Tax- 700 FINAL

Acc 700 Milestone One

Vlad Ashurov

SNHU

06/12/19

Introduction

Financial statements provide investors, management, and other stakeholders with an incredible amount of data necessary in their decision-making processes. On the premise that financial statements data on its face value says little about the real status and performance as well as the position of the reporting entity, several analytical tools and techniques such as ratio analysis, composite analysis, and trend analysis have been adopted and used to quantitatively analyze this information. This report serves to analyze and present financial performance and position of Chester, Inc. through these techniques to guide the management in its decision-making process regarding the planned expansion.

Financial Ratio Analysis

Liquidity Ratios

These ratios are known to aid in assessing the state of short-term financial healthiness of an entity. In other words, they indicate whether an entity has enough cash on an ongoing basis to pay its obligations when they mature (Henry, Robinson, & van Greuning, 2011). Under this category, this report computed three ratios: current ratio, quick ratio, and the cash ratio. The importance of current ratio is to show the flow of cash soon as the company meets its short-run obligations using the short-term assets. It was established that in the periods 2013, 2014, and 2015, Chester, Inc. had current ratio values of 1.77, 1.40, and 1.36 respectively. Although the trend was slightly dropping, these results indicate that Chester, Inc. had enough short-term assets in every year to cover all outstanding current liabilities, thereby supporting its trading activities to run smoothly. However, its competitor’s, Under Armour, Inc., current ratio was very strong: 2.65, 3.67, and 3.13 in 2013, 2014, and 2015 respectively (Morningstar, 2019).

The quick ratio is a more stringent liquidity measure that assesses an entity’s ability to meet its obligations without the inventory item of current assets (Bradbury, n.d; Henry, Robinson, & van Greuning, 2011). Like the current ratio, Chester, Inc. recorded a declining trend in quick ratio of 0.98, 0.69, and 0.03. These findings indicate that in the absence of inventories, Chester, Inc. could not manage to meet its maturing liabilities. On the other hand, its competitor performed better with quick ratio values of 1.31, 2.07 and 1.18 over the same periods (Morningstar, 2019).

Relative to the current and quick ratios, the cash ratio is much more restrictive in measuring an entity’s liquidity level because it only considers the more liquid assets (cash and cash equivalents) and their ability to pay off current debt (Henry, Robinson, & van Greuning, 2011). The analysis showed that the cash ratio values were 0.04, 0.01, and 0.02 in 2013, 2014, and 2015 respectively. These results show that Chester, Inc. lacked the capacity to pay off maturing debt obligations using its most liquid assets.

Solvency Ratios

These ratios are useful in determining the degree to which a firm utilizes borrowed funds, and the associated safety and risk level. They show the stability and long-term solvency of a company. Their analysis is crucial because debt management determines an entity’s long-term financial stability (Nikolai, Bazley, & Jones, 2009). The equity ratio indicates the proportion of company’s assets that have been financed by borrowings vis-à-vis owners’ funds. The analysis results revealed that in the periods, 2013, 2014, and 2015, the equity ratio had a declining trend: 45.1%, 21%, and 18% respectively. These findings imply that the portion of the company financed by owners was decreasing and debt was rising.

Total debt to equity ratio is imperative is evaluating an entity’s financial leverage. It is also useful in evaluating the ability of stockholders’ funds to cover all debts in the event of liquidation. This report established that the debt to equity ratio was 0.55, 0.79, and 0.82 in 2013, 2014, and 2015 respectively. These results imply that Chester Inc.’s financial stability was weakening as the proportion of debt to equity was rising. However, relative to its competitor, Under Armour, Inc., whose financial leverage values were 1.50, 1.55, and 1.72 in 2013, 2014, and 2015 respectively (Morningstar, 2019), Chester, Inc. has a stronger financial stability business.

The interest coverage ratio shows how many folds a firm’s operating incomes can cover its interest charge (Henry, Robinson, & van Greuning, 2011). A higher value of times interest earned ratio implies that the solvency is stronger and assures debtors that the company can service its debts using operating earnings. An analysis by this report found that in 2014, the times interest cover ratio improved to 12.01 times from 10.08 times in 2013 before dropping to 6.72 times in 2015. This drop signifies a decline in its solvency in 2015. However, its rival’s performance was better with interest coverage ratio of 36.16%, 49.24%, and 41.48 in 2013, 2014, and 2015 respectively (Morningstar, 2019).

Profitability Ratios

They are used to evaluate an entity’s effectiveness in meeting its profit earnings ability. They are computed in reference to resources invested such as the assets, and capital, and turnover. The net profit margin shows the portion of sales that is left after all expenses (Nikolai, Bazley, & Jones, 2009). The findings of this report were that the net profit margin of Chester, Inc. was 2.1%, 7.9%, and 3.1% in 2013, 2014, and 2015 respectively. Although its performance had improved in 2014, the sharp drop in 2015 may raise queries about its potential future profitability. This performance was below that of its rival, which had net profit margin values of 6.95%, 6.75%, and 5.87% in 2013 through 2015 respectively (Morningstar, 2019). It was also lower than the industry’s net profit margin (TTM) of 7.72% (Reuters, 2019).

The gross margin indicates the portion of every net turnover left after cost of sales. It also shows the amount available to cater for operating and other expenses. The results of this report were that the gross margin recoded in 2013, 2014, and 2015 was 41.4%, 37.9%, and 32.6%, which were below its competitor that recorded values of 48.74%, 49.03%, and 48.08% respectively (Morningstar, 2019), and the industry’s gross margin of 41.68%. The declining trend could be an indication of intense competition or adverse economic conditions.

