Pinnacle Manufacturing Company’s Financial Forecast Case Study

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Financial trend analysis for Pinnacle Manufacturing Company

Account balance	% change 2012 – 2013	% change 2011 – 2012
Net sales	1.45%	2.70%
Cost of goods sold	2.85%	4.18%
Operating expenses	-2.51%	2.40%
Income from operations	1.87%	-23.10%
Net receivables	51.30%	8.61%
Inventory	26.23%	1.05%
Account payable	37.09%	24.71%
Long-term debt	9.30%	-0.17%

Debt to equity, Net income before tax/sales, gross margin percentage, inventory turnover

Ratio	2013	2012	2011
Current ratio	1.75	1.93	2.19
Debt to equity	90.5%	73.9%	70.8%
Net income before taxes/sales	1.39%	1.28%	2.11%
Gross margin	27.50%	28.49%	29.51%
Inventory turnover	3.8	4.2	4.0

Summary of observations about Pinnacle’s business

The company continues to experience growth in both net sales and cost of sales in 2012 and 2013. However, the rate of growth in 2012 was higher than that reported in 2013. Besides, the rate of growth for the cost of sales is higher than that of net sales. This leads to a decrease in the rate of growth of gross profit margin. The company resorted to cost-cutting strategies which led to the 2.51% decline in operating expenses in 2013. This strategy led to an increase in income from operations by 1.87% in 2013. The net income before tax to sales shows that the company is profitable even though there was a slight decline in the rate of growth.

In the balance sheet section, there was significant growth in net receivables and inventory in 2013. The rate of growth of receivables indicates a probable collection problem now and in the future. Further, the rate of growth of inventory may lead to a build-up. This may cause an increase in inventory handling costs and obsolescence. It also explains the decline in inventory turnover. The current ratio deteriorated.

This shows that the ability of the company to settle immediate obligations using current assets is declining. Despite the trend observed, the value of the current ratio is still high and it is not a cause of concern. The debt to equity ratio increased during the period. It shows that the leverage level increased due to an increase in the debt level. This may be a cause of concern because the use of too much debt puts shareholders’ funds at risk. The interest expense reduces profits.

A common-size income statement for 2011-2013

Pinnacle Manufacturing. The common size, income statement. For the year ended 31^st December.

	2013	2012	2011
Sales	100.00%	100.00%	100.00%
Sales Returns and Allowances	0.12%	0.12%	0.12%
Cost of Sales*	72.41%	71.43%	70.40%
Gross Profit	27.47%	28.45%	29.48%
OPERATING EXPENSES-Allocated
Salaries-Management	1.51%	1.61%	1.58%
Salaries-Office	0.21%	0.20%	0.21%
Licensing and certification fees	0.13%	0.12%	0.11%
Security	0.36%	0.43%	0.44%
Insurance	0.06%	0.07%	0.07%
Medical benefits	0.02%	0.02%	0.02%
Advertising	0.11%	0.12%	0.11%
Business publications	0.00%	0.00%	0.00%
Property taxes	0.01%	0.12%	0.12%
Bad debts	0.56%	0.70%	0.68%
Depreciation expense	3.54%	3.12%	3.02%
Accounting fees	0.18%	0.20%	0.21%
Total operating expenses-Allocated	6.69%	6.70%	6.58%
OPERATING EXPENSES-Direct
Salaries-Sales	9.92%	10.30%	10.29%
Wages Rental	0.33%	0.40%	0.40%
Wages-Mechanics	0.74%	0.90%	0.92%
Wages-Warehouse	3.24%	3.59%	3.78%
Garbage collection	0.02%	0.02%	0.03%
Payroll benefits	1.76%	1.97%	2.00%
Rent- Warehouse	0.53%	0.51%	0.52%
Telephone	0.02%	0.03%	0.04%
Utilities	0.17%	0.18%	0.19%
Postage	0.06%	0.09%	0.10%
Linen service	0.01%	0.01%	0.01%
Repairs and maintenance	0.11%	0.11%	0.12%
Cleaning service	0.06%	0.05%	0.05%
Legal service	0.26%	0.13%	0.11%
Fuel	0.19%	0.23%	0.19%
Travel and entertainment	0.07%	0.07%	0.07%
Pension expense	0.15%	0.16%	0.09%
Office supplies	0.10%	0.10%	0.12%
Miscellaneous	0.20%	0.07%	0.10%
Total operating expenses-Direct	17.94%	18.94%	19.13%
Total Operating Expenses	24.63%	25.63%	25.71%
Operating Income	2.83%	2.82%	3.77%
Other Expense-Interest	1.45%	1.55%	1.66%
Income Before Taxes	1.39%	1.28%	2.11%
Federal Income Taxes	0.59%	0.58%	0.93%
Net Income	0.80%	0.70%	1.19%

Accounts for which there is a concern about material misstatements

Account	An estimate of $amount of potential misstatement
Depreciation expense	The expensed by $694,801. This could partly be a result of the increase in property, plant, and expense but it appears overstated.
Property taxes	A decrease of $155,424 when the balance of properties in the balance sheet has increased could be an indication of omission or misstatement.
Interest expense	The interest-bearing short-term and long-term debt increased by $7,155,235, while the interest expense declined by $117,269. It is expected that as debt increases, then the interest expense will also increase by the same proportion that is 21.92%.
Income tax	The federal income tax as a percentage of net income before tax is 45.21% in 2012. If the same rate is applied in 2013, the federal income tax is expected to be $947,585.19. Therefore, the value for the year 2013 is understated by $64,148.
Bad debts	The value of bad debts declined by $192,361 despite the increase in accounts receivable. It could be an indication that the allowance for bad debts was understated.

Data for evaluating the potential for misstatements

The information in previous parts focuses on the performance of the entire company. Therefore, it is suitable for analyzing the potential misstatements in all accounts apart from the direct expenses. For the direct expenses, it is suitable to use the disaggregated information for each division.

The likelihood that Pinnacle is likely to fail financially in the next 12 months

There is a low likelihood that the Pinnacle manufacturing company will fail financially in the next twelve months. The results show that the company has been profitable during the period of analysis and that it is making adequate cash flow. Besides, there are no indications that the company is facing financial difficulties. Even though some ratios such as current ratio and debt to equity have declined, they are still high enough to cause an alarm over the going concern of the business.

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