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					    Financial Analysis


                                            Competition Bikes, inc,
                                          Executive Summary Report

    Horizontal, Vertical, Trend and Ratio Analysis

            The assessments of the financial health of Competition Bikes, Inc. (CB) are derived using

    the attached income statements and balance sheets. Focusing on calendar years # 6, 7 and 8 to

    gauge the growth and stability of this company.

            Between the years # 6 and 7, Competition Bikes, Inc. had a significant growth in new

    earnings that was not extended on into year # 8. The net earnings moved from a positive 313.4

    % to a dramatic loss of 81.6% .

    A.1.a) Horizontal Analysis Results

            Horizontal Analysis is a direct comparative analysis of each line item across the same

    time frames of a particular company. It is calculated in dollars and percentages. An analysis will

    look at how the accounts have fluctuated from one year to the next.

                                           The formula used is:

    Dollar change = This Year’s Balance – Last Year’s Balance. Percent change = Dollar Change .

            The income statement from year # 6 to year # 7, exhibited a sales increase of 33%.

    There was only a 31 percent increase in product costs. This decrease in cost of materials was

    offset by sales expense of 33 percent and an increase in general operating espense – totaling 20

    percent.. These line expenses both increased from year # 6 through year # 8. These increases

    offset the profit from an increase in sales. CB experienced greater gross profits in year # 7 than
year # 6. The balance sheet also shows a growth in assets. Total assets increased by 2.9%.

Liabilities increased to only a slight 1.2% . This is a positive indicator of growth for Competition

Bikes, Inc.

       A comparative review of the CB income statement from year # 7 to year #8, shows a

decrease in sales by 15 percent. Product costs went down by 14 percent and sales expense

decreased by 15 percent. The general operating expense increased by 1 percent. The decrease in

product cost and sales expense was not significant enough to offset the decrease in sales. The end

result was a dramatic decrease in net income by 82%. The balance sheet shows total assets

decreasing by – 0.1% with liabilities also decreasing by -1.9%. This is a positive sign of


       “The horizontal analysis will provide an analysis of the financial performance of

       Competition Bikes, Inc. and provides an overview of potential trends of the

        company .”(Ashfaq, n.d.).

       The years # 7 and 8 utilizing the horizontal analysis further shows that total revenues

decreased by 15.0% . Total expenses decreased by an impressive 69.1%. The result was

earnings before income taxes (EBIT) decreased 313.4% and net earnings reduced 81.6%.


A horizontal analysis of CB is derived utilizing the income statement for Years 8, 7 and 6.

       Competition Bikes, Inc.’s financial strength was solely relied on by use of their income

Statements. It revealed a decline in growth in year #8 from year #7 . A 15% decline in

net sales resulted in a 16.3% decline in overall gross profit.

       The 15% reduction in sales is an overall operational area of concern. The decline has
been attributed to a decrease in the economy.. It is anticipated that sales trends will remain

steady for the next three years. For CB to recover from a such a steep decrease in sales, new

fiscal policies are necessary to remain a solvent company.

       Since sales were down, the products were not manufactured and the cost of goods sold is

aligned with this reduction. The Gross Profit was reduced also because of the lack of sales and

can affect future expansion of CB.

Operation Expenses

       The operational expenses seen a 3.6% decline. This decline was not equal to the decrease

in revenue. Management must keep expenses related to sales income. If they had kept in line the

operational expenses would have declined in lieu of increased.

       There are a few areas of concern within this area that must be addressed.

Selling Expenses

       Sales expenses are reduced by 14.9%. This is consistent with the reduced sale. Sales is

remunerated by a percentage.

       The reduction in sales paralleled the reduction in total sales expenses. Notably was the

decrease in advertising costs by 16.3 percent. A reduction in advertising can be partially

attributable to the decrease in gross sales.

       The Cost of Utilities steadily grew. CB experienced an 11.1% growth. This would not be

suspect except why did utilities needed for production increased when production decreased.

       In addition to the utility costs, all other general and administration expenses increased by

7.6 percent. This is of concern, besides utilities, all other costs were either below or even with

year # 7.
Balance Sheets and Total Assets

         CB reduced the accounts receivable account by 15 %. The horizontal analysis of the

current assets shows that the assets have grown 16.5% from year 7 to year # 8. The result of

collecting on accounts receivable was an infusion of $ 107,640 dollars. The cash balance rose


         Analysis shows that the accumulated depreciation was reduced by $ 230,000 or 50%.

The total assets were reduced by 0.1% or $2, 400.


         With a reduction of Accounts Receivable, the cash infusion was apparently partially used

to reduce the total liabilities by $ 38,500 or 1.9 percent. These reductions were in the long term

liabilities column. Reducing Mortgage and other long-term liabilities.

         A significant line of concern on the balance sheet is the increased purchase of raw

materials with a decrease in sales. This explains the unexplained increase in current liabilities of


A.1.B ) Vertical Analysis Results

         Vertical analysis is a method of analyzing financial statements against net sales of

the company. This analysis will illustrate how one credit or debit can have a positive or

negative effect on the net sales profit.

Income Statement

The income statement of CB, vertical analysis shows the following results.

         Gross Profit is the total sales minus the cost of goods sold. Net sales profit is determined
by crediting the fixed general operational expenses to the cost of goods sold. This determines

profit. Gross sales profit is an indicator of the company’s profit on all goods sold. The

significance of this number is maintaining market share and the viability of the product. Gross

sales allow for a cash influx to maintain operations. An analysis identifies weaknesses to discuss

potential remedies needed to increase the gross profit ratio. The gross profit ratio is determined

by the following formula:

                            Gross Profit Ratio = Gross Profit/ Net Sales

                    An analysis of the income statement of CB was performed.

                                 Gross Profit for CB is assessed as:

       Year 8 Gross Profit - 1,371,400- net Sales Year 8 / 5,083,000 = 27.0%

       Year 7 Gross Profit- 1,638,000 - net Sales Year 7 / 5,980,000 = 27.4%

       Year 6 Gross Profit - 1,191,000 -net Sales Year 6 / 4,485,000 = 26.6%

       The GP is trailing down. This is after a record year in - #7. This creates concern,

particularly when compared to year 6 when the GP was 26.6%. A GP of 27% is considered a

nice reasonable profit. CB needs to pay particular attention to this decrease. A decrease in GP is

a decrease in cash flow, market share and will affect CB’s net earnings. This decrease will

affect the ability to generate cash reserves..

       Operating Expenses Ratio (OER) is to determine the cost of normal business operations.

                                The formula is calculated as follows:

                               OER = Operating Expenses/Net Sales

                           Operating Expenses for CB were assessed as:

                      OE Year 8- 1,273,867 / Net Sales / 5,083,000 = 25.1%
                      OE Year 7- 1,322,075 / Net Sales / 5,980,000 = 22.1%

                      OE Year 6- 1,066,895/ Net Sales / 4,485,000 = 23.8%

       Year 6 assets represent 24.5 cents out of every dollar and total liabilities are 47.5%.

       Year 7 assets were increased to 31.9 cents. This was possible by the accounts

receivable increasing from 6.5% to 16.6%. Liabilities decreased to 46.7%.

       The financial statements show that operating expenses are 25.1% of every dollar made by

CB. These expenses include sales expenses, general and administration expenses.

       Year 8-

Since year 7, the operating expenses have increased 3%. It is most notable with a reduction in

sales in year 8. Most significant is the sales expenses were not reduced in year 8 consistent with

the major reduction in gross sales. Steadily, the sales expenses stay within 6.7% of gross sales.

Appropriate reductions were not made in sales advertising in year 8 . Sales Commissions were

lower due to the lower sales. This is an indication, CB had established sales commissions

according gross sales. Sales commissions have maintained at 3% of net sales.

        General and administration expenses increased steadily. Specifically, there was an

increase in the cost of general and administration expenses from 15.5% to 18.4%. One notable

reason for this increase was that salaries were increased in year 8.

       Executive Commissions increased from year 7 to year 8 . Sales income needs to be

directly related to sales profits. This may be an indicator of CB not being in financially good

health in the near future. If their remuneration was directly linked to their net profit, then the

percentage would have stayed more consistent..

       The cost of general and administration expenses rose in year 8 by $12,000 or 0.7%. This
Figure is an additional indicator that the financial health of CB is deteriorating.

Executives need to adjust and control expenses.

                                 Net Earnings for CB years 8, 7, 6:

                Net Earnings Year 8- 36,100 / 5,083,000 = 0.7%

                Net Earnings Year 7- 196,294 / 5,980,000 = 3.3%

                Net Earnings Year 6 - 47,479 / 4,485,000 = 1.1%

       These ratios should be of major concern to CB. They are breaking even between sales

and expenses. This slim margin is indicative that expenses are too high. The 2.6% reduction in

net earnings is below their prior year 6 net earnings.

Balance Sheet

In reviewing the Balance Sheet of CB, the following vertical analysis was performed below.

Current Ratio

       Current Ratio is used to determine whether a company can pay its short-term debt.

                        Current Assets Ratio is determined by the formula:

                        Current Ratio = Current Assets/Current Liabilities

Current Ratio for CB was computed by:

Current Assets Year 8/ Current Liabilities-Year 8 1,606,817/ 300,200 = 5.35X

Current Assets Year 7/ Current Liabilities- Year 7 1,379,217/ 233,700 = 5.9X

Current Assets Year 6/ Current Liabilities- Year 6 1,029,303/ 105,080 = 9.7X

       Although CB’s year 8 Current Ratio is 5.35X, its current liabilities, the continued
reduction is a concern..

        Competition Bikes, Inc's income performance deteriorated between year 7 and 8.

