This summary report offers a projection of Competition Bikes’ future growth potential by analyzing the company’s financial statements for the past three years, comparing it with other companies within the cycling industry, and assessing its compliance with maintaining internal controls over all phases of company management including financial reporting. Company strengths and weaknesses are identified, with special attention paid to possible solutions for the weaknesses. In addition, potential risks are addressed with corrective action recommended for mitigating those risks.
A 1 a. Horizontal Analysis
Comparative Income Statements:
By comparing valid Income Statements for the past three years (Year 6, Year 7, and Year 8) for Competition Bikes, a few line items jump out right away. For instance, Net Sales are down 15% from Year 7 to Year 8 while they had gone up 33% from Year 6 to Year 7. A drop in sales is a weakness, and a 15% drop in one year is especially disconcerting. For a retail business like Competition Bikes, sales are essential. For this reason, there are more weaknesses than strengths seen from Year 7 to Year 8, which is the latest year of data provided.
Another weakness noted is in the area of Gross Profits which also decreased from Year 7 to Year 8, quite significantly, by 16.3%. Gross Profits had gone up 37.5% from Year 6 to Year 7 which was a strength for the company, resulting at least partially from stronger sales from Year 6 to Year 7. A decrease in Net Sales leads to a decrease in Gross Profits. On the plus side, one noted strength is the decrease in Cost of Goods Sold (COGS) by 14.5% from Year 7 to Year 8, which helped to offset the decrease in sales. The cost per unit appears to have increased slightly, but that is somewhat expected based on volume reduction of this magnitude, and is still seen as a strength in the area of cost containment.
An additional weakness noted in the Comparative Income Statements is that of “General and Administrative Expenses” increasing by 18.4% from Year 7 to Year 8 at the same time that Sales decreased. Within the General and Administrative expenses, there are really three categories that draw attention: Utilities, Other General & Administrative Expenses, and Research & Development. To begin with, there was an 11.1% increase in the cost of Utilities from Year 7 to Year 8, which was unexpected given the decrease in sales. Next, the “Other General and Admin Expenses” increased by 7.6% at a time when the sales did not support this additional overhead. And finally, there was a notable decrease in the “Research and Development” category from Year 7 to Year 8, which may have been as a result of the sales decrease for the year. As long as the decrease in Research and Development does not have a negative impact on future sales, then the reduction would be seen as a near term strength for Competitive Bikes as a method of decreasing operational expenses.
The result of these and other financial considerations was that the Operating Income fell sharply by 69.1% from Year 7 to Year 8, while it had gone up 154.6% from Year 6 to Year 7. The sharp decline in Operating Income lead to a sharp decline in the Earnings Before Income Taxes (EBIT) line item which fell 81.6% from Year 7 to Year 8 (a decrease of $213,592) when it had risen 313.4% from Year 6 to Year 7 at a robust gain of $198,420 before income taxes. The decrease in EBIT is a definite weakness, which was directly affected by much weaker sales and greater expenses from Year 7 to Year 8.
The question, then, is why have sales fallen? Several possibilities emerge from the financial statements. For one thing, Advertising expenses dropped by 16.3 % during the same time period of Year 7 to Year 8, which could be because the cost of advertising went down, but is more likely because of a conscious decision to cut back on Advertising. Net Sales were down by 15% in…