Japman 0nly

Financial Information

Prepared for CFO of Custom Snowboards, Inc.

Key Points for Bank Officer

Custom Snowboards has provided a vertical analysis, horizontal analysis, and trend analysis for the banker to consider in making his decision.

Vertical Analysis

In order for the banker to determine his investment is secure, he will want to see several different lines from the vertical analysis.

To begin with, the comparative income statements for Years 12-14 show that the company’s cost of goods sold has remained steady each year, at 69.6% of net sales. Gross profit has also remained steady at 30.4% of net sales each year. This shows that the company has a history of not having large fluctuations of cost of goods sold, meaning that their gross profit is fairly predictable.

Total selling expenses have remained constant, at 11.8% of net sales each year. This will be attractive to the banker, because he will know that his investment is with a steady and predictable company.

Total Operating Expenses have risen from 26.5% in Year 12, to 27.1% in Year 13, to 27.8% in Year 14. This is because Custom Snowboards has increased their administrative salaries and executive compensation. There has also been a slight increase in utilities, which have gone up from 3.7% in Year 12 to 3.8% in Year 14. Additionally, a slight increase in other general and admin expenses can account for the increase in total operating expenses, from 1.8% in Year 12, to 2.3% in Year 13, to 2.5% in Year 14. All of these changes are relatively minor, but have decreased the operating income from 3.9% in Year 12 to 2.6% in Year 14.

The net earnings for the company have decrease slightly over the past three years. Year 12 saw net earnings at 2% of net sales, while Year 13 was 1.6% and Year 14 was 1.2%. These changes are a result of the decrease in operating income.

A vertical analysis of the balance sheets for Years 12-14 show that the company has more than doubled its cash and cash equivalents, from 7% in Year 12 to 16% in Year 14. There has also been an increase in other current assets, from 5.5% in Year 12 to 6.1% in Year 14. These increases in assets are great for the company. Unfortunately, the company has seen total current assets decrease from Year 13 to Year 14. Year 12 had total current assets at 42.3%. This number jumped to 49.8% in Year 13, and then fell to 45% in Year 14. This reduction is because Custom Snowboards saw a significant decrease in short-term investments in Year 14. Short-term investments dropped to 1.7%, when they have been previously at 10% in Year 13 and at 8.6% in Year 12.

Another increase in assets did occur. Custom Snowboards increased their furniture, fixtures, and equipment to 27.5% of total assets. This number had been 17.3% in Year 12 and 16.7% in Year 13.

The company has made great achievements in paying off liabilities. Their mortgage has steadily decreased each year, which means that they are making regular payments. This will be attractive to a banker looking to make an investment in the company. Further, other long term liabilities have decreased, from 3.5% in Year 12 to 2.8% in Year 14. Total liabilities are sitting at 48.5% of total liabilities and equity for Year 14. Previous years were at 52.2% (Year 13) and 57% (Year 12). An investment banker will be more attracted to Custom Snowboards because of this information.

Another number that will encourage the banker is the company’s retained earnings. In Year 12, only 8.4% of total liabilities and equity went into retained earnings. In Year 13, this number jumped to 14.3% and in Year 14 it went up to 18.5%. This increase is excellent; because that means that the company is investing more money in itself.

Horizontal Analysis

The horizontal analysis shows that Custom Snowboards has seen an increase in net sales and gross profit each year. Their sales and gross profits were up 3.21% from Year 12 to Year 13, and up 1.91% from Year 13 to Year 14. This indicates that the company is continuing to grow.

Operating Income has decreased 11.98% from Year 12 to 13 and also decreased 19.20% from Year 13 to Year 14. The large decrease in Year 14 is likely due to the fact that administrative salaries increased by 13.64% over Year 13 and executive compensation increased by 10.26% over the previous year.

Due to the decrease in operating income, along with a 90.63% decrease in interest income in Year 14, Custom Snowboards’ net earnings are down by 27.79%. Year 13 saw a decrease of 14.42% in net earnings. These numbers will likely be concerning to the investment banker.