In year 8, for every gross dollar generated, it retained 0.7 cents. In year 7, 3.3 cents was
retained. The overall profitability of the company decreased.

A.1.C ) Trend Analysis

       Trend analysis calculates the percent change in an account over two years or more. This

is to illustrate if the company is moving positively or negatively.

                                     The formula is as follows:

                                  (Any year $ / Base Year $) x 100

Year 6 is used as the base year

To evaluate CB net sales profits for years 8, 7, and 6 the following trend analysis was completed:

Net sales- year #8/ 5,083,000 - year # 7/ 5,980,000 - year# 6 / 4,485,000

COG - year #8/ 3,711,600 – year # 7/ 4,324,200 – year # 6/ 3,294,000

Gross Profit- year# 8/ 1,371,400 - year # 7/ 1,638,000- year #6/ 1,191,000

Sales Expense - year # 8/ 338,748- year # 7/ 397,960- year # 6 / 299,220

Total G&A Expenses- year# 8 / 935,119- year # 7 / 924,115- year# 6 / 967,675

Total Operating Expenses- year # 8/ 1,273,867- year 7/ 1,322,075- year #6/ 1,066,895

Operating Income – year# 8 / 97,533- year # 7/ 315,925 – year# 6 / 124,105

EBIT- year # 8/ 48,133- year# 7/ 261,725- year #6/ 63,305

Net Earnings – year # 8/ 36,100- year # 7/ 196,294- year# 6 / 47,479

Net Sales – year # 8/ 113.3%- year #7 / 133.3%- year # 6/ 100.0%

Cost of Goods Sold- year# 8/ 112.7% - year # 7/ 131.3% - year# 6/ 100.0%

Gross Profit – year # 8/ 115.1%- year # 7/ 137.5%- year 6/ 100.0%

Selling Expense – year # 8/ 113.2% - year # 7/ 133.0%- year # 6/ 100.0%

Total G&A Expenses - year # 8 / 96.6%- year # 7 / 95.5%- year 6/ 100.0%
Total Operating Expenses – year# 8 / 119.4%- year 7/ 123.9% - year 6/ 100.0%

Operating Income – year # 8/ 78.6%- year 7/ 254.6%- year 6/ 100.0%

EBIT- year # 8/ 76.0%- year 7/ 413.4%- year 6/ 100.0%

Net Earnings – year #8/ 76.0%- year# 7/ 413.4%- year # 6/ 100.0%

Net Sales decreased in Year 8 in comparison to Year 7. This was calculated by:

Year # 8 Trend : (5,083,000/4,485,000) x 100 = 113.3 %

Year # 7 Trend : (5,980,000/4,485,000) x 100 = 133.3 %

       This is a concern since net sales profit was in a decline from Year # 7. However, it did

not fall below year # 6 Net Sales.

       Sales should continue to increase annually.. To establish the stability of the company

and the viability of the product.

Cost of Goods Sold for Year # 8 and 7 were evaluated as follows:

Year # 8 Trend : (3,711,600/ 3,294,000) x 100 = 112.7%

Year # 7 Trend : (4,324,200/ 3,294,000) x 100 = 131.3%

       In Year # 8, the Cost of Goods decreased compared to Year # 7.

Year # 8 Trend : (5,083,000/4,485,000) x 100 = 113.3 %

Year # 7 Trend : (5,980,000/4,485,000) x 100 = 133.3 %

       For Year 8, the trend shows that the cost of goods is reduced but is not in line with the

reduction in sales. The Cost of Goods needs to be evaluated to insure that the proper pricing of

the goods is in line with the sales point of the merchandise..

       In EBIT and net earnings, year 7 provided the trend boost with a 413.4% increase in

growth. This was due to the tremendous growth in sales. In year 8, EBIT and Net Earnings
were dramatically reduced even below year 6. This is of major concern. Although sales were

reduced, operating expenses were not reduced to produce a better EBIT and net earnings.

Reduction in expenses should have been made throughout the year as the reduction in sales was


        The trend analysis for year # 8, compared to year # 7. Policy change may be needed

when sales are decreasing and expenses are increasing. This simple business fact produces a

strong EBIT and net earnings dividend .

Trend analysis for future years.

Competition Bikes, INC. Year 11- Year 10- Year 9- Year 8

Net Sales year # 11/- 5,083,000-year # 10/ 5,980,000- year # 9/ 4,485,000- year # 8/ 5,083,000

Trend Percentages – year #11/ 111.8- year # 10/ 107.6- year #9/ 103.2- year #8 / 100.0

        In base year 6, the trend percentage is 100%. Year 7 trend percentage is 133.3%. The

year 8 trend percentage is 113%. Although lower than year 7, it is still higher than the base year


        This trend analysis illustrates sales in year 8 were 13.3% of year 6 sales. This represents

an increase in balance over a three year period. The results are a favorable impact to the

company. The trend is less favorable in the next three years. From year 8 to 11, the trend

analysis is only an 11.8% increase in sales. This is lower than the previous three-year period.

 This would still be a favorable impact for CB. The company will recover from its year 8 losses.

They need to be cognizant and pay attention to their operating expenses to insure profitability.

A.1.D) Ratio Analysis

        Ratio analysis examines “the financial infrastructure of the firm, its characteristics, and
the impact of management decisions on financial performance” (Skillsoft, n.d.). The ratio

analysis indicates CB’s ability to pay short term liabilities. Ratio analysis has been

reviewed in the summary analysis approach. This concludes all aspects of the companies

financial activities to isolate the following key areas of responsibility:

Liquidity Ratios

       “Liquidity ratios measure the short-term solvency of a business solvency.” (Skillsoft,

        Ratio Analysis) These ratios are used by creditors to evaluate if a company has the
       ability to pay back its obligations and liabilities.

       The liquidity ratios for CB will also determine how well it is performing financially.

These ratios will determine cash reserves and availability, inventory turnover and the

management of assets and liabilities.

Current Ratio

           Current Ratio is used to determine whether CB can pay its short-term debt. Current

                                          Assets Ratio formula is:

                         Current Ratio = Current Assets/Current Liabilities

Current assets year 8/ Current Liabilities Year 8 -1,606,817/ 300,200 = 5.35X

Current assets year 7/ Current Liabilities Year 7 -1,379,217/ 233,700 = 5.9X

Current assets year 6/ Current Liabilities Year 6 -1,029,303/ 105,080 = 9.7X

       CB’s Year 8 Current Ratio is 5.35X in current liabilities, the continued reduction is a

point of concern. As the ratio continues to decline, the increase in liabilities must be curtailed

until assets recover.

Quick Ratio

       Quick Ratio determines how well a company can pay back its creditors. It is utilized to
determine their solvency. If their assets outweigh their liabilities. .

                                            The formula is:

                          Quick Ratio = Liquid Assets / Current Liabilities

Year # 8 Quick Ratio = ( 445,024 + 220,000 + 609,960) / 300,200 = 4.25 %

Year # 7 Quick Ratio = ( 118,550 + 220,000 + 717,600) / 233,700 = 4.52 %

Year # 6 Quick Ratio = ( 261,000 + 198,500 + 271,503) / 105,080 = 6.96 %

        The acid test ratio for year 8 is 4.25. This is lower than year # 7, 4.52. Although, it is

higher than its competition, Two Wheel Racing (2WR). Their ratio is slightly lower at 4.2

        Competition Bikes Inc., is solvent and can meet its short-term debt obligations 5.35 times

over. From an investors stand point, this company is performing well. From a creditors stand

point, they are credit worthy.

        The quick ratio analysis indicates that CB continues to increase its risk in covering its

immediate liabilities. If this ratio continues to decline, this will result in a risk of increased

financial problems or their ability to receive credit lines. Another indicator of the analysis is that

inventory is accumulating. 2WR is excelling CB in most all financial areas. 2WR’s Gross

Profit is 32.10 % compared to CB’s Gross Profit of 27.0%

        CB has a weakness in their P/E Ratio of 83.73. 2WR P/E Ratio is 29. Stockholders

may look at this higher P/E Ratio for CB unfavorably. This higher P/E Ratio may be an indicator

that the stock price for CB is overpriced. This possibly could indicate that 2WR’s stock is priced

correctly and allow 2WR possible future growth and strength.

Current Ratio for CB was assessed as:

Current assets Year # 8- 1,606,817 / Current Liabilities - 300, 200 = 5.35X
Current assets Year # 7- 1,379,217 / Current Liabilities - 233,700 = 5.9X

Current assets Year # 6 - 1,029,303 / Current Liabilities - 105,080 = 9.7X

        2WR has a lower ability to pay short-term debt than CB . This is a weakness for 2WR.

2WR has a lower average collection period by collecting on accounts faster than CB.


        2WR and CB are very competitive with different strengths and weaknesses. If CB

continues to decrease sales and if 2WR increases sales this year – the following year may be the

end of CB.

A.2) Working Capital Analysis

        Working Capital is a measure of a company’s financial health in the short-term. It is

required for production and continuous operations. CB’s working capital is invested in

their inventory and accounts receivable. Working capital also provides an indication of whether

current debts can be paid as they are incurred. Working capital is necessary for the company to

continue a growth pattern. Operating expenses like late fees, could be slowly draining CB of


        “Positive working capital means that the company is able to pay off its short-term

        liabilities.” (Investopedia, Working Capital, n.d.)

        A definition of working capital is:

        Gross Working Capital- is referred to as Total Current Assets.

        Another definition is:

        Net Working Capital - is referred to as Current Assets – Current Liabilities.
CB Working Capital is as follows:

Year # 8 - $ 1,306,617

Year # 7 - $ 1,145,517

Year # 6 - $ 1,104,223

        CB working capital has increased dramatically in one year. It can pay its short-term

liabilities better than in previous years.

