Introduction
Growth and expansion is a key ingredient for the success of a company. Management of companies often considers expanding their scale of operation within the domestic markets and in foreign markets as a significant measure of success. However, such growth and expansion often come with a number of challenges. One such key challenge is the availability of finances that can cover all the costs of expansion. Internal finances available are never adequate for such massive investments required. Therefore, in most cases, companies often prefer to seek for external sources of funds. Before financial institutions and other capital providers can release their finances for funding in the company, they have to carry out a thorough financial analysis of a company. Such analysis is often carried out over a given time period. This gives them an overview of the financial strengths and weaknesses of the company.
Aim of the Paper
The paper presents an evaluation of the financial aspect of Custom Snowboard Inc. The paper is divided into two parts. The first part of the paper seeks to present a report to the Chief Financial Officer. This report gives detailed analysis of the financial performance of the company. It focuses on ratio analysis and financial risk analysis. The second part of the paper seeks to prepare a comprehensive report that gives recommendations on expansion into the European market. Specifically, the section focuses on historical analysis of the financial data of the company, evaluation of future performance, risk analysis, and evaluation of the possible options for expansion.
Overview of the Financial Position of the Company
A Summary of Key Points of the Company’s Financial Position
Banks are often concerned about their exposure to the risk of default when they loan money to customers. Therefore, they often carry out an all round analysis of a company before lending money. Analysis of the financial position of the company will focus on profitability, solvency, and liquidity.
Credit History
First, the bank looks at the current liabilities of the company. This helps them to know the current debt level of the company and the whole amount they other creditors. When they assess the current liability of the customer, the bank ensures that they do not over-extend their exposure to credit risk of default to one customer. Further, when analyzing the credit history of the company, the bank will also check the period when a company makes late loan repayments. The bank will also be interested in the period when the organization defaults payment (McLaney & Atrill, 2008). The current liabilities declined by 3.7 percent in year 13. However, in year 14, the value increased by 0.7%. Further, the accounts payable and notes payable decreased by 6.4% in year 13. The value later increased by 1.3% in year 14.
The increase is equivalent to the value by which sales decline in the same year. It can be an indication that the company makes late payment. Further, the long-term liabilities declined from $860,000 in year 12 to $750,000 in year 14. The proportion of long term debt that is payable within a year remained constant at $55,000 over the three years. It may indicate that the company uses revenue and not capital to repay loans. Also, mortgage payable and other liabilities declined by 6.4 percent in year 13. The value further declined by 6.8 percent in year 14. The trends show the company made consistent repayments of debts. The total amount of liabilities also declined by 6 percent in year 13 and further by 5.8 percent in year 14. This shows that the management is efficient in handling debt. It is worth noting that despite the decline in sales and debt repayment, the value of retained earnings increased over the period. The total increase for the three years amounted to $66,375.
The Ability to Repay
The second area that the bank will look at is the ability of the company to repay the principal amount and the interest expense. This can be evaluated in terms of liquidity and profitability. In terms of liquidity, the bank will evaluate the ability of the company to meet its liabilities promptly. Current assets and current liabilities are used to assess the liquidity of a company. The value of current assets increased by 12.3 percent in year 13. However, the value declined by 16.6 percent in year 14. The increase in year 13 was mainly caused by an increase in cash (by 64.1%) and short-term investment (by 20%). However, the decline in year 14 was caused by an increase in the value of furniture, fixtures, and equipment (by 66.7 percent). It can be observed that the company might have disposed the short-term investments (worth $150,000) to acquire assets. This indicates that the company does not plow back capital into the business. Further, the account receivable balance declined by 6.4 percent in year 13. However, the value increased by 1.3 percent in year 14. The increase is consistent with the changes in the value of sales. Finally, the total assets decreased by 0.5 percent in year 13. It further declined by 2.3 percent in year 14. It can be observed that the amount of total assets did not decline as much as the decline in sales.
The other aspect on ability to repay is profitability. The ability of an entity to generate profit depends on the sales volume and management of expenses. In year 13 sales declined by 6.44 percent but increased by 1.28 percent in year 14. The gross profit and selling expenses changed in the same proportion as sales. However, in year 13 the general and administrative expenses increased by 7.24 percent and further by 6.5 percent in year 14. Thus, the management was efficient in managing selling and distribution expenses but not general and administrative expense. Despite the increase in sales in year 14, the amount of net profit declined by 67.66 percent in year 13 and further by 72.11 percent in year 14. This might not be a good indication of the profitability of the company.