The horizontal analysis of the comparative balance sheet shows that total current assets are down by 8.3% over Year 13. However, Year 13 saw an increase of 21.5% in current assets over Year 12. The decrease in current assets in Year 14 is not much of a concern, because total assets were increased by 1.5%, due to the 66.7% increase in furniture, fixtures and equipment over the previous year. Additionally, total assets increased 3.3% from Year 12 to 13. Custom Snowboards is a company that is steadily increasing their assets, which will be attractive to the investment banker.

All of the company’s long-term liabilities have been decreasing from year to year, while the current liabilities have only slightly increased. In fact, total liabilities were down 5.3% from Year 12 to 13 and decreased 5.7% from Year 13 to 14. This is a strong plus for the company.

The amount of retained earnings and stockholder’s equity has been increasing each year also. This means that the company is seeing positive growth, and the investment banker will likely consider Custom Snowboards a good investment.

Trend Analysis

The historical trend analysis for Custom Snowboards shows that the company has been steadily increasing their sales each year. The base year, Year 12, saw sales of $6,520,500. Year 13 saw an increase of 103.2% and Year 14 saw an increase over the base year of 105.2%. This trend analysis shows that while Year 14 didn’t see as large of an increase as Year 13, they still saw one. The company feels that the worldwide economic slowdown has impacted their sales in Year 14, but that the Winter Olympic Games generated an interest in their product. It is pretty impressive that even during rough economic times that the company can still see an increase in sales.

The forecasted trend analysis sets Year 14 as the base year, with sales of $6,858,600. Custom Snowboards expects to see an increase of 103% in Year 15, 102% in Year 16, and 103.7% in Year 17. This shows that the company is expecting to sell more than the base each for each projected year. However, they are anticipating Year 16 to not see sales as high as Year 15 and Year 17. It is unsure why the company feels this will occur, but regardless, it is still an increase over the base year and an increase over Years 12-14.

The company’s sales predictions seem to be accurate. Their predictions are not unrealistic, and are attainable. The company also has the most durable and reliable product in their market, which makes it even more likely that they will meet the sales predictions.

Based on the historical trend analysis and the forecasted trend analysis, the investment banker will not have any concerns, as each year sees acceptable sales.

Mitigating Risks

There are some risks that the investment banker might be concerned about, so Custom Snowboards should be prepared to address them.

Risk: The decrease in total current assets.

The decrease in total current assets would be one thing that catches the banker’s eye. Since short term investments have decreased, it has lowered the amount of total current assets. However, the increase in furniture, fixtures, and equipments has balanced that out, giving total assets a small increase of 1.5% over Year 13. Therefore, the banker should not be concerned about this realignment of assets, so long as the company is sure to point out to him that total assets have been increasing each year. If the banker remains concerned, Custom Snowboards should make efforts to increase their short-term investments for the next reporting period by investing in short term stocks or bonds.

Risk: Total operating expenses have been increasing and may continue to do so.

Total operating expenses have been slightly increasing each year, which may at first be a concern to the banker since they are lowering the operating income. These expenses have been increasing due to increases in administrative salary and executive compensation. Custom Snowboards should be prepared to tell the banker about additional employees that needed to be hired due to increased sales. Additionally, the company should be prepared to show that the increase in executive compensation was also a result of higher sales. These increases in salary and compensation are likely a result of the company performing so well, and the investment banker should not be concerned. However, in an effort to eliminate this risk, Custom Snowboards could take action by lowering salaries or paying less executive compensation if it is deemed necessary. It will be important for the company to reassure the banker that it is going to cut those salaries to reduce operating expenses, so that the banker know that this pattern is not going to continue.

Risk: Net earnings have been decreasing and may continue to do so

The net earnings for the company might also be considered a risk by the banker. They have dropped from $110,400 in Year 13 to $79,725 in Year 14. This is in part because of the drop in operating income, as discussed above. Additionally, the $2,900 drop in interest income for Year 14 can account for part of this issue. This significant decrease in Year 14 can, and should be, mitigated by having the company invest more in short-term investments. Additionally, the company should take actions to increase sales in the next year in order to increase net earnings. These steps will allow the banker to see that the decreasing net earnings are not a pattern that Custom Snowboards is going to continue.