Improving Working Capital.

        Working Capital is essential in companies for the day to day operations. For CB to

increase working capital, it must evaluate several areas of its operations to include specifically its

collection policy. The first way to improve working capital is to increase sales. By increasing

sales, cash flow increases.

        A notable improvement would be reducing CB’s average collection period from 43.8

days to standard 30 days. This policy action will increase cash flow for CB. In year 8 operating

cycle, revealed 46.9 days conversion from capital to revenue. This included 22.5 day payables

outstanding and 47.7 day sales outstanding. CB should negotiate a 30 day net from suppliers and

a 15 day net from customers. CB should be more diligent in their collection efforts.

Consideration should be made on the increase of interest rates for accounts. To impose penalties

for delinquent accounts. This policy would increase cash flow, reduce potential late fees from

CB’s suppliers and could generate funds to support advertising, R&D and ultimately funds to

the net profit.
       To improve the working capital for CB, a review of their supply chain and Just-In- Time

strategy would be prudent. Their current strategy of ordering supplies on a monthly budget

instead of a sales trend is resulting in higher raw materials costs. Purchases should be tied to

sales and a specific strategy and not to budgets.

Working Capital to Increase Profits

       With an increase in working capital, CU should invest into a lighter frame to compete

against 2WR.

A.3) Internal Controls

        “The purchasing department will issue a purchase order to the supplier based on the

        monthly budget projections. Purchasing checks with three sources for similar quality

        materials and selects the low bidder from the three. The purchase order is sent to the

        supplier by the Purchasing Department on the first of the projected month. Upon receipt

        of the goods they will be brought to the production line for use during the month. Any

        unused parts are sent to the raw materials inventory stores on the last day of the month.

       Purchasing sends the suppliers invoice to accounting and accounting writes a check to

        pay the invoice (Sarbanes - Oxley Act (SOX).”

       Segregation of duties creates a checks and balances system. This greatly reduce the

ability to misappropriate items from the company. The internal controls state that the purchasing

department will issue the purchase order. The expenditure of company funds is under scrutiny by

auditors and is resulting in misinformation about the company’s financial strength. The

prevention of theft and fraud is paramount in an assembly company.

       The audit shows the purchase order system as probably the single largest problem in the
company. Many individuals can access the system and generate a payment. The company is

vulnerable to untold losses. Problem, the purchasing department controls the selection of vendors,

purchasing materials and the receiving of materials. This system only pertains to the budgeted

transactions. Purchase agents authorize the purchase and issues the purchase order based on

budgeted amounts.

       There is not a solid policy to insure the receipt of goods authorized in the purchase order.

The end result is goods being received that were not ordered or needed..

A.3. A ) Corrective Actions

CB needs to implement the following to be compliant with SOX:

1. Establish processes and policies to an independent or management review of the

three sources who are bidding for the vendor supplier work. To discourage the favoritism of one

of three sources.

2. Establish a separate entity for the physical writing of the purchase order.

3. Implement policies for accurate confirmation of the invoice and the goods. Establish policies

to insure that the goods ordered were delivered. Appropriate payment of the invoice so that the

person ordering and receiving is separate entity.

A.3.B ) Risks

Risks that have been identified:

Financial, the purchasing from a non-qualified resource.

Financial, the receiving of unapproved goods.

The receipt of goods that are not timely delivered causing assembly delays.
The delivery of unnecessary goods in conflict with the Just-In-Time strategy.

A.3.BI ) Risk Mitigation

Area Risk Mitigation

        Purchasing from a non-qualified source. The need to implement policy on

review of three bids that include an independent review of the source bids in relation to

1) compliance

2) Independence from resource

        Implement management approval and review of all selections of potential sources to

Insure policy compliance and to eliminate the potential for purchases being aligned with internal


       Implement policy concerning the receiving of unapproved goods and receipt of all

goods. Compliance of strict adherence to the purchase order specifications for receipt of

delivered goods.

       Implement policy and process concerning appropriate receipt of goods so that goods are

received according to scheduled purchases.

       Fraudulent invoices being paid would be eliminated if the process has several checks and


A.4) Sarbanes-Oxley Compliance

       “The Sarbanes-Oxley Act (often abbreviated as SOX) was enacted by the U.S. Congress

        in 2002 in the aftermath of several corporate accounting scandals. Accounting problems

        at Enron and WorldCom, and other debacles, resulted in a precipitous drop in the

        investing public’s confidence in companies published financial statements. SOX was
        enacted to bring about reform in companies financial reporting processes, as well as the

        internal and external auditing of the financial reporting process. Under SOX, a

        company’s top executive, including the CEO (chief executive officer) and the CFO

        (chief financial officer), can be held criminally responsible if their financial statements

        prove to be fraudulent or materially misstate the firm’s financial condition” (Hilton,


       SOX has become the standard of accounting principles since its inception in 2002.

SOX deals with internal controls concerning financial reporting. These controls include polices,

processes and procedures that are used to accurately determine an accurate picture of a

corporation’s financial position.

       Specific internal controls include approval cycles of financials to include expense reports

        and invoices, as well as authorizations and verifications of the corporation’s operating

       performance, assets security and duty separation and can not only cover the executive

       officers but also all employees of the corporation (Hilton, 2009).

       Corporate Responsibility of Financial Reports (Section 302)

       Section 302 outlines corporate officer responsibility to continually evaluate the

company’s financial internal reporting controls. To implement and evaluate controls for financial

reporting accuracy.

A.4A) Noncompliance Actions

Material Weakness

The CB financial statement has several material weaknesses.

1. Lack of internal controls in violation of SOX “establishing and maintaining
adequate internal control over financial reporting” (SEC, 2003);

2. With missing inventory, an assessment of its liquidity is overstated. “issued an attestation
report on management's assessment of the company's internal control over financial reporting”
(SEC, 2003).

Recommendations for corrective actions for noncompliant with the Sarbanes-Oxley requirement

 Sox Section 404 – Contract an independent auditor to evaluate Competition Bikes Inc., internal

Sox Section 906 – Strict requirements of adherence of corporate responsibility for financial

       The directive states that “Management is responsible for ensuring the internal control

Processes to prevent material misstatements from being reported in the financial statements”

but does not report on the specific internal controls over the financial reporting nor identify the

framework that was used to insure and evaluate the internal controls.

       The letter does not provide details in its assessment that internal controls are effective.

Simply stating that it is effective based on the COSO is not enough since COSO Internal

Control-Integrated Framework states that “material weakness is considered in relation to an

entity’s financial reporting objective…” (COSO, 2011)

       In summary of non-compliance corrective actions. A check and balance of all purchase

orders and received goods would alleviate the majority of compliance and profitability issues. A

thorough implementation of Just- In –Time strategy for raw materials would move CB into a

more profitable venture.

                                                      ~ Robert Hixon

Ashfaq,     Qazi.    (n.d.)    Financial    Statement     Analysis.      Retrieved     from

COSO. (2011 Dec). Internal Control – Integrated Framework. Committee of Sponsoring
Organizations     of    the    Treadway Commission    (COSO).    Retrieved   from

Hilton, Ronald. (2009). Managerial Accounting: Creating Value in the Dynamic Business
Environment, 8th Edition, Appendix I. McGraw-Hill Higher Education. (Appendix I).

Investopedia,        (n.d.)        Working          Capital.       Retrieved           from

Securities and Exchange Commission hereinafter referred to as SEC. (2003, June). Final Rule:
Management’s Report On Internal Control Over Financial Reporting and Certification of
Disclosure in Exchange Act Periodic Reports. 17 CFR PARTS 210, 228, 229, 240, 249, 270 and
274. [RELEASE NOS. 33-8238; 34-47986; IC-26068; File Nos. S7-40-02; S7-06-03]. Retrieved

Skillsoft.    (n.d.)     Ratio   Analysis   for    Financial Statements.   Retrieved from

The Sarbanes-Oxley Act hereinafter referred to as SOX. (n.d.). A Guide to the Sarbanes-Oxley
Act. Retrieved from


                                      Competition Bikes, Inc.

                               Budget Concerns illustrated in year #9

A 1) Competition Bikes, Inc. ( CB ) budget for year # 9 contains the required schedules. There

are five remaining concerns.

Concern # 1 – Quarterly Budget

        My first concern is that the budget should be further divided into quarters. Bicycling is

predominantly a temperate weather activity. Purchasing of raw materials for the onset of a sales

increase in demand should incur a quarter prior to demand. Conversely, the quarter prior to a

historically slower quarter should have a budget with less purchase of raw materials. Reserve

inventory is satisfactory for an unexpected sudden demand for finished product.

Concern # 2 – Sales Projections

        According to Hilton,( 2009)

        “The sales budget is based on projections that take into account trend information as well

        as market, competitor, and other econometric information to provide an accurate forecast
        of future sales.”

        The projection of 3,510 sold units in year # 9 is not supported by the previous year #8

sales. In year # 8 there was a 15% decrease in units sold than in year # 7. Optimism of a

return of a sales level rivaling year #7 is appreciated. The reality is that if sales do not rival year

#7 , the budget should have a variance allowance in a post historically slow quarter for an

adjustment in material purchases and other production activities.

        Based solely on facts provided by the company, year # 8 reduced sales was primarily due

to a downturn in the overall economic situation which affected professional rider’s sponsorship.

CB also stated that this decrease in sponsorship is anticipated to continue though this year and

the following two years. Based on their own statements, there would not be justification for an

optimistic sales forecast.

Concern # 3 – Uncollectable Accounts

        CB’s master budget fails to specify in their cash budget line, reference to uncollectable

receivables. With the production of such a high quality specialized product, economic factors

like lack of sponsorship is proven to be a variable factor that could generate delinquent accounts.