Other Risks
The analysis will be used to evaluate the risk of default, foreign exchange variation, and liquidity risk. This can significantly affect the financial results of the company. Also, the bank can also be exposed to the risks that arise from business combinations such as mergers and acquisitions. Finally, the other risks are the effectiveness of the internal control framework function of the company and cooperation with the various regulatory authorities (Atrill, 2009).
How Financial Risks Pointed Can be Mitigated by the Company
There are a number of ways that the company can mitigate the risks discussed in the previous section. The first way is by providing collateral for the loan. The collateral can be in the form of the assets of the company. Secondly, the management of the company should maintain a sound liquidity position of the company. This will enable the company to pay immediate obligations as they fall due. Thirdly, the management should improve the internal process of the company. This should aim at increasing the profitability of the company thus reducing the operating risk. Further, the management of the company should ensure complete adherence to the rules and regulations of the authorities. This will minimize the risk of non-compliance. Finally, the management of the company needs to carry out a thorough due diligence before engaging in a business combination with other companies. This reduces the risks that arise from such combinations.
Ratio Analysis
Ratio analysis breaks down the financial statement of a company into components that can be analyzed easily. The results of ratio analysis enable users to have a better view of the financial strengths and weaknesses of the company. This section discusses the ratios that indicate the ability of the company to repay the loan.
Profitability and Efficiency Ratios
The table presented below summarizes the ratios of the company.
As can be observed in the table presented above, the profitability of the company declined as indicated by the operating profit margin, net profit margin, return on assets, and return on common equity between years 13 and 14. There was no significant change in the operational efficiency of the company as indicated by no change in the value of inventory turnover and average collection period. The ratios do not give a good indication in terms of the ability to pay of the company. It can also be observed that the competitor performed better than the company.
Liquidity Ratios
The table presented below summarizes the liquidity ratios of the company.
The liquidity ratios of the company were quite high. The current ratio shows that the company can pay up to six times of the current liabilities using current assets. It can also be observed that the liquidity ratio is also higher than those of the competitors such as Winter sports
Leverage and Solvency Ratios
The table presented below summarizes the ratios of the company.
The leverage level of the company declined from 52.5% in year 13 to 50.4% in year 14. This can be attributed to a reduction in the amount of debt. It is a good indication to the debt provider. However, the solvency of the company deteriorated over the period. It can be attributed to the decline in profitability. This shows that the ability of the company to pay interest expenses declined. In summary, it can be observed that the financial health of the company declined and it implies that the ability of the company to repay the loan also declined.
Expansion Into the European Market
Historical Analysis of Past Performance of Custom Snowboard Inc.
In this section, vertical and horizontal analysis will be used to evaluate the past performance of the company. The horizontal and vertical analyses are presented in Table 1 and Table 2. The horizontal analysis shows that there was a general increase in the values between year 12 and year 13. However, between years 13 and 14, the company experienced a decline in key values such as sales net income. The balance sheet value decreased over the three year period. The total assets, liabilities, and shareholders’ equity declined over the period. The vertical analysis allows an analyst to evaluate ratio analysis of a company. For instance, it can be observed that the gross profit margin and the selling and distribution expenses did not change over the period. The operating expenses increased over the years. This resulted in a decline in operating income and net earnings. Further, the total current assets and the net property plant and equipment were erratic over the period. They did not exhibit any trend. The total liabilities declined over the period while the value of total stockholder’s equity increased over the period.
Table 1. Horizontal Analysis
Custom Snowboard Inc.
Comparative Income Statement
For the period ended 31st Dec 12, 13 and 14.
Custom Snowboard Inc.
Comparative Balance Sheet. For the period ended 31st Dec 12, 13 and 14.
Table 2. Vertical Analysis
Custom Snowboard Inc.
Income Statement – vertical analysis. For the period ended 31st Dec 12, 13 and 14.
Custom Snowboard Inc.
