Introduction
The company in question is Chester, Inc. for the sale of sportswear, which has a dynamics of indicators for 2013-2015. For this work, an analysis is presented according to GAAP standards since, for public companies, there must be compliance with the financial reporting format prescribed by Regulation S-X. Thus, unlike the accessible IFRS format, which, on the one hand, can display only essential indicators for the industry and the company, it can hide specific details, leaving room for investors to manipulate finances (Hong et al., 2018). However, the only point that will be taken over from IFRS is the requirement to present comparative information for the previous reporting period, which is optional for GAAP. Therefore, each section of the financial analysis contains information for three years, in accordance with the requirements of IFRS, and reflects the reporting indicators of the GAAP standard.
Discussion
Detailed analytics can be provided by ratios calculated based on items from the balance sheet, cash flows, and income statement. To display the liquidity or the company’s ability to cope at the moment with short-term obligations during the three years under review, the following indicators were chosen. First, the current ratio, which is classic for this section, compares the company’s current assets with liabilities for financial stability at a point in time. Secondly, the acid-test ratio, which also considers these two indicators, only minus inventory from current assets. Finally, the operating cash flow ratio reflects the company’s turnover compared to short-term liabilities.
The current ratio, in general, is not bad for the company and is relatively stable. In addition, in the case of GAAP, extraordinary and other unusual items of expenditure are taken into account that are not included in the IFRS standard, which indicates greater transparency in Chester’s relationship (Hong et al., 2018). The downward dynamics may signal the investment of current funds in the company’s development, as evidenced by purchases in 2014. However, according to this indicator, Chester is several times inferior to Under Armor – 3 times and Columbia – 4 times (Macrotrends, 2022a, Macrotrends, 2022b). The retail market with a fast turnover requires, in order to remain competitive, to use mechanisms to improve this indicator and, accordingly, the value of current assets (Fildes et al., 2019). Considering various fashion trends and sports events, a more significant number of assets allows the necessary flexibility in the enterprise and is constantly ready for restructuring.
The ratio of inventory to other current assets is also not in favor of the company, especially against the background of competitors. Inventory management is an essential component of the economic efficiency of a business, namely the ability to adequately and long-term planning. Columbia Sportswear’s assets mainly were cash on hand before a slight change in dynamics in 2015. Under Armor is numerically closer to Chester, but the company’s acid test is significantly higher with stock and lower debt. However, in the case of Chester, the LIFO method used in GAAP standards is used, which indicates high current costs, but a relatively stable picture in the long run. In addition, according to GAAP, intangible assets do not have potential growth dynamics, unlike IFRS, where revaluation often occurs and contributes to the growth of this indicator (Hong et al., 2018). This indicator better reflects the adaptability and agility of the organization under consideration at a given point in time, in contrast to the current ratio, because inventory assets of unsold products are the most illiquid component of the current balance sheet item.
Finally, the operating cash flow ratio allows evaluation of the company’s turnover and the availability of development opportunities based on current liabilities. Unlike IFRS, under GAAP, development costs cannot be capitalized, therefore Chester’s competitors will have a certain advantage in this indicator (Hong et al., 2018). The most successful company in the industry is Columbia, in this indicator. Downward dynamics are typical for all three companies; however, Chester is beginning to recover turnover earlier than others. This fact signals that the company could adapt to the crisis for the industry earlier and better than others, while Under Armor came to a figure of less than 1 percent (Macrotrends, 2022b). Although this indicator is one of the most affected by various factors, it demonstrates the company’s liquidity in the shortest time.
Solvency is demonstrated by more long-term stability when it is no longer analyzed short-term assets and liabilities but their total number. The debt to equity ratio shows the ratio of debt to equity and is a tiny indicator across the industry due to relatively small long-term liabilities (Macrotrends, 2022a, Macrotrends, 2022b). On the other hand, Chester has numbers that are starting to rise steadily by 2015, demonstrating the potential danger for the company in repayments on borrowed funds. Under Armor, even during the global crisis due to the pandemic, did not miss values above 0.5, while at Chester, they reached 3 and 4 for 2014 and 2015, respectively.