Concern # 4 – Raw material levels

        CB is budgeting for 140 unproduced bikes including labor. The Just- In – Time principle

states that although it is preferred to have additional parts the risk is that these parts could

become obsolete. It may be prudent to reduce this level of additional parts inventory. A loss of

possible revenue does not justify the possible loss in asset value due to the parts becoming


Concern # 5 – Utilities Expense

        The manufacturing overhead schedule of CB, itemizes utilities at a fixed level. It was

evident in year #8 that utilities expenses increased when production went down. This factor is

compounded in complexity when the SG&A schedule has two individual utilities line items.
One is listed as Utilities and the second is Utilities and Services. Both line items are listed

under Facility and General Operations.

A 2 ) Flexible Budget

       A flexible budget is a budget with figures that are based on actual output. This number is

then compared to a company's static budget (fixed) to determine variances or differences. The

difference between what level of expense was budgeted and what was actual. A flexible budget

adjusts for changes in the volume of activity. The flexible budget is more sophisticated and than

a static budget. A flexible budget allows for increases in sales and product demand. It allows for

a larger than normal purchase of a raw materials if a tremendous price reduction becomes

available. The budget is used to determine how effectively a company is planning and

performing. Unlike the static budget, the flexible budget provides management with the actual

number, rather than the planned number.

       In a budget the fixed cost remains constant. One positive reason the numbers may

change is an increase in projected sales volume. Variable cost can affect a flexible budget in a

positive light because it allows the company an opportunity to adjust to reduce their expenses. If

a company foresees a decrease in demand, they can reduce their labor and material expenses so

cash reserves can be maintained. Because variable cost may vary, the company has the

possibility to spend less than the planned amount which would produce a favorable effect on the

flexible budget.

A 2a ) My suggestions for correcting my concerns are as follows:

       The master budget should be prepared in quarters and not just an annual budget. This

simple adjustment would allow management the flexibility to adjust expenses based on actual
sales revenue. My concerns would all be addressed as the quarter sales and actual expenses and

revenues are realized.

       Sales projections are more difficult to project a year in advance than a few months in

advance. If CB does realize an increase in sales, management can increase production and order

more raw materials. If CB realizes a continued decrease in sales then reductions can be initiated

sooner to prevent an accumulation of antiquated parts and head off unnecessary sales expenses

like advertising. This is an example of variance allowances.

       In year # 8, CB was successful in their collection of delinquent accounts. By initiating a

policy early in the year of applying accounts receivable to their budget and being diligent in

changing policies, for example: 30 days net from their suppliers and 15 days net from their own

accounts – the results can be reviewed more often and corrections made sooner. An increase in

delinquency would also be an indicator of a decrease in future orders.

       CB had a previous policy to order raw materials based on a static budget. With the

implementation of a flexible budget, CB can adjust their need and supply of materials on a more

regular schedule. Their previous compliance issue concerning purchase orders and deliveries

could be more closely monitored in this quarterly budget. The practice of increasing their assets

with antiquated parts would be curtailed. The decision to assemble bikes from parts in

anticipation of realized sales could be forecasted to increase sales revenue without missing a

potential opportunity. The decision to save labor on assembly could also be forecasted utilizing

variance analysis.

       In year #8 CB had an increase in utilities expense with a decrease in production. With a

quarterly analysis the utility expenses may indicate a potential unnecessary drain on cash
reserves. If the expense is increasing and production is decreased, an investigation by an outside

firm of the infrastructure may be necessary and warranted. In this instance, variance analysis

would detect a potential waste of natural resources that is happening without managements

knowledge. It is an increase in expense without any explanation.

A 2B ) Management by exception can least best be illustrated by the 4 % annual increase in the

utilities expense. When a projected budget is exceeded. Action by management on any notable

discrepancy in anticipated projections and realized expenses or results is within the role of

management and needs corrective action and further financial analysis.

       In this example of a steady increase of utilities expense is not minuscule. It was not a

spike but an increasing large percentage. There is sufficient historical data to determine a budget.

In setting the budget in year seven based on year six of $130,000, then the actual dollar figure of

$135,000 is alarming. Then to set the budget at $135,000 and in year 8, the actual dollar figure is

$140,000. This is an NOT an example of management by exception which necessitates

upper management attention. Subordinate managers can and should be addressing this rising cost.

       In a company’s budget variances, management needs to take decisive action. Profit is

made or lost by pennies. Management by exception is illustrated best below:

       Dramatic sales or profit decreases in performance and analysis reports are key factors of

management by exception. This is information that the senior management needs to be aware of

to make corrective action. This practice is reserved only for the senior managers that have the

authority and skills to remedy.

       Management by exception dictates that a manager's attention should not be directed
towards the parts of the organization where budgets are not being exceeding or that subordinate

managers have the skills to remedy. Time and effort would be wasted by senior management

on areas of the organization with a relatively smooth operation..

       If the original plans and budgets are proceeding as planned, the difference between

actual results and initial plans will be minimal. The end expense will fall between standards

If actual results fail to conform to the budget or standards, the performance reporting system

Signals to management of an " exception. The utility expenses are falling out of standards and


       Not all variances are worth investigating. Differences between end results and budgeted

or planned results are not always the exact same. Every variance cannot be investigated. It would

be cost prohibitive to trace every insignificant variance. Especially for senior managers.

       Our example of the ever increasing utility bill is a justified investigation. When

production is down, the utilities continue to increase. Subordinate managers should be concerned.

       Managers should decide to investigate variances based on dollar or percentage changes.

Industry standards and relative weather, personnel, holidays, all play a factor on the variances

seen in manufacturing. Percentage or dollar variances at the exact same time as in previous years

could justify a management investigation in the process causing the variance. The most

dependable strategy is to plot variance data to determine a statistical chart. The idea

behind this chart is that many random variance fluctuations from similar time periods are normal

and expected. These fluctuations are expected even with the best budget and control fluctuations.
                                                               ~ Robert Hixon


Hill Hilton, Ronald W. ( 2009 ) Managerial Accounting: creating value in a dynamic business
environment – New York ,Mc Graw – Hill

Task 3

                                 Capital Structure and Budgeting

A 1 ) Competition Bikes, inc. needs to generate a cash infusion for expansion. The options are

bank loans and stock offerings. The focus of this report is to provide analysis as to ultimately

merge or acquire Canadian Biking, inc. by Competition Bikes, inc. This report will

concentrate on the following five key areas and give recommendations on the following:

1) Capital structure approach options

2) Capital structure approach justification

3) Capital budget concerns

4) Working capital for acquisition and expansion

5) Expansion recommendation to either – acquire or merge

         “Capital structure is the manner in which a firm’s assets are financed; that is, the right-

         hand side of the balance sheet. Capital structure is normally expressed as the percentage

         of each type of capital used by the firm debt, preferred stock, and common equity.”

         (Capital Structure Decision, 2002)

         To be analyzed are the two main components which are debt capital and equity capital.
The decision on the best capital structure is to analyze many factors including but not limited to

gross sales which is an indicator of the demand and viability of the product, assets, growth rate,

current tax liabilities, potential profitability and changing market demands.

The five primary factors to consider in capital structure are as follows;

       “1.Tax benefit of Debt: Debt is the cheapest source of long-term finance, when compared

        with other source equity, because the interest on debt finance is a tax-deductible expense.

       Hence, debt can be accepted as tax sheltered source of finance, which helps in

       shareholders’ wealth maximization.

       2. Control: Equity shareholders have voting right to elect the directors of the company.

       Raising funds by way of issue of new equity shares to the public may lead to loss of

       control. If the main objective of management is to maintain control, they will have to

       prefer debt and preference shares in additional capital requirements. However the

       company earnings should be such that it is able to repay the debt in time.

       3. Flexibility: The capital structure should be determined within the debt capacity of the

       company, and this capacity should not be exceeded. The debt capacity of a company

       depends on its ability to generate future cash flows. It should have enough cash to pay the

       debt obligations. The capital structure should be able to adapt its capital structure with a

       minimum cost and delay if warranted by a changed situation.

       4. Industry Standards: A company needs to examine industry standards of debt-equity

       mix while planning its capital structure. For example Electrical Industry tries to maintain

       debt-equity ratio of less than 2:1; Chemical Industry has a conservative debt policy; and

       in Automobile Industry government permits a debt – equity ratio of 2:1.
          5. Company Size: Companies that are very small must rely to a considerable degree on

          the owner’s fund for their financing; they find it difficult to obtain long–term debts.

          Large companies can make use of different sources of funds. (kkhsou, 2012) “

          Debt Capital is a long term debt. Bank loans and bonds are the two primary sources of

loans. Debt Capital is an expensive form of equity but has tax advantages. The return of

investment has a greater return for the investor or lender. Equity Capital or stock holders equity

has the greatest risk for investors.

Capital Structure Options

          “The two principal sources of finance for a company are equity and debt. What should be

          the proportion of equity and debt in the capital structure of the firm?” (Manage Mentor,

          2003). A number of various theories may be utilized to make a determination. These

          theories are known as the net income theory (NI), the net operating income theory (NIO),

          the traditional theory, and the Modigliani and Miller Theory (MM).

          To make an informed decision on the best capital structure approach. It is best to use a

number of elements, operating structure, assets, sales, assets, growth rate, taxes and market

conditions. These capital structure options were reviewed to determine the best approach for the

Canadian Bikes, inc. merger or acquisition to raise the $600,000 and maximize shareholder


· 9% bonds

· 50% preferred (5%, $50 par) and 50% Common Stock

· 20% - 9% bonds and Common Stock

· 40% - 9% bonds and Common Stock
· 60% - 9% bonds and Common Stock

        Canadian Bikes, inc. EBIT figures were considered. Utilizing both the low and moderate

projections. The accompanying tables show the EBIT data. Displayed are each year with the

impact of each of the low and moderate EBIT. The earnings per share of common stock show

both options.