Balance sheet – vertical analysis
For the period ended 31st Dec 12, 13 and 14
Analysis of the Historical Performance of the Company
An evaluation of the historical analysis of the company will give an indication of the future performance of the company. From the vertical and horizontal analysis of the company, the value of sales decreased by 6.44 percent in year 13. However, in year 14, the value declined by 1.28%. The value of gross profit and the selling expenses declined by the same proportion as sales. Further, the value of general and administrative expenses increased by 7.24 percent in year 13 and further by 6.5 percent in year 14. The large increase in the value of general and administrative expenses was as a result of an increase in the amount of salaries, utilities, and other expenses. Further, interest income and interest expense declined by $2,200 and by $5,000 respectively. These changes contributed to the decline in net earnings by $146,025 over the three year period.
The value of current assets increased by 12.3 percent in year 13. However, the value declined by 16.6 percent in year 14. The increase in year 13 was mainly caused by an increase in cash (by 64.1%) and short-term investment (by 20%). However, the decline in year 14 was caused by an increase in the value of furniture, fixtures, and equipment (by 66.7 percent). It can be observed that the company might have disposed the short-term investments (worth $150,000) to acquire assets. This indicates that the company does not plow back capital into the business. Further, the account receivable balance declined by 6.4 percent in year 13. However, the value increased by 1.3 percent in year 14. The increase is consistent with the changes in the value of sales. Further, inventory of raw materials changed in the same proportion as sales. The value of other current assets increased by 9.5 percent in year 13 and further by 5.8 percent in year 14. Finally, the total assets decreased by 0.5 percent in year 13. It further declined by 2.3 percent in year 14. It can be observed that the amount of total assets did not decline as much as the decline in sales.
The current liabilities declined by 3.7 percent in year 13. However, in year 14, the value increased by 0.7%. Further, the accounts payable and notes payable decreased by 6.4% in year 13. The value later increased by 1.3% in year 14. The increase is equivalent to the value by which sales decline in the same year. Further, the long-term liabilities declined from $860,000 in year 12 to $750,000 in year 14. The proportion of long-term debt that is payable within a year remained constant at $55,000 over the three years. Also, mortgage payable and other liabilities declined by 6.4 percent in year 13. The value further declined by 6.8 percent in year 14. The total amount of liabilities also declined by 6 percent in year 13 and further by 5.8 percent in year 14.
There were no changes in the values of common stock and paid in capital. The total increase in the value of retained earnings for the three years amounted to $66,375. Further, the total change in the value of total equities and equities over the three years was 2.7%.
Analysis of Future Performance
The past trend of the performance of the company can be used to evaluate future performance. From the analysis above, it can be observed that the net sales increased thereafter it declined. The same trend can be extended in the future. For instance, in year 15, sales will increase by 3 percent (equivalent to $191,751), decline by about 1 percent ($63,917) in year 16 followed by an increase by 3.7 percent ($239,050) in year 17. Other variables that change proportionately to changes in sales such as gross profit and selling expenses will follow the same trend. Finally, between year 12 and 17, the company will report the highest amount of sales in year 12, that is, $6,745,900.
How the Current Operations Can be Improved Through Better Cost Controls
Currently, the company uses the traditional method of costing. Under this method, predetermined overhead rates are used to allocate indirect costs to the products. This method allocates costs to products irrespective of their contribution to the product. The approach is simple though it does not give a fair representation of the cost of the product. The management can improve on this method by using the activity-based costing. The method allocates costs based on their contribution in the production of a product. The method groups the activities in a production process and allocates indirect costs that relate to each group. This approach will enable the management to monitor the costs of each type of products that are being produced. The company produces two categories of the products. Under the traditional method, the regular snowboard costs $119 while the personalized snowboard costs $162. However, when activity-based costing is used the regular snowboard costs $105 while the personalized snowboard costs $218. Thus, the two different type of costing yield different results. The traditional costing overstates the cost of regular snowboard and understates the cost of personalized snowboard. Use of activity based costing reveals that the cost of personalized snowboard is quite high. The management needs to implement measures to reduce the cost of producing the personalized snowboard. Thus, the change in costing system can enable the management to come up with measures to manage the cost of each type of snowboard better (Holmes, Sugden, & Gee, 2008).
