Financial analysis of the "Competition Bikes Inc." company - Part 2

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A.1.b. Vertical Analysis Results

Using vertical analysis in finding out the weaknesses and strength of the company in sales composition and total assets, evidently there were inconsistencies in some areas that affected the company's operations. In year 6 the total sales is $4,485,000 less than the cost of goods at 73.4% will only leave the company with 26.6% of gross sales out of the total for that year. It appears that the total assets for that same year is almost the same as the total amount of sales, this means the company was accurately imposing control. The following year (year 7), it shows a steady increase on sales as the gross profit went up to 27.4% as compared to 26.6% from the previous year and the company was able to minimize the cost of goods for year 7 since it shows on the report that that the cost went down by 0.8%.

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This small difference became an addition to the gross profit, but in general we can see that the company is consistent in terms of sales and cost of goods. The company also showed consistency on keeping the expenses percentage at 6.7% which can be identified as strength, any signs of higher percentage on expenses would suggest that the company was not able to exercise control on expenses especially if it showed high percentage of expenses but low on sales which could have been a sign of weakness. Total admin expenses on year 8 however was relatively high at 18.4% which is a weakness because it shows that the company was able to make adequate adjustments on lower down admin expenses even when the sales on that year was not the good.

This is also the reason why the operating income went down to 1.9% on year 8 because of high admin expenses considering low income. Year 7 on the other hand showed a sign of strength by increasing operating income to 5.3%. In terms of total assets, the company had an increase in their accounts receivables on year 7 by 10.1% from the previous year showing 16.6%, that means the company still has awaiting payments from distributors and having to know that means positive outcome for the company in increasing the total assets and this was also a sign of strength for the company. But that was changed on year 8 as there was a decrease on accounts receivables of 2.5%. Despite the drop on cash and cash equivalents on year 7, it was redeemed by the accounts receivables increasing the total assets to 31.9% as compared to 24.5% from last year which is a good sign of strength.

But one of the most obvious differences in the company's assets is the increase in cash and cash equivalents on year 8. This is because going back from year 7 the number of accounts receivables were already collected and was classified as cash equivalents in year 8. This change is caused by the payment cycle in which distributors were given 30 days after delivery to pay for the products. When year 7 ended the amount of receivables was carried over to year 8 as cash assets. Relatively in year 8 the accounts receivables were still high as compared to year 6 but lower than year 7. It has something to do with the amount of net sales in year 8 because it is relatively lower by $897,000, but the company had failed on keeping the cost of goods down which is again a sign of weakness.

The fact that the sales was low on year 8 the cost of goods should have been lower as well, but it looks like the cost even got higher on year 8 as compared to year 7 even if the gross profit on year 8 is lower by 0.4% from year 7. In terms of assets year 8 have the highest at 37.2% because of the consistency in accounts receivables, inventory and raw materials inventory. But the biggest change and probably the good positive side of year 8 were the increased cash and cash equivalents. The strength of the company showed in the vertical analysis is their ability to balance the net sales against the cost of goods, although there were a few ups and down by a few percent, it is still a positive review of consistency in controlling these areas. The weakness on the other hand is evident on the cost of goods part. The fact that the company did not do on sales in year 8 the cost should have been lower instead but what happened is that the cost even came out higher than the previous year. The company still has to improve on controlling the cost in order to make a more positive result.

A.1.c. Trend Analysis

Historically, Competition Bikes Inc. has failed to set an upward trend in net sales. Year 6 to 7 was a positive trend, but in order to establish a strong business presence companies such as CBI has to make an upward trend for at least five consecutive years, otherwise early failure would make it difficult for the company to recover in the next following years. A five-year positive increase in sales would provide a company with a buffer in case the business experienced slowness. To analyze Competition Bikes Inc. in terms of net sales trending, year 7 topped year 6 by 33.3%, but year 8 came lower than year 7, it should have been better if year 8 had topped year 7.

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The 20% negative on net sales on year 8 from year 7 is a bad sign although year 8 is still higher than year 6, but to average the three year sales record the company still has a 13.3% advantage in general. If we are to make a forecast based on year 6, 7 and 8, we would be able to come up with an up and down trend. But to make a positive forward trend on sales considering the average advantage of 13.3%, it would look like the company still has a good future. Based on the net sales for the past three years, the forecast trend can assume to have a gradual yearly increase. If the three year sales trend shows 13.3% positivity, therefore the company can expect to have an increase in sales within the same period of time.

If we are to calculate the accumulated increase in sales in year 9, 10 and 11 in forecasts it would be equivalent to 11.8%. This is a reasonable assumption since the average increase in net sales from year 6 to 7 is 13.3%. In general, the company will have a positive chance to recover but gradually, as long as there's a positive net sales average every year the future will be good for Competition Bikes Inc. What the company should do is to make sure that the high sales will cover the lower ones.