Capital Structure Recommendation maximizing shareholder return

       A capital approach that maximizes shareholder return. I reviewed five options based on

two key factors; earning per common share and net earnings. These two factors were the primary

considerations for key reasons. The result returned $15,000 in preferred stock dividends under

each scenario.

       To raise the $600,000 for capital improvements my first concern was the earning per

common share. The EBIT for each of the five years, #9 – #13, considering the low projected

sales and the moderate projected sales were considered. The earnings for both in relation to the

per common share was calculated. The result for the 50% preferred (5%, $50 par) and 50%

common stock option is roughly equal. With exception for year # 9 by 0.01. This was based on

the low projection. In summary, the earning for each common or preferred share of stock is the

best when the 50% preferred (5%, $50 par) and 50% Common Stock option is used.

       My second factor analyzed was the net income results for each of the five options. In

every calendar year using the low and the moderate projections, the 50% preferred (5%, $50 par)

and 50% Common Stock options outperform all other options. The net earnings exceed tens of

thousands of dollars each calendar year. In the course of the five year analysis, the net income

variances are dramatic. In both categories the 50% preferred (5%, $50 par) and 50% Common
Stock option is the best.

        The final factor analyzed was the annual return of $15,000 in preferred stock dividends

EBIT figures from Canadian Bikes, inc. Budgeted Earnings in US dollars

Year/          Low $/         Moderate $/

9-             74,816 /       109,816

10 -           84,714/        128,814

11-            94,501/        148,160

12-            106,872/       169,568

13-            109,200/       181,546

Table 1--

Earnings per Common Share Based on Low & Moderate Figures|

Options- Year 9 / Year 10/ Year 11/ Year 12/ Year 13

Low Mod Low Mod Low Mod Low Mod Low Mod

9% bonds 0.016/ 0.043/ 0.024/ 0.058/ 0.031/ 0.072/ 0.041/ 0.089/ 0.042/ 0.098

50% preferred (5%, $50 par) and 50%Commonstock-

0.032 / 0.053/ 0.038/ 0.044 / 0.075 / 0.05/ 0.088/ 0.052 / 0.095

20% - 9% bonds and Common

Stock-0.033 /0.051 /0.038 / 0.061/ 0.043 / 0.071 / 0.050 /0.082 / 0.051/ 0.088

40% - 9% bonds and Common

Stock 0.030 / 0.050/ 0.035 /0.060/ 0.041/ 0.071/ 0.048 / 0.083/ 0.049 / 0.090

60% - 9% bonds and Common

Stock 026/ 0.04/ 0.032 / 0.060/ 0.038/ 0.071/ 0.046 /0.085/ 0.047/ 0.092
Table 2 --

Net Earnings utilizing both Low & Moderate Figures

Five Year Totals Years 9 – 13 Average Earning per Share Based on Low Projection

9% bonds 50% preferred 20% - 9% bonds 40% - 9% bonds 60% - 9% bonds

(5%, $50 par) and Common Stock and Common Stock and Common Stock

50% Common Stock 50%

0.031 0.043 0.043 0.041 0.040

Five Year Totals Years 9 – 13 Average Earning per Share Based on Moderate Projection

0.072 0.075 0.071 0.071 0.071

Five Year Totals Years 9 – 13 Average Net Earning Based on Low Projection

9% bonds 50% preferred 20% - 9% bonds 40% - 9% bonds 60% - 9% bonds

(5%, $50 par) and Common Stock and Common Stock and Common Stock

50% Common Stock 50%

$30,014 $70,516 $62,416 $54,116 $46,216

Five Year Totals Years 9 – 13 Average Net Earning Based on Moderate Projection

$70,186 $110,686 $102,586 $94,486 $86,386

       It is my recommendation that CB pursue a combination of approaches to acquire the cash

infusion that is desired. CB should retain 50% preferred stock, offer 50% common stock and

secure debt capital - bank loans or bonds.

A1 a ) While retaining 50% preferred stock the investors with the most to gain and lose will be

insured a guaranteed dividend. The preferred investors will retain control of the company. They

can steer the destiny of the company. They will be undoubtedly become the board of directors
and can decide on dividends to common stock holders in the best interest of the company. The

board of directors can take advantage of tax deductions and pay off debt capital. This strategy

allows the board to incur debt without losing control of the destiny of the company. Retaining

the preferred stock has a dollar value that can be made up with debt capital while retaining

control of the company.

        This strategy will result in the highest earnings per share ( EPS ) during the first three

years. During years four and five, securing a 9% bond would generate the second highest EPS.

The option with the greatest return of investment ( ROI ) to the investor is the 50% preferred

stock and 50% common stock.

                                      Internal Rate of Return

       The other measure for evaluating the investment is the internal rate of return, IRR. “You

       can think of IRR as the rate of growth a project is expected to generate. While the actual

       rate of return that a given project ends up generating will often differ from its estimated

       IRR rate, a project with a substantially higher IRR value than other available options

       would still provide a much better chance of strong growth.” (investopedia, 2012).

A 2 ) Net Present Value: NPV is considered a “sophisticated capital budgeting technique and it

has consideration for the time value of money where as the payback a technique does not. It is

also determined by subtracting the initial cost of the project from the NPV with a discounted rate

that equal to what Competition Bikes cost of capital.” (Gitman, 2008)

       NPV compares the dollar value of today to future dollar values. This is adjusted with

consideration of inflation and returns to account.
                                       The formula for NPV is:

                      NPV = Present value of cash inflow – initial investment

C0 is the initial investment which is a negative cash flow showing that money is going out;

        The funds going out is subtracted from the discounted sum of cash flow influx. It is

required that the net present value needs to be a positive number. This factor is crucial in

determining if the decision is a valuable investment.

                                          Criteria for NPV:

NPV greater than $0- then the Competition Bikes, inc. should move forward

NPV less than $0 - then Competition Bikes, inc. should not move forward.

                                    Internal Rate of Return (IRR):

        “IRR is more widely used over NPR. The IRR is the discount rate that equates the NPV

        of the investment opportunity with the $0. It is compounded annual rate of return that the

        company will earn if it invests in the project and receives the given cash inflows.

        (Gitman, 2008) “

Criteria for IRR:

IRR is greater than cost of capital -- accept the project

IRR is less than cost of capital-- reject the project

Scenario one with anticipated low demand.

1. Capital improvements of $600,000

2. Ten year depreciation schedule.

The building will be a fixed asset at the end of the ten year term of $200,000.

3. Projected sales projections::
Year 9 – 500 Carbon Lite models

Year s 10- 11 – 1% growth      Years 12- 13 – 2% growth

Cost of goods sold will increase proportionately

4. Selling and administrative anticipated expenses for Canadian Bikes, inc. operations:

Year 9 : $250,000       Year 10 : $240,000     Year 11 : $230,000   Year 12 : $220,000

Year 15 : $210,000      Stabilizing after year # 5.

5. Competition Bikes requires a 10% hurdle rate to justify a capital investment.

       The IRR, utilizing the worst case scenario with the low demand, is 8.2% IRR. This

factor alone indicates a good project. Acquiring Canadian Bikes, inc. not a certainty but with an

increase in the economy and sponsorships, the return of investment may prove to be a strategic


Moderate demand scenario.

1. Total investment of capital improvements-- $600,000

2. Depreciation tax write offs / credits over the next 10 years.

The acquisition will n asset worth $250,000 at the end of the depreciation schedule. This will be
an asset.

3. Anticipated sales:

Year 9 – 500 Carbon Lite models Years 10- 11 – 3% growth per year Years 12- 13 – 5%

growth per year .Cost of goods will increase steadily at about 2% per year

4. Budgeted sales and administrative expenses for Canadian Bikes, inc.:

Year 9 : $250,000 Year 10 : $240,000 Year 11 : $230,000 Year 12 : $220,000

Year 15 : $220,000

5. Competition Bikes, inc. is faced with a 10% hurdle rate to first pursue a capital investment.
        The strong NPV was the single most significant factor that most influenced my decision

to endorse this acquisition. With just moderate increases in demand, the returns would be

respectable. Illustrated by the NPV formula. The an outcome of an impressive +$8,447. With a

moderate growth rate of only 3% in years ten and eleven. This growth rate is anticipated to

through the next two years at 5 %. Just moderate growth rates through this analysis indicate

Competition Bikes, inc. have a substantial ability to service this amount of debt.

        The IRR theory analysis outcome with a moderate demand scenario produces- a 10.4%

IRR. Analysis dictates this project as a great candidate for acquisition.

        The following analysis of the calculations for NPV based are figured on the low and

moderate demand. As demonstrated, the data the NPV under the low demand projection is a

negative $39,281 and the moderate demand projection is a positive $8,447.

                              Low Demand             Moderate Demand

Total Present Value             $560,710                       $608,447

Investment                      $600,000                      $600,000

Net Present Value               - $39,281                     $ 8,447

        The moderate demand is a positive dollar figure. This demonstrates the optimistic nature

of the merger This merger combines desired technologies and new markets. The acquisition also

will acquire a substantial asset – the facilities.

        My primary concern is cost of cogs sold. From years #9 -#13 the COGS budget remains

flat which is not realistic.. This negative impact on the EBIT would could be set off by

depreciation schedules.

        My second primary concern is the budget decreases in the sales and administrative
expense. There is no indication that these expenses would decrease Competition Bikes has had

increases in administration expenses when sales were down. If sales increase, how can

administration expenses and sales expenses decrease ?