The return on equity ratio computes profitability in reference to the stockholders’ capital. It assesses how much of profit was earned by every $1 contributed by shareholders. The ratio also indicates an entity’s efficiency as well as that of its management in controlling costs of sales and other expenses (Nikolai, Bazley, & Jones, 2009). The results obtained by this report showed that Chester, Inc.’s return on equity was 12.9%, 15.4%, and 7.1% in 2013, 2014, and 2015 respectively. It can be concluded that Chester, Inc. and its management’s effectiveness in meeting its profit earnings ability drastically declined, by over 50%, in 2015 from 2014. These results were lower than the 17.34%, 17.31%, and 15.41% posted by its rival, Under Armour, Inc. (Morningstar, 2019), and industry’s return on equity (TTM) of 18.26% (Reuters, 2019).

Vertical analysis and Horizontal Analysis

Vertical Analysis

In the vertical analysis, the total assets item was used as the base upon which all other assets were expressed. Similarly, the total liabilities and equity value was used to analyze the portion of all elements of equity and liabilities. On average, it was established that all current assets formed 97.50% of total assets over the three years, implying that Chester Inc.’s non-current assets are very few (2.5%). Other main items were the accounts receivable at 40.94%, 42.48%, and 42.03% in 2013, 2014, and 2015 respectively. These figures show that Chester, Inc. advanced more goods on credit and its credit policy is conservative (40%-42%). Another significant item was inventory, which formed 47% of total assets in 2013 and 57% in both 2014 and 2015.

Total current liabilities were the highest items at 54.85%, 65.45%, and 71.54% in 2013, 2014, and 2015 respectively. Over the same periods, total liabilities were rising: 54.85% in 2013, 79.05% in 2014, and 81.86% in 2015. Conversely, total equity amounts were dropping: 45.15% in 2013, 20.95% in 2014, and 18.14% in 2015.

In income statement, all elements were analyzed with reference to the sales item. The cost of sales was rising (58.58%, 62.08%, and 67.39%) leading to a decrease in gross margin values (41.42%, 37.92%, and 32.61%) in 2013, 2014, and 2015 respectively. The total operating expenses were 30.12% in 2013, 22.59% in 2014, and 25.47% in 2015 with the highest item being administrative wages at 6.98%, 7.07%, and 7.41% respectively. After deducting all expenses, the net income in 2013, 2014, and 2015 was 2.13%, 7.90%, and 3.13% respectively.

Horizontal Analysis

This analysis was conducted in relative to the prior period. Generally, the trend analysis of current assets’ elements indicated that there was a performance improvement in 2015 relative to 2014. For instance, its accounts receivable had risen by 175.29% in 2014, but dropped by 13.16% in 2013 to indicate that it had collected more dues from customers. Provision for inventory obsolescence also improved from an increase of 222.34% in 2014 to a drop of 13% in 2015. Current liabilities rose by 235.90% in 2014 before dropping by 9.60% in 2015. Total liabilities also improved in 2015 as there was a 9.12% drop. Further results showed that total owners’ equity improved in 2014 by 23.14% before recording a 24.24% drop in 2015.

Trend analysis of income statement items showed an improvement in sales performance from a drop of 14.13% in 2014 to a rise of 2.45%. Though the cost of sales increased in 2015, there was an improvement in relative gross profit amount. In terms of management of expenses, the management’s efficiency improved in 2014 as there was expense drop of 35.61% but declined in 2015 following a 15.54% increase in expenses. Further results indicated that the net income improved by 218.04% in 2014 but dropped by 59.43% in 2015.

Conclusion and Recommendation

Generally, the results of ratio, vertical, and horizontal analysis indicated that relative to 2014, Chester, Inc. posted lower results in 2015. In additionally and overall, it performed poorly relative to its peers and the industry averages. Therefore, the necessary strategies should be implemented to improve its financial performance. In terms of liquidity, the management should develop sound strategies to ensure efficient use of assets and manage the structure of liabilities. To improve profitability, the management must ensure that the company operates efficiently and properly markets its offerings. Finally, Chester, Inc. should review its capital structure policy to ensure that its debt level does not compromise its going concern.

References

Bradbury, C. (n.d.). Financial statement analysis: Ratios. Retrieved from Plymouth State University: http://www.nhvthfma.org/resources/documents/fs%20analysis%20presentation%20for%20hfma.pdf

Drake, P. P. (n.d.). Financial ratio analysis. Retrieved from James Madison University: http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf

Henry, E., Robinson, T. R., & van Greuning, J. H. (2011). Financial analysis techniques. Retrieved from CFA Institute: https://www.cfainstitute.org/-/media/documents/support/programs/cfa/2019-L1V3R26-footnotes.pdf

Morningstar. (2019). Under Armour Inc. Retrieved from Morningstar, Inc.: http://financials.morningstar.com/ratios/r.html?t=UA&region=usa&culture=en-US

Nikolai, L., Bazley, J. D., & Jones, J. P. (2009). Intermediate accounting (book only). Boston: Cengage Learning.

Reuters. (2019). Columbia Sportswear Co. Retrieved from Reuters: https://www.reuters.com/finance/stocks/financial-highlights/COLM.O