It is believed that the debt burden should not exceed 30% of the company’s assets, while for retailers with relatively fast sales, this figure can vary up to 35%. Columbia keeps below a third at all, maintaining momentum over the years (Macrotrends, 2022a), while Under Armor is gradually aiming for growth up to 55% (Macrotrends, 2022b). In this case, Chester’s position is disappointing, which is dictated by an instant increase to almost 90%, although even in 40% percent, as a rule, they already see the danger of default (Sunardi et al., 2020). This practice is highly detrimental to Chester, even if it has a positive financial impact right now. However, in this case, according to GAAP, fixed assets are valued according to the cost model, which accordingly grows at Chester from period to period. The IFRS uses the revaluation method, which is more flexible and allows for a more adequate estimate in such relationships.
Finally, the third indicator, leverage, reflects the investor attractiveness of the company’s project as a whole. Competitors did not exceed 2 in those years, while Chester posted 4 and 5 in those two years. This fact indicates that the company is significantly increasing its debt load since the equity does not change to a much lesser extent relative to the dynamics. At the same time, it is worth considering the above differences between GAAP and IFRS: the lack of capitalization of development funds, the stagnation of the value of intangible assets, the impossibility of restoring the inventory amount, and accounting for extraordinary losses (Hong et al., 2018). As a result, Chester has more transparent financial reporting, and all of these disadvantages are probably the only ones compared to competitors.
The last group is represented by profitability indicators, which reflect the effectiveness of the company’s operations. Retail, as a rule, has lower gross profit margins due to the lack of production, although not in all cases: the industry average is 45% (Macrotrends, 2022a, Macrotrends, 2022b). Columbia and Under Armor, with relative success, gradually improved the dynamics in 2013-2015, while Chester lost significantly in this indicator. Likely, the price of goods is higher, which signals the incredible power of manufacturers in Porter’s five forces, and Chester did not find mechanisms to raise prices and optimize business processes accordingly.
Similar statistics are reflected by the net profit margin, which on average, fluctuates at the level of 5%. Under Armor shows a downward trend, and Columbia is ascending by the same indicators (Macrotrends, 2022a, Macrotrends, 2022b). Chester had an unexpected takeoff in 2014 but returned to a 2% figure, which practically deprives the company of accumulation of assets for agility and development in the market compared to competitors in the long term. Under Armor is recovering its position at the level of 6% after the crisis of 2020 with a figure of -12% (Macrotrends, 2022b). Any difficult situation that requires significant expenses from Chester can lead the company to an extended loss of profit.
At the same time, the ROA and ROE figures are positive in Chester’s financial analysis. Firstly, they significantly exceed the same indicators of competitors, inclined to calmer dynamics by order of magnitude smaller numbers. Secondly, these indicators demonstrate the company’s ability to use its assets and increase profitability effectively. Chester has excellent potential profitability, mainly due to the ability to optimize many business processes that reduce a significant part of profits and turnover, bringing only 2% to the net profit margin.
Conclusion
Vertical and horizontal analyses revealed the following 10% deviations from the norm. First, the company significantly increased the credit line, which led to a significant skew in the dynamics of interest in the balance sheet and partly in the income statement. Second, while the company improved operating costs in 2015 by purchasing equipment in 2014, unit efficiency has become more costly with falling sales and rising returns. Consequently, Chester loses its already untapped potential, which can be significantly unlocked, as demonstrated by the financial analysis of competitors.
References
Fildes, R., Ma, S., & Kolassa, S. (2019). Retail forecasting: Research and practice. International Journal of Forecasting, 2019. Web.
Hong, P. K., Paik, D. G., & Smith, J. V. D. L. (2018). A study of long-lived asset impairment under US GAAP and IFRS within the US institutional environment. Journal of International Accounting, Auditing and Taxation, 31, 74-89. Web.
Macrotrends. (2022a). Columbia Sportswear Financial Ratios for Analysis 2009-2022 | COLM. Web.
Macrotrends. (2022b). Under Armour Financial Ratios for Analysis 2009-2022 | UAA. Web.
Sunardi, N., Husain, T., & Kadim, A. (2020). Determinants of Debt Policy and Company’s Performance. International Journal of Economics and Business Administration, 8(4), 204-213.