       The most conservative approach for Competition Bikes, inc. to obtain their working

capital is to would be to lease the building and pay the licensing fee. Accumulation of assets like

the building and the technology is a tangible value..

       “Working capital is how much in liquid assets a company has on hand and available.

       Working capital is needed to pay for any monthly expenses and any unexpected expenses

       that may arise during such time. Working capital is to meet the short-term obligations of

       the business, and to build and grow the business. (Wolfe, 2012)”

       My recommendation is for Competition Bikes, inc. to pursue the strategy of selling 50 %

common stock and bonds. This will provide the $600,000 funds for operating cash flow and to

acquire the Canadian Bikes, inc. The purchase the buildings and technology will be collateral to

leverage the stock and bond sale.

        “Scholars have found over the years that insufficient capital is one of the main reasons

       for small business failure, coupled with lack of experience, poor location, poor inventory

       management and over-investment in fixed assets, according to the Small Business

       Association.” (Mansueto Ventures LLC, 2011)

A 4) Merger or acquisition is the dilemma for Competition Bikes? The best decision is not only

for the company but for the stock holders. Competition Bikes, Inc. needs to determine if a

merger or an acquisition is the best option.
        When Competition Bikes, inc. acquires Canadian Bike, they purchased a large market

share. This will increase their efficiency while capitalizing on the key component of this

acquisition, a new market. They will also acquire Canadian Bikes technology. This acquisition

will be less effective than developing a similar technology. They also acquire a valuable real

estate asset.

        Competition Bikes, inc. can tax depreciation and potential bond interest tax savings

resulting in a higher dividend to share holders.

        Canadian Bikes estimates a 10% increase in gross sales in the next 5 years. This is an

added benefit to the acquisition for Competition Bikes, inc. These competitive factors makes an

acquisition a more savvy venture than a merger. A merger where Competition Bikes, inc. leases

a building, develops a great market share and pays a licensing agreement is conservative but

within five years Competition Bikes, inc. will be the strongest competitive bicycle manufacturer

in North America.

        This acquisition will built company assets. Not spend expend cash to just manufacturer


                                              Robert Hixon

Capital Structure Decision. (2002). Retrieved January 18, 2011, from Harcourt, Inc:

Krishna Kanta Handiqui State Open University. (2012). Introduction to Capital Structure policies
andDividend decisions. capital_structure.html

Jason Van Bergen (2010)

Wolfe, L. (2012). What is working Capital. Retrieved January 24, 2012, from Guide :

Mansueto Ventures LLC. (2011). Retrieved January 24, 2012, from How to Manager Cash Flow:
Gitman, L. (2008). Principles of Managerial Finance 12th edition. Addison Wesley.

Net Present Value. (n.d.). Retrieved January 22, 2011, from Finance Formulas:

Stallman, C. (n.d.). Common Stock vs. Preferred Stock. Retrieved January 18, 2011, from

McClure, B. (2012). Mergers and Acquisitions: Definition. Retrieved                        from /university/mergers/mergers1.asp#axzz1twXn8VBp
Task 4

         Activity based costing accounting (ABC) distributes the manufacturing overhead to

products in a more efficient way, than in the traditional way. Activity based costing specifically

allocates the correct percentage of resources to individual products.

         ABC is more logical and a more sophisticated method to monitor and allocate company

costs to objects or products than traditional costing. With traditional costing, the overhead costs

may be allocated exclusively on machine hour basis. ABC identifies the many activities for cost

accounting. Taking into consideration all of the resources a company may consume. ABC then

calculates only the activity cost to produce the product. This critical difference is important due

to some products requiring many activities and some products require few activities.

                         Activity based costing versus Traditional Costing

         The primary difference between ABC (Activity Based Costing) and TCA (Traditional

Cost Accounting). ABC assigns all specific activities and TCA may just calculate machine hours

as the total cost ABC is more accurate and complex, encompassing only activities and resources

to produce individual products. Knowing the exact cost to produce separate different products in

one factory. Traditional Cost Accounting is rather simple and less efficient. ABC with

separating expenses can also identify excess raw material and therefore more closely be in line

with a Just-In-Time strategy. This strategy can reduce the accumulation of possibly

obsolete raw materials and help stream line the production line.

         Activity Based Costing was initiated in 1981. The methodology is still in the relatively
new stages of accuracy. ABC has a separate overhead and varies by activity and product.

Conversely, Traditional Cost Accounting was initiated in the late 1800’s. The task of calculating

the specific cost of a finished product under the traditional method was less precise. The cost of

goods simply divided by finished products bone activity. The Activity Based Costing method

calculates the exact expenses to produce each individual product using several activities.

       With stiff competition, initiating the latest methods of accounting and production, are

necessary to produce a profit. In the case of Competition Bikes, inc, utilizing the Just in time

strategy ( JIT ) and the Activity Based Accounting would improve Competition Bikes return on


        Excess inventory would be greatly reduced. During different stages of production,

parts would be ordered to insure that production is continued but excess parts would not

accumulate. Implemented correctly, Just in Time would focus on production improvement. This

would stream line manufacturing, efficiency and quality. To achieve improvement in key areas,

requires employee involvement to improve flow and quality.

       Activity Based Costing is a more accurate way of costing finished products. This method

makes Traditional Cost Accounting method obsolete. The Activity Based Costing method is

preferred when overhead is too high and there is an abundance of remaining parts. The accuracy

of product costing is imperative. If the analysis of the final numbers of cost of goods is too low,

it would appear that the company was operating efficiently. Conversely, if in fact there was

many parts remaining, the company lost money.

       “If a manufacturer wants to know the true cost to produce specific products for specific
       customers, the traditional method of cost accounting is inadequate. Activity based costing

       (ABC) was developed to overcome the shortcomings of the traditional method. Instead of

       just one cost driver such as machine hours, ABC will use many cost drivers to allocate a

       manufacturer’s indirect costs. A few of the cost drivers that would be used under ABC

       include the number of machine setups, the pounds of material purchased or used, the

       number of engineering change orders, the number of machine hours, and so on

       ( Averkamp, 2004) .”

       The total of all activities gives a more precise cost factor accurate cost factor.

       Activity Based Costing is steadily being utilized and implemented due to the increase in

overhead costs and the array of different products being produced. The evidence that Activity

Based Costing has become the standard is that machine hours and direct labor hours accounting

is no longer in practice.

                    Primary reasons Activity Based Costing should be utilized:

1. Activity based costing provides a more accurate overhead cost position.

2. Activity Based Costing gives valuable information to management on operations that add

value and those that do not. ABC is instrumental in capital investments, pricing, organizational

change and product mix.

3. Activity Based Costing can more easily identify production activities and resources..

4. Activity Based Costing has been proven for being effective in controlling costs, improving

profits and productivity. This is an example of not reinventing the wheel. ABC works.

       Concerning directly to Competition Bikes, inc. – utilizing Traditional Cost accounting the

Titanium units cost was $239,020 but utilizing Activity Based Costing, the cost of was $232 340.
       The traditional costing method analysis shows the titanium frame cost $713. The ABC

method analyses shows the titanium unit at $656. Utilizing the traditional costing method, the

traditional total cost is $1,460 to produce .Activity Based Costing is $1,359. The ABC method

more accurately puts the cost of production of just the titanium unit by $57. The cost to produce

the Carbon Lite unit decreases by $101.

       To summarize and support the implementation of the ABC method to replace the

traditional method for Competition Bikes, inc. is primarily because the traditional method uses

a percentage of the total and ABC method uses details of only the precise activities needed for

individual products.

       Our product line is comprised of primarily the titanium line - 900 or 65 percent of our

product sales and our carbonlite line is 500 of our product sales or 35 percent. The titanium line

is 50.7 percent of our manufacturing overhead and the carbonlite is 49.3 percent. Under the

traditional method the titanium is 48.5 of our total cost and the carbolite is 51.4 percent of our

total cost. Under the ABC method, the titanium is 44.7 percent and the carbonlite is 55.3 percent.

The ABC method is more precise. We see that the Carbonlite is only 35 percent of our sales but

is 55 percent of our total expenses

       This change in methodology brings exact activities into consideration. In quality control

for the titanium line we spend only $2, 104 but for the carbonite quality control we spend

$116,896. In engineering services, the titanium line we spend $12,500 and in the carbonlite line

we spend $62,500.

       We need to know our exact production cost to accurately figure our breakeven point and

Pricing on each individual product.
A 2a)

                                      BREAKEVEN POINT

        Breakeven is the difference between a business making a profit or becoming insolvent.

Determining the breakeven point for a company is critical to either success and growth or failure.

If management is unaware of their financial situation, if they have incorrect or inaccurate

information they may have an incorrect breakeven point thus selling units at a loss to the ultimate

demise of the company.

To determine a company’s breakeven point, I utilized the accompanying Excel spread sheet.:

                          Fixed Cost / (Unit Price - Variable Unit Cost)

                        Sales price – variable costs = contribution margin.

The breakeven analysis point has many variables:

· Selling Price per Unit: The set market value for sales of the product.

· Fixed Cost totals: The Activity Based Costing of production per unit. This is fixed.

· Variable Cost total: Projected total production costs including variables.

· Unit Cost variables: Expenses beyond production control that are unexpected.

· Net Profit forecast: Total revenue minus total cost. Production cost is the breakeven point.

        When a company offers many different products, an average contribution margin per unit

determines the fixed cost of the product. Then the profit generated above the breakeven point is

the number of units the division must sell for the company to breakeven. This average or

weighted average has a contribution margin. It measures the expenses the company has to invest
to produce and market the products.

