The following is a summary report is an analysis of the current financial statements of Custom Snowboards Inc. The company wishes to be considered for an extended long term loan for a European expansion. We have arrived at a selection of key financial statement line items, conducted a risk assessment, and ratios and if the loan is granted, analysis on how to track the progress of the company’s ability to repay the loan.
Financial Statement Analysis
Income statements and balance sheets were reviewed to summarize the following key points that could impact the loan decision.
Horizontal, vertical, trend, and ratio analysis were also reviewed to provide a solid understanding of the financial highlights of Custom Snowboards in the areas of profitability, liquidity, and solvency.
Revenue includes net sales, cost of goods sold, and gross profit. Gross profit continues to grow at 30.4% with .23%/ $4,900 from year 12 to 13, and .93%/ $19,600 from year 13 to 14. Net sales also showed the same growth at 100%. The company expects continued growth over the next three years and according to the trend analysis, has the ability to do so.
This demonstrates the company’s ability to keep overhead under control and maintain constant margin in relation to sales, consistent year after year. The expenses are variable in relation to the sales. Higher gross sales leads to higher operating income available to service debt in the form of interest payments.
The increase in utilities and other general and admin expenses should not fluctuate as they are fixed expenses. This should be reviewed to determine if the increase was due to faulty equipment, temporary increase in market costs, or permanent increases. The compensation parts, administration salaries as we as executive compensation increased as well. Overall, the operating income declined from year to year which impacts Custom Snowboards ability to service debt.
Net earnings also declined as a result impacting earnings per share. This reflects the company did not manage these expenses well however, Custom Snowboards Inc. has grown as well so the increase could be due to hiring of more employees, or higher quality employees, or awarding those doing well within the company already. This could also impact moral and welfare of employees who become happier and more productive. The trend analysis shows continued growth to balance this bottom line.
Assets and Liabilities.
Overall, liabilities decreased, assets increased. Although current assets show a decline in year 14, the total assets continue to rise. Cash and cash equivalents have gone up, short-term show a slightly distorted view as the company took out an investment in year 12 which lowered cash and raised investments but then did the opposite as the investment was cashed in. Over the three years, the company shows it had sufficient liquidity to pay current liabilities owed. Increased assets and decreased liabilities shows the company’s ability to pay its long term debt and interest. Current ratio of 7.06 in year 13 and 6.56 in year 14 reiterates the ability to pay debts while maintaining daily operations. This higher current ratio also indicates Custom Snowboards should be taking more risks and investing money back into the company. This loan and consequently the expansion to Europe will deliver exactly that. The company is showing a steady increase in retained earnings as well.
The most prevailing financial risks the bank loan officer may take note in is the general and administrative expenses continued increase. The company should review the reasons for the increase as well as the specific area in which is causing the issue and try to address the issue to lower the expenses. Processes should be developed to eliminate the excess expenses and decrease the risk associated with remaining items.
The other risk is the increase in compensation. Maintaining highly qualified and trained staff may be what the company needs. Custom Snowboards will need to ensure employees stay motivated to produce inventory and drive sales. A commissioning program could be implemented in addition to salaries or awards based on performance and higher net sales.
Custom Snowboards can minimize risk by continuing to grow sales and reinvesting into the company. Expansion to Europe is one way. Another is to invest money into research and development, and marketing. No increase in research and development happened in the past three years and could prove beneficial to the company. Website create and maintenance can also be used to mitigate risks. A well working website can bring in more sales and possible reduce the compensation budget as employees leave through natural attrition.
Another way the company can impact liquidity and mitigate risk is by paying debts on time and as soon as possible. This lowers interest and saves the company money it can be investing in short-term investments. Collecting outstanding debts is also an important way to mitigate risk. Custom Snowboards can maintain its accounts payables increase without increasing portion of long-term debt. The company can mitigate the risk of accounts receivable not paid on time by ensuring products are delivered on time, properly invoiced, and accurate goods. Accounts receivable should be paid under 30 days but accounts payable lengthened to 60.
Inventory should remain stable so assets are higher than liabilities. Excess inventory uses capital that should be used in other investments in the company. The company can accurate and strict inventory records to make sure it knows what it has on hand, and what needs to be ordered. Matching billing cycles to production will optimize assets. Building good rapport with vendors and being loyal customers who pay their bills on time could afford the company certain vendor discounts to lower cost.
Custom Snowboards’ Ratio Analysis was reviewed to determine the company’s ability to repay the principle and interest on the five year loan. The current ratio as discussed previously, shows the company’s ability to pay for its current liabilities, with its current assets. The current ratio shows the company can do just that. Since Custom Snowboards has the ability to pay for its current liabilities 6 times over, that should be a strong indication to the bank that the company has the ability and will pay its short-term loan. The higher number also indicates the company needs to start placing money in profitable investments such as expansion. The acid test ratio, or quick ratio tells the same story as the current ration, without inventory.
The debt ratio shows how much of the company’s assets are financed unveiling any hidden debt management issues as well as a long term solvency indicator. In this case, Custom Snowboards debt ratio is a little high with industry standards at about 40%. However, Custom Snowboards’ debt ratio has decreased in year 14 indicating the company is gaining a better handle on its debt management.
The average collection period is the amount of days the company waits before payments on received on accounts receivable. Collecting monies creates cash that can be used to make payments on the company’s own debts. Custom Snowboards is receiving payments in 11 days. Winter sports set the bar at a high 32.5 days which shows that Custom Snowboards does a much better job at managing account receivable.
Gross profit margin is monies remaining subtracting good sold costs. Gross profit margin pays additional expenses and should not fluctuate. The steady 30.4% shows the bank that Custom Snowboards is consistent and their gross profit is enough to sustain future operations.
The operating profit margin includes all expenses. This ratio should be going up as it measures the company’s pricing strategy and operating efficiencies however, Custom Snowboards operating profit margin is declining and will need to be addressed.
Net profit margin shows how the company turns revenues into profits from sales. At less than 2%, Custom Snowboards is not doing well in this are either. Winter Sports is well above Custom Snowboards with 5.1%. The bank will not look upon the idea that the company cannot turn sales into profits as a positive.
Earnings per share (EPS) indicates profitability for the shareholders. At .10 and .15, Custom Snowboards has proven it can create wealth for its investors. The company is doing better than Winter Sports in this area but should take note of the decline and take steps to ensure this is not a trend.
The company’s return on total assets is at 5%. Although dropping from 7.3% the year before, it is still higher than its competitors. As with the earnings per share, Custom Snowboards should take care in ensuring the decline is not a trend. The return on total assets shows the bank that the company can use their assets to create income. Income that can be used to pay loans.
The price earnings ratio is the market value of how much an investor is willing to pay for $1 of current earnings, indicating future growth. Custom Snowboards’ price earnings ratio is a higher 30.59 while the competitions is at 29. The bank however, may see the investors were more hesitant in year 14 as the price earnings ratio dropped from 66.22 to 30.59.
Finally, times interest ratio measures the company’s ability to pay its interest on debts, pre-tax. Custom Snowboards times interest earned is nearly half Winter Sports 5.10, at 2.65. Failure to pay interest rates could result in financial failure, including bankruptcy. This number indicates that the company can only pay its interest a little over twice with pre-tax earnings. This leaves little room for error. The bank may see this as a gauge that Custom Snowboards should find ways to increase this number prior to adding more debt.