How to Improve the Current Operations
The current operations can be improved in a number of ways. For instance, the management can reduce the material handling costs by using better inventory management approaches such as just-in-time. In this approach, the management will purchase raw materials only when it needs to produce. Currently, the closing inventory of raw materials amounts to $35,000 while the value of finished snowboard amounts to $130,000 in the three years. Thus, the use of just-in-time will lower the value of closing inventory by a significant amount. These discharge the amount tied in the closing inventory to be used as working capital. Thus, the use of just-in-time improves efficiency of the company.
Internal and External Risks that the Company Can Face in the Expansion Process
Custom Snowboard Inc. is likely to face a number of both internal and external risks in the process of expansion into the new market. Consider an option where the company decided to merge with SnowFun, Inc. An internal risk that the company may face is the inability of the two companies to work together. This can arise from the inadequacy of the resources of the companies. Secondly, the two companies may have different corporate cultures and internal processes. This can hinder cooperation between the two companies. The third risk is the inability to manage the operations of the new company efficiently. This can be attributed to the fact that the two companies are now managed by two different groups. The ownership of the company may also affect the sales level of the new company. This also increases business risk. Finally, the company might face financial risk. This arises from the factor that the amount received from sales may not adequately cover the operating costs. A key external risk that the company may face is the inability to acquire a significant market share in the new market. This might affect the profitability of the organization. Secondly, the company may also face risks that the new regulations will impact on the operations of the company negatively (Collier, 2009).
There are a number of measures that the management can take to mitigate the risks discussed above. One way of mitigating risk is by carrying an extensive analysis of the various options before making any decision. The analysis should focus on carrying out a sensitivity analysis of the impact of the risks on profitability of the company. This will entail carrying out extensive financial analysis of the various options. Further, such analysis should also evaluate the impact of new regulation on the operations of the company.
Potential Returns of Procuring a New Plant in Europe
There are a number of non-financial benefits that arise from either setting up a new plant or merger and acquisition. For instance, the acquisition of the European-based company instead of setting up a new plant will benefit the company in a number of ways. First, the company will have a customer base that was tapped by the acquired company. The company will now focus on expanding the market. This may result in an increase in the overall performance of the company. Secondly, the resulting economies of scale that come with the acquisition will result in a reduction of costs and increased profitability. Finally, the acquisition will enable the company to exchange valuable ideas and resources with the acquired company. This improves overall efficiency of the company. On the other hand, setting up a new plant will enable the company to retain control over its operations.
A number of methods such as net present value (NPV) and internal rate of return (IRR) can be used to estimate the potential returns from setting up a new plant. The NPV for setting up the new plant amounts to $80,899. This implies that the project is viable and should be ventured into while the IRR is 12.1 percent. This exceeds the cost of capital of 10 percent and should be accepted.
Lease or Buy and Merger or Acquisition
The calculations are presented in the tables below.
Merger.
Acquisition.
Buy or lease option.
Explanation
The lease option generates the present value of outflows amounting to $653,355 while the buy option will generate a present value of outflows amounting to $597,723. The buy option requires a cash outflow amounting to $809,409. Besides, starting operations will require $200,000 of working capital to start operations. Thus, a lease option is cheaper than the buy option. The company can either buy or lease, or merge or acquire another company. Merging with the European company will result in an increase in the number of shares by 100,000 shares at a cost of $240,000 and an increase in the earnings per share from $0.98 to $1.18. The company can also buy the European based company at a cost of $720,000. The generated will generate the present value of the cash flows amounting to $732,522.
The best option to implement in this analysis is to build with sales leaseback. This preserves the working capital incurred at the beginning of operations. Besides, it eliminates expenses that relate to property taxes. Further, the company will be able to build its already well-known brand in the European market.
Financing Recommendation to the Chief Executive Officer
The recommendations above show that the project is viable. Thus, the management to find the most suitable financing option. This will entail evaluating the impact of the various financing options on the profit.
Based on the sensitivity analysis presented in the table above, use of debt financing reduces the earnings attributed to shareholders. Thus, use of common equity will be the most viable.
References
Atrill, P. (2009). Financial management for decision makers. New York: Financial Times Prentice Hall.
Collier, P. (2009). Accounting for managers. London: John Wiley & Sons Ltd.
Holmes, G., Sugden, A., & Gee, P. (2008). Interpreting company reports. New York: Financial Times Prentice Hall.
McLaney, E., & Atrill, P. (2008). Financial accounting for decision makers. New York: Financial Times Prentice Hall.