       Contribution margin and contribution margin ratio

       “Key calculations when using CVP analysis are the contribution margin and the

       contribution margin ratio. The contribution margin represents the amount of income or

       profit the company made before deducting its fixed costs. Said another way, it is the

       amount of sales dollars available to cover (or contribute to) fixed costs. When calculated

       as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed costs

       are covered, the next dollar of sales results in the company having income.

       The contribution margin is sales revenue minus all variable costs. It may be calculated

       using dollars or on a per unit basis ( Cliff Notes, 2012)”

       The accompanying Excel spreadsheet was utilized to calculate the breakeven point for

Competition Bikes, inc

Example of the formula:.

       The ABC method utilized to figure the breakeven point, must have accurate figures.

Periodically, with an increase in production the breakeven point of a product increases. To

determine the new breakeven point, requires new fixed and variable costs input. into the
spreadsheet that was created. This will provide the new breakeven point.


        The individual breakeven point per unit is accomplished by calculating the product mix.

The titanium line divided by the total and the Carbon Lite divided by the total. A weighted

margin is arrived at $181.71. If $ 399, 943 is the fixed cost then divided by breakeven of $181.71

the total sales of units required is 2201 units.

        Weighted average with the titanium line of 900 in sales at nearly twice that of the

Carbonlite with 500 sales. The weighted average contribution margin is $181.71. Individual unit

calculations are $ 221 for each titanium sale and $ 111 for each Carbonlite sale.

        Net earnings to remain constant would require more sales to break even.

        The San Diego plant has a breakeven point utilizing the Cost-Volume-Profit method. The

number of sales for the Titanium line is 1415 units. The breakeven point for the Carbon Lite line

is 786 units. The Titanium line breakeven point in sales revenue is $1,273,500 The Carbon Lite

line breakeven point is $1,175,070 in sales revenue.


                               BREAKEVEN ANALYSIS CHANGE

        It is common knowledge that if a company’s fixed and variable expenses increase then

the end product must increase in price. If the company is forced to increase their fixed costs by

$50,000 and if vendors increase material costs by 10 percent. Competition Bikes, inc. must

increase their per unit sales price to achieve the same breakeven point. This may be avoided if
the company negotiates a decrease in supplies for the purchase of a higher quantity, They must

be careful to not end up with excess inventory at year end.

          Cost-volume-profit ( CVP ) is utilized to analyze how an increase in raw materials and

reduced production can negatively affect a company. A CVP analysis must include sales,

administrative costs and manufacturing costs. These expenses should be labeled variable or


        Sales price per unit is constant per schedule- fixed.

       Variable costs per unit are fixed and constant.

       Total fixed costs are fixed an constant.

       Assuming everything produced is sold.

       The affects of costs are only because of activity changes.

       All products produced by a company are sold in the same mix

Example of utilizing the CVP. When the fixed costs are increased by $50,000 and with an

increase of 10 percent in raw materials, the results for Competition Bikes inc., the contribution

profit margin for the Titanium line went from $ 221 to $ 191. The Carbon Lite went from $111

to $44.

          The weighted breakeven was $690 but increased to $871 for Competition Bikes, inc. due

to the $50,000 over head cost and the 10 percent materials increase. With the decrease in

contribution profit sales price, obviously they must increase sales price and / or increase sales

volume. If we increase our over head an additional $50,000 and we have an additional increase

of 10 percent of raw materials our new breakeven point on sales will be 3254 more units. Nearly

a 50 percent increase.
        The cost profit tab shows with the increases in the $ 50,000 overhead and 10 percent

product increase, the Titanium sales price goes to $1415 from $900, the variable cost goes to

$709.30 and the contribution margin drops to $191 from $221. The carbonlite price at $1,495,

the variable costs goes to $ 1,451 with only a contribution margin profit of $44 from $111. The

sales weight average contribution margin per unit is $138 from $181.71. We need to sell 2092

titanium models and 1162 carbonlite models.

        With the $50, 000 increase and only a weighted average of $138 from $181 – this

requires an additional sale of 362 units.

        In summary, with both of these increases, we will have to increase our sales from 2201 to


Harold Averkamp, CPA Cost-Volume-Profit Analysis. 30 Sep 2012,articleId-21229.html

Task 5 Notes:

By careful of changing storyline and excel data. The principles and verbage remains.

                                   Custom Snowboards, Inc.

                                      Presentation to CFO
A1) Summary Introduction

        Custom Snowboards Inc. is located in Minneapolis, Minnesota, USA. Their current sales

are divided as follows:. Currently, 20 percent in the European market, 5 percent in the Canadian

market and the majority or 75 percent of sales are in the United States market. Currently there

are small warehouse and administrative facilities in both the European and Canadian markets to

service respective customers.

        Four years ago the company offered shares of the company on the public Midwest Stock

exchange. Jim Swartz, the founder retained 51 percent of the available shares. Custom

Snowboards Inc. management is evaluating a more aggressive market position in the European

market. Among the strategies for an increase in market share is to acquire an already established

European manufacturer that desires to be acquired. The European Snowfun, Inc. acquisition

would require a loan from a bank, for one million dollars.
       A bank is performing due diligence and requires an appropriate presentation before

determining a decision. The terms of the one million dollar loan are: 6.75 percent Apr interest,

60 month term and a $300,000 compensating balance fund. This fund is non-interest bearing, the

bank is trustee for use at their discretion for other endeavors.

       The final approval or denial hinges on this presentation.
Key Points

        A company’s financial picture has key points that could affect and impact a loan

officer’s decision. The primary decision is how the debt would be paid back.

        A vertical analysis from a submitted financial statement shows the relationship of items

to the base amount. This is the 100 percent figure. The main points from a vertical analysis

considered are : Net sales from year 12 was at its peak, $6,601,000 with gross profit of

$2,009,000. The following year #13 showed an increase to $6,633,200 net sales and a gross

profit of $2,018,800. In year #14 some concern was that sales declined $225,400 but gross

profits only declined $68,600. This was due to management efforts at cutting operating expenses.

Total sales expense in year #12 was $779,000. In year #13 total sales expense was $782,800. In

year #14 sales expense had dropped to $756,200. Current assets in year # 12 was $738,690.

Current assets jumped up in year # 13 to $ 880,950 but in year #14 dropped to $ 740,155 but

still $1,465 above year #12. Net property and equipment asset value is remaining steady. There

was a drop of $100,000 in year #13 but year #14 held at one million as it was in year #12.

Concerning total liabilities and equity: in year #12- $1,738,590, year #13- $1,780,950, Finally in

year #14 it declined to near year #12 or $1,740,155.

       The horizontal analysis key points indicates changes from dollar form. We can

concentrate on the profitability. During year #12 and #13 the percentage of change was 0.49

percent for net sales. During year #13 and #14 results shows a variance of -3.40 percent or

$225,400. A key point to a bank loan officer is operating income. This point or factor is

important because it helps determine if the company has the ability to pay back the debt. The

variance in year #12 and #13 was -23.56 percent or $ 63,500. The variance in year #13 and #14

was -52.91 percent or $109,000 . The variance nearly doubled with decreasing net sales. In year
# 12 and #13, net earnings had a variance of -30.91 percent or $43,350. In year #13 and year

#14 a variance of -82.74 percent or $80,175.

       A key point in the percentages of the trend analysis occurs between year #12 and year

#17. Trend percentages: year # 12 - 100 percent, year #13 - 100.5 percent, year #14 decline to

- 97.1 percent, year # 15 increase to 103 percent, year # 16 - 102 percent, finally year # 17

increase to - 103.7 percent.

A2)    Risks

       Lenders look for risks in financial statements to find concerns. The simple question is,

can Custom Snowboard, Inc. be capable to repay the loan? Loans are risks to banks. Lenders

require a strong business plan, credit report and financial reports with profitability. The primary

concern for the lender is if the business fails, how may the lender be repaid. If financial

information indicates that repayment is minimal this mitigates the lenders risk.

       The capital structure debt to ratio at 100 percent anticipated financing, then EPS is -2.53

percent. Estimated return of 17.2 percent and a estimated share value of -1.47. The capital

structure debt to ratio is positive. With 80 percent financing, the expected EPS is -0.135. The

estimated required rate of return is 14 percent . The estimated share value at -0.96. With only 30

percent financing expected, the EPS is -0.028. The estimated required return is at 11.8. The

estimated share value is -0.23. If the long term debt, which yields 10 percent on the estimated

required return. The capital structure debt to ratio will remain positive.

       An expansion into Europe is of major concern and potential risk to the lender. The lender

will need sales forecasts and profitability projections. This is the advantage of acquiring an

established company. In year #15 earnings were $60,118 with a gross profit of $ 310,440. In
Year # 16 earnings were $108, 392 with gross profits of $372,528. In year # 17 earnings further

increased to $166,732 with increased gross profits to $447,034. Earnings continued to escalate in

year #18 to $220,438 with a gross profit of $ 491,737. Earnings and gross profit reached an apex

in year #19. Earnings of $257,665 and gross profits of $ 540,911. The income statements

demonstrate a positive growth pattern. The mitigating factor of the European expansion is less a

factor with such impressive positive growth.

          Another risk and concern for the lender is an American company conducting business in

a foreign country. With a changing world, as countries encounter political unrest, economic

downfall and uncertainty, a lender will require collateral for its investment. Mitigating some of

this risk is the North American Free Trade Agreement (NAFTA). This legislation eliminates

most barriers to trade and investment in Canada ,the United States and Mexico. The USDA

(2011) reports that over 70 percent of our exports are high value consumer oriented products

category. The creation of NAFTA created the largest free trade area in the world. This

agreement linked hundreds of millions of people and produced trillions of dollars of goods and

services. This mitigating factor, with regards to a potential trade barrier, actually opened up new

markets, increased economic prospects and prosperity in the United States , Canada and Mexico.

