the paper will focus on:
- Horizontal analysis results
Sales and cost of goods sold in 2007increased by 33.3% and 31.7% respectively, the trend changed to a reduction of 15.0% and 14.5% in 2008. The trend is an indication of a company that lost massive business in 2008, the drop was fast and rapid. In 2008, selling expenses increased by 33% and dropped by 14.9% in 2009; this can have two indications, one, and increased cost effectiveness or there was reduced business and teams were not highly robust. In Competition Bikes Inc, the second assumption holds. General expenses increased by 20.4% and 1.2% in 2008 and 2009 respectively. Since the company was having reduced sales, the increased general expenses shows weakness in cost managing. Operating income and net earnings increased by 154.67% and 313.4% in 2008 respectively, they reduced in 2009 with 69.1% and 81.6% respectively. This is an indication that the company operations are not yielding income as expected in 2009.
Total current assets reduced from 34% recorded between year 6 and 7 to 16.5% recorded in year seven and 8. This is an indication that the company disposed some of its current assets. Fixed assets increased by 2.9 % in year 6/7 and decreased by 0.1 in year 7/8, this is an indication of a company whose fixed assets remained relatively stable. With such stability, profitability should be the same. Total liability in year 6/7 increased by 1.2% and reduced by 1.9% in year 7/8: an indication of proper liability management. - Vertical analysis
Gross profit margin for year 6, year 7 and year 8 was 26.4%, 27.4% and 27% respectively. This rate is relatively stable. It shows a company with stable sales and purchasing policies. The ratio of operating expenses to that of gross profit remained stable at 6.7%, this shows that the company had policies that ensured that operating expenses are regulated as per the changes in gross profit. Total general expenses for year 6, 7 and 8 were 17.1%, 15.5% and 18.4% respectively; the rate is stable, though in year 7, it seems management of this expense was better since, it is the year that had the highest gross profit yet the lowest rate of general expenses. Total expenses were 23.8%, 22.1% and 25.7% in year 6, 7, and 8 respectively. The year that has had lowest expenses had the highest gross profit margin. This may be attributed to two factors, one there was good cost management in year 7 or the company was enjoying marginal production benefits. It may also be because of economies of scale.
Earnings before income tax were 1.4 in year 6, 4.4 in year 7 and 0.9% in year 8. The rate of year eight is lower than that of year six despite having a higher gross margin. This shows an increased inefficiency in 2008.
The company seem to have invested in short term assets that have growth in all the three years, in year 6; the assets grew by 24.5, in year7 by 31.9 and 37.2% in year 8. Cash and receivables formed the greatest portion of current assets thus the business can be seen to have become more robust and is securing an increased sale. - Trend analysis
Having year 6 as the base year, the company has had increased net sales. The change in year 7 is at a rate of 33% while that at year 8 is at 13%. Though sales have been increasing when compared to that of year 6, year 8’s sales were lower than that of year 7. Past trend shows a business that is not stable in maintaining increased sales. The strength of using the analysis is that it gives an analysis of the past performance that the business has had and the differences among years. The limitation that Competition Bikes Inc trend analysis has is lack of industry rates to compare what was happening in the industry and the performance of the company. Making a conclusion whether year 7 was a boom period thus the increased sales or the company operations reduced in year 8 is not possible with current information.
When forecasting the future and use year 2008 as the base year, then an increased sales trend slightly different historical performance is noted. This is where in year 9 the sales are expected to increase by 3.2%, year 10 by 7.6%, year 11 by 11.8%. Following the future trend analysis, the company is expected to have an increased sales, this offers management with the required pathway to follow. It’s the base of a future strategy formed on past performance and trend.The weakness of future trend analysis is that it does not offer the actual strategy to be used to attain the future sales expectations. Secondly, the future is unpredictable thus, what are more relevant is the future strategies and not future projections. - Ratio analysis results
Current ratio and quick ratio for the company were, 5.90, 5.35 and 4.52 and 4.25 for year 7 and 8 respectively. This is an indication of a company that have adequate working capital and can meet its financial obligations when they fall due. In normal circumstances, a business should have at-least a current ratio and quick ratio of two. The ratio shows a business with sound operating capital for the two years.
Average collection time was lower in year 7 and 8 as 43.8%; this shows that the company had debt management policies in years 7 and 8 were unchanged, the company did not come up with better dept collection measure. This shows a company whose management is relaxed and not robust enough to collect debt. This can probably explain the debt ratio that was, 46.7% and 45.9% in year 7 and 8 respectively, where the fall in year 8 can be attributed to reduced sales.
Gross profit margin was 27.4% and 27.0% in year 7 and 8 respectively. An indication of a company that is reducing either its prices or one that cost of production is increasing. However, the marginal change is minimal.
Operating profit margin stood at, 5.3% and 1.9% in years 7 and 8 respectively, this shows that the company in year 7 had a problem managing its costs and expenses. It can be argued that marginal operating expenses were increasing expenses than the gains they had. Net profit margin followed the trend of operating profit margin at 3.3% and 0.7 % in years 7 and 8 respectively.
EPS is dependent with the rate of company’s performance, in this case, the company had 0.20% and 0.8% in years 7 and 8 respectively, and this reflects the changes in the profitability of the company.
In years seven and eight, return on total assets, return on common equity and price earning ration were 4.5 and 8.10, 8.5, and 1.5 and 49.67 and 88.73 respectively. They are pegged on the performance of the company in terms of how productivity the company.