A.1.d. Ratio Analysis

In order to find out if Competition Bikes Inc. was able to make at least a 10% turnover from the business, a ratio analysis is important to be able to extract the anticipated turnover. Anything that's below 10% is considered low business turn-over; therefore, a change in business analysis is needed. In definition, ratio analysis is to conduct a quantitative analysis of the company's financial information. The way to calculate ratio is to compare current year against the previous years, other companies and to the industry standards. By doing so we would be able to see if the company is performing well and how well it is doing in the industry level (Investopedia.com, Ratio Analysis N.D.).

Competition Bikes Inc. in general as compared in ratio to Two Wheels Racing is doing much better. Two Wheel racing only poses 4.4% in overall ratio while CBI's turnover came at 5.35% in year 8 although it is lower than the previous year. The same goes with the acid test ratio and with the average collection period which comes out better than what Two Wheel Racing has at 3.4% with a difference of 0.85% from CBI's year 8 ratios but that is the only thing that makes CBI better than Two Wheel Racing. In terms of debt TWR has less than CBI with a difference of 7.9% on year 8 and 8.7% on year 7. In profit margin TWR is better than CBI with a difference of 5.1% on year 8 and 4.7% on year 7.

Operating profit margin appears to be higher on TWR particularly on CBI's year 8 which has a difference of 3.3%. Net profit difference of 5.07% on CBI's year 8 in favor of TWR. Among other things like return of total assets and common equity, we can assume that CBI is worst than TWR. The only thing that CBI topped TWR with is the current ratio as well as pricing and earnings ratio.

We can see the difference since TWR only has 29% as compared to 83.73% of CBI. That is a difference of 54.73% pricing/earning that makes CBI better than TWR, but in terms of operational strategy TWR have done a better job done CBI. CBI has a higher debt that takes out much of the gross profit which in return also affects the net profit margin. It is only fitting that CBI has a higher pricing otherwise it would have rendered the gross and net profit margin at negative ratio. It appears that the company (CBI) has a pricing advantage that covers most of losses in other financial areas, but the amount of debt that they have compromises the return of equity and assets.

This is the area where CBI is at the weakest, the amount of debt they have affects the outcome of equity ratio, in a common business operation the company with a high debt ratio tends to have lesser return of equity which poses a disadvantage on the side of the investors. TWR although has a less pricing ratio was able to balance it out with the net profit and debt. If CBIs is selling a Carbon Lite bike at $2, 990 per unit and provides a trade discount of 50% to the distributors, then CBI is making $1, 495 out of a single bike unit. To compare that with the cost of goods each bike unit's component package is $275, plus the carbon strips that makes up the main features of the bike costs $378 (42 strips at $9 each).

In total that is already $653, then let’s add up labor cost, 15 hours is needed to complete assembly and the average hour wage is $20 (relatively high because of the skill level), labor cost average is $300, and lastly the manufacturing overhead of $94.529 per unit. To put all things together each unit costs $1, 047.529 (carbon strips $378 + component package $275 + wage $300 + overhead $94.529 = $1, 047.529). In relation to selling price after 50% distributor trade discounts the ratio of mark-up price to production cost is 29.93%, now the ratio between selling price and cost of production without the trade discount is 64.97% (selling price before trade discount $2, 990 - production cost $1, 047.529 = ($1, 942.471 / selling price = price over cost ratio 64.97%). Given that equation it appears that the mark up price is high and that explains the price/earnings ratio of 83.73% from that of TWR at 29%.

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It's the strength of Competition Bikes Inc. but the amount of debt makes it their weakness. CBI appears to have lesser assets that explain the debt, if a company has more assets it means more resources and limits debt. For TWR their asset is at 4.80% as opposed to 0.80% of CBI, this also explains why TWR has lesser debt than CBI. The less debt that a company has to pay the larger the gross profit margin will be, evidently since CBI has more debt than TWR they have a smaller gross profit margin. The same goes with the difference in ratio with net profit margin between TWR and CBI, having that CBI has 0.7% of net profit margin and TWR has 5.14%.

Clearly, the pricing strategy helped CBI in balancing all areas of their financial margins otherwise more negative results would make the company suffer from loses. The importance of ratio and proportion in the balance sheet is to determine efficiency of the company in utilizing sales revenue and assessing profitability (Bhatia, Roshini. May 14, 2011). A.2. Competition Bikes Inc. Working Capital Analysis Working capital by definition is a strategy for managerial accounting that focuses on levels of efficiency in components of current liabilities, current assets and working capital. The analysis will check if the company has sufficient flow of cash in order to meet operating expenses and debt obligations (Investopedia.com. N.D.).

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