          The question of collateral as a risk is minimized by substantial assets held by Custom

Snowboards Inc. headquartered in Minnesota. The land, inventory, equipment, manufacturing

plant, and physical assets could collateralize the loan nicely at the relief of concerns by the

lender. Banks are in the business to make loans. Minimizing concerns and mitigating risks

concerning this expansion to the lender, is recognizing the continued positive growth of earnings

by Custom Snowboards Inc. The collateral and positive growth should secure a loan from the

A3)      Ratio Analysis

         Custom Snowboards, Inc. main competitor is Winter Sports. Their current ratio is 4.2 as

compared to the higher ratios of Custom Snowboards, inc. In year # 13 - 6.82, in year #14- 5.84.

The higher the ratios, is an indication that a business has sufficient current assets for maintenance

of normal business day to day operations. This ratio indicates that Custom Snowboards, Inc is

most likely than not to satisfy its liabilities in the next 12 month period. This is the primary

strength of the company. This ratio also indicates that Custom Snowboards, inc. has excellent

financial strength for the short term. Ratios higher than 1.5 or 2.0 dictate that a company should

secure funds to further expand the business.

                                      Custom                                Sports
                                  Snowboards, Inc.
      Ratio Analysis:              Year       Year                          Year 14
                                     14          13

Current Ratio                        5.84          6.82                                            4.2

Acid-Test Ratio                      3.64          4.66                                            3.4

Inventory Turnover                 33.33          33.41                                       30.4

Average Collection Period            11.0          11.0                                       32.5

Debt Ratio                           50.4          51.7                                38 percent
                                  percent       percent

Gross Profit Margin                  30.4          30.4                              32.10 percent
                                  percent       percent

Operating Profit Margin               1.5           3.1                               5.20 percent
                                 percent       percent

Net Profit Margin                    0.3           1.5                              5.14 percent
                                 percent       percent

Earnings per Share                  0.02          0.11                                       0.08

Return on Total Assets               1.0           5.4                              4.80 percent
                                 percent       percent

Return on Common Equity              1.9          11.4                              8.10 percent
                                 percent       percent

Price / Earnings Ratio            170.52         90.82                                         29

Times Interest Earned               1.29          2.58                                        5.1

       The quick ratio or acid test determines if a company has adequate short term assets to

manage its immediate liabilities, without having to liquidate its inventory. The higher the quick

ratio or acid test is an indicator of a company’s ability to turn liquidate inventory and current

assets into immediate cash. This insures liquidity of a company. An analysis of Custom

Snowboards in year # 13 is 4.66. In year # 14 it was 3.64. Winter Sports ratios were below 3.4 in

year #14.

       Inventory levels are determined by the turnover rate of a company. A high turnover rate

is an indicator of avoiding accumulation of obsolete parts and a high demand. The turnover rate

was lower for Winter Sports in year #14 – 30.4. The turnover rate of Custom Snowboards, inc.

in year #13 was 33.41 and in year #14 - 33.33.

       Winter Sports average collection period in year #14 was 32.5 days, nearly three times the

rate of Custom Snowboards, inc. Their ability to convert receivables to cash reserves was only

11 days, in both years #13 and #14. The higher the turnover ratio determines the rate at which

cash is collected. This indicates that Custom Snowboards, Inc (CS) will benefit by collecting
funds at an impressive rate of 30 days or less. Having assets and adequate capital makes CS a

more efficient company that can operate more efficiently.

       Debt ratio for Winter Sports debt ratio in year #14 was 38 percent . Custom

Snowboards was 52.5 percent in year #13 and reduced in year #14 -50.4 percent. Debt ratio

compares a company’s total assets to its total debt. This ratio is the proportion of assets financed

by debt. The higher the debt ratio to assets indicates the leveraged amount. The higher the

leveraged amount, the higher the risk to the lender. The positive mitigating factor for this risk is

in future years. This was evidenced by the decline in year #14. The preferred debt ratio is 30

percent. This would improve a company’s credit rating to decrease the proportion of assets

financed by debt.

       Winter Sports Gross Profit Margin in year # 14 was 32.10 percent . Custom Snowboards,

Inc. in both year # 13 and # 14 was 30.4 percent . To determine a company’s manufacturing and

distribution efficiency during the production process, the Gross Profit Margin is utilized. This

margin is necessary to set a value of a product and a sales price . The higher the ratio indicates a

more efficient operating company.

       After paying the production costs including wages and materials the profit is the

Operating Profit Margin Ratio. This is an indicator of the efficiency that a company is at

controlling costs and expenses related to business operations. Winter Sports for year # 14 was

5.20 percent but for Custom Snowboards Inc in year #13 was 3.1 percent and in year # 14 was

1.5 percent. The risk for the company in this analysis is that for each dollar invested that it

earns roughly 2 cents from each dollar of sales. To mitigate risks basic variables in forecasting

need to be alternating. By decreasing or increasing production the growth rate can manipulate the

         Net Profit Margin is the profit a company makes for every dollar it generates in sales. Net

profit margin is net income divided by sales is the amount of each sales dollar remaining after

ALL expenses have been paid. A higher profit margin is better. Winter Sports has a distinct

advantage with a net profit margin of 5.14 percent in year #14. Custom Snowboards, inc. in year

#13was 1.5 percent and in year # 14 was 0.53 percent. A lower profit margin may indicate a

pricing strategy. A high-volume lower price approach will generate a higher market share. This

still represents that Winter Sports was more efficient and had a greater profit per dollar of sales.

         Winter Sports Earnings per share in year #14 was 0.08. Custom Snowboards, inc. in year

#13 was 0.11 and in year #14 it was only 0.02. Earnings per share is the amount of net income

paid or earned for each share of company common stock. Earnings per share is a indicator of the

profitability of a company. To mitigate risks, a company should be diligent at reducing costs and

increasing revenue. Acquiring the European Snowfun, Inc. company may increase earnings per


         How profitable a company uses its assets is called return on total assets. Winter Sports in

year #14 was 4.80 percent. Custom Snowboards, Inc. in year # 13 was 5.45 percent but in year

# 14 it was 1.0 percent. The profitability rate is low and the company is in need of

improvements and decisions during an economic slowdown. This is a prime time opportunity to

make some major cost saving decisions. To mitigate risks, the decisions on allocating resources

and the decision to acquire another company needs reevaluated.

         Return on Common Equity is the ratio between common stockholder’s equity and net

income. This ratio reveals a corporation’s profitability by measuring the profit a company

generates from the investment from shareholders. The higher the ratio the better the company is
performing. Winter Sports in year #14 was 8.10 percent, Custom Snowboards, Inc. in year #13

was an impressive 11.4 percent. The concern was the dramatic decline in year #14 to 1.9

percent. This was attributed to a total economic slowdown. This analysis presents a low return

on common equity. The company may not be adjusting its spending to compensate for economic

conditions making the company not profitable which is a major weakness. This ratio permits

companies and investors to compare companies profits that their investment earns per dollar. To

mitigate risks, the company might decide to diversify its own investments into several other

assets such as stocks, bonds, or buying other companies like the European Snowfun, inc. This

may prove profitable in the long run.

       The ratio of the market price for a share of common stock in relation to a company’s

earnings per share is called the Price/Ratio Earning. The valuation ratio of a company’s per share

earnings and current share price. The higher the P/E is a major indicator of how much th stock is

worth on the market. A low P/E is a weakness and the company stock value is lower with low

investor confidence. Winter Sports, inc. in year # 14 was only 29. Custom Snowboards, inc. in

year # 13 was 90.82 and in year # 14 was an impressive 170.52.

       To measure a company’s ability service its debt Times Interest Earned ratio. Higher ratios

are desired. Lower ratios indicate an inability to service debt compared to competitors which is a

weakness. Winter Sports, inc. in year #14 was 5.1, In year # 13 Custom Snowboards, Inc. was

2.91 and in year # 14 it was down to 1.53. Investors find this undesirable and lower earnings

indicate an inability to meet interest payments. In year #13 indicates for ever $1.53 the

organization earns $1.53 worth of income on each dollar of interest expense. To increase the

Times Interest Earned ratio as a mitigating factor is simply to reduce debt. The reduction in

interest expense reduces the debt. This will elevate the Times Interest Earned ratio. This is due to
the income number will be divided by a lower interest expense number. Lower debt and lower

interest expense will have a better debt servicing ability.

       The company liabilities during the year is abnormal concerning mortgage payable -

$650,000. The majority of assets are mortgaged. The manufacturing plants, the land, furnishings

net cost is only $900,000 and that was mortgaged. The lender requiring a $300,000 The

company applying for a loan with a stipulation to maintain a $300,000 compensating balance

will further burden the company.

       Trend analysis provides economic information concerning the strength of an industry or

an individual business. It dismisses uncertainties in a business concerning slow sales, seasonal

demands and inventory. Trend Analysis is critical to management when making business

decisions with regards to the organizations operations. Historical trend analysis percentages

helps determine future growth in the economic marketplace. Custom Snowboards, Inc. in year

#12 was 100 percent, in year # 13 was 100.5 percent and in year # 14 a slight decline or

weakness at 97.1 percent. The trend analysis forecast in years # 14-17 is more positive. In year

#14 the forecast was 100 percent, in year #15 was 103 percent, in year #16 experienced a

slight decline to 102 percent and in year # 17 experienced an increase to 103.7 percent. The

lender is considering the $1,000,000 loan with terms of 5 year repayment at 6.75 percent interest,

but the catch is a $300,000 compensating balance. The lender will most likely want additional

collateral to mitigate risks. Custom Snowboards, inc. could secure additional properties possibly

from investors. The lender will make its decision on their risks and the mitigating factors

associated with this loan after this presentation.