Times interest earned gauges the ability of a company to meet its interest charges; in competition bike Inc in years 7 and 8 stood times interest earned stood at 5.27 and 1.77 respectively. This is an indication of company that can cover its interest effectively. Its pre-tax profit is adequate to cover its debt interest obligations.
Working capital of Competition Bikes Inc
Working capital is the operating capital/finances available in a business to meet its short-term liabilities as they fall due; at any one time a company should not have excess working capital and neither should it have limited working capital. When a company have excess working capital, chances that money will be misused are high, and when working capital has a deficit, the a company cannot meet its financial obligations effectively.
In both years 7 and 8, Competition Bikes Inc has had positive working capital that indicates that the company is able to finance its financial obligations when they fall due. Despite this positive working capital, the company can improve its working capital further by enhancing the collection of money owned by debtors. It can be noted that debt collection rate remained unchanged for the two years at 43.8%; this offers a room for improvement. The falling current ration at 5.90 and 5.35 for year 7 and 8, respectively, is an indication that if the trend will not be looked into in the future, then the company is likely to suffer operating capital deficits.
Another approach that the company can adopt is to lower its liabilities and improve income/profit. Operating capital is current assets net of liabilities, so when the company have increased current assets and reduced liabilities, then the organisational working capital will increase.
When a company have excess capital, then it is able to operate smoothly with adequate flow of finances to cater for its financial obligations when they fall due. When this happens, good relations with suppliers, and creditors is developed which lead to more business. Opportunities arise in course of doing business, if a company have excess capital, it will be able to take advantage of opportunities as they come for its operational benefit. Business grows through management of available working capital (Carlon, 2009).
Internal controls for the Competition Bikes Inc. purchasing system
The purchasing department is given the task of choosing the most efficient and less costly supplier. After inviting for tenders, they choose the best and supply him with purchases order. After receipt of goods, they are entered into books of store-man who manages them from there. Any part required must be ordered from the store with proper authorisation. When payment is being done, a receiving report, supplier invoice, and purchase order are sort from purchasing before payment is released.
When making a decision on the chosen supplier, the company is only interested on cost and availability; this is a weak approach since it does not consider other factors like quality and reliability of the supplier. There are high chances that people can be taking advantage of this weakness. The next weakness in the internal control is seen from receipt of goods; the receiving have no copy of the purchases order made, they thus receive goods delivered blindly. Secondly, no first check to confirm that ordered goods were the ones derived at the right quality and quantity. The third weakness of the system is that there is only one signatory to cash payments; all powers to pay are invested in the treasurer. At the receipt and payment, there is no delivery note form the supplier.
To address the weakness of internal control, the company should have robust internal checks and balances, internal audits should be enhanced to ensure that the company is operating well. Purchasing control is an important strategy in maintaining and attaining growth trend and strategy required by the company. Supply chain management tools which ensure procurement is done from reliable suppliers, quality checks are put in place and payments are authorised by reliable members of staff is important. The treasurer should not have the sole power to sign checks.
The company is faced with the risk of getting substandard supplies, which might be of the inappropriate quantity. This is so because there is no internal communication between the purchasing and receiving department. When payment is being done, no reconciliation with delivery order, a factor that can lead to payment of unsupplied goods. Having one signatory is also risky to embezzlement of funds.
To mitigate the risks, the company should adopt an effective internal control, operate an effective integrated logistics, and supply chain management. It should ensure that receiving department has a copy of purchase order and compares what has been delivered and what was ordered. When doing payments, delivery note is an important tool to reconcile them. At any one point, there should be at least three signatories of checks. When goods are procured, there are the requirements that each department has, choosing the supplier should not be based only on cost, but should include quality and reliability of the supplier.
Adopting an effective integrated procurement and supply chain management will assist the company mitigate against losses that can develop from the system. When receiving goods, it is important to have a particular department, whose goods procured will be used, personnel to gauge the quality of the goods. The person with the store-man should determine the quantity of goods sent to the store. They should give a report to the paying department.
Compliance with Sarbanes–Oxley requirements
Under Sarbanes–Oxley requirements, a company’s management should have full control of internal control process to ensure there is proper management of company’s resources. In the case of Competition Bikes Inc, there are some weaknesses in the internal controls. There are chances that some funds may be embezzled. This shows that the company is not compliant with Sarbanes–Oxley requirements. The truthfulness of financial accounts is doubtful since it is not known whether the figures given are the correct ones.
The purchasing system has only one signatory of checks and there are no checks and balances set to ensure that he signs only the correct amount of money to pay for expenses. The assets of the company like motor vehicle are at risk to be used for the benefit of certain individuals in the organisation. From the internal process given, there is no lead-time on goods procured thus company’s vehicles can be used for other non-trade operations and yet the company caters for the expenses.
Although the company internal strength portrayed is that its procures after vetting a supplier for cost and availability; this can policy can put the company at the risk of having some suppliers strategically placing themselves to win the company’s tender whereas they are not offering quality products. Alternatively, the company does not seek for samples from suppliers to determine quality of the products.
To comply with Sarbanes–Oxley requirements, the company should embrace an effective internal control. Employees and departments should be accountable to certain programs to ensure that there is compliance with company’s assets management. Adopting modern strategic management tools as six-sigma, integrated chain management and automated stock management system, will assist the company solve internal control-related problems (Noreen, Brewer, & Garrison, 2011).
References
Carlon, S. et al. (2009). Accounting: Building business skills. New York: John Wiley & Sons
Noreen, E., Brewer, B., & Garrison, H. (2011). Managerial accounting for managers. New York: McGraw Hill.