All of these risks will concern the banker, because they will lead him to believe that Custom Snowboards will not be able to pay back a loan. By mitigating these risks, the investment banker is more likely to loan money to Custom Snowboards.

Ratio Analysis

The investment banker will also look at key ratios in Custom Snowboards’ ratio analysis to see how they compare with their competitor, Winter Sports. This will give the banker a good feel for Custom Snowboards’ industry standing. The key ratios that a banker will look at are discussed below.

Current Ratio

The current ratio tells if a company is able to pay off its liabilities. The higher the ratio, the better able a company is to pay off the liabilities with assets (Horngren, Harrison, & Oliver, 2009). Custom Snowboards had a current ratio of 6.85 in Year 13 and 6.21 in Year 14. Although this number has slightly decreased, it is still a strong number, especially when compared to Winter Sports’ current ratio of 4.2 in Year 14.

This means that Custom Snowboards is able to pay off its liabilities, and is in a better position to do so than their competitor. It also shows that the company is not too liquid. This will be important for the banker to know, because it shows that Custom Snowboards is able to pay off any loan he might approve.

Acid-Test Ratio

The acid-test ratio is a way to determine if a company could pay off all its current liabilities if they became due immediately. For this ratio, a company should strive to have as high of a number as possible. A 1.0 is considered a “safe” number (Horngren et al., 2009).

Custom Snowboards had an acid-test ratio of 4.68 in Year 13 and 4.00 in Year 14. Both of these numbers beat Winter Sports’ ratio of 3.4 for Year 14. This means that Custom Snowboards is able to pay off all their liabilities if they came due immediately, and they are in a better position to do so than their competitor. This will be a positive indicator for the banker that the company will be able to pay off a bank loan.

Inventory Turnover

The inventory turnover ratio is a measure of how many times a company sells its average inventory per year. A higher number is better for a company, because it means that they can easily sell their inventory (Horngren et al., 2009).

Year 13 saw an inventory turnover of 33.86, while Year 14 saw an inventory turnover of 33.33. Winter Sports had an inventory turnover of 30.4 in Year 14. This means that Custom Snowboards is doing a better job of selling off their inventory than Winter Sports is. While the number slightly decreased in Year 14, the company is still doing a good job at selling their inventory, which reduces inventory holding costs.

This information will be useful to the banker, because it will show him that Custom Snowboards is capable of selling their inventory quickly. This reduces holding costs, which frees up more money to pay off a bank loan. Further, it shows that Custom Snowboards is selling a product that customers want. The banker will be unlikely to loan money to a company that cannot sell its inventory because there is no demand for the product.

Average Collection Period

The average collection period ratio tells how many days it takes the company to collect on receivables. The smaller the number is, the fewer days it takes for the company to get their cash (Horngren et al., 2009).

Custom Snowboards has amazing average collection periods of 11 days for both years on the ratio analysis. This is far superior over the competitor, whose average collection period is 32.5 days. This means that Custom Snowboards gets their cash from accounts receivable far faster than the competition. This benefits the company’s cash conversion cycle, giving them more working capital, which will look attractive to the investment banker. When a company has more cash, they are better able to pay all debts, including any loan the banker may approve.

Debt Ratio

The debt ratio is a measure of a company’s ability to pay off its debts. For this ratio, the lower the number is, the better of a position the company is in (Horngren et al., 2009).

Custom Snowboards saw a debt ratio of 52.2% in Year 13 and 48.5% in Year 14. Winter Sports saw a debt ratio of 38% in Year 14. This indicates that the competition is in a better position to pay off their debts. However, Custom Snowboards has improved their debt ratio from Year 13. It will be important for the banker to know that improvements are being made concerning the amount of debt and the company’s ability to pay it off.

Gross Profit Margin

The gross profit margin is a very important number for an investor to keep an eye on. An increase in this number means that the company has had an increase in profits, while a decrease could signal problems within the company (Horngren et al., 2009).

For Years 13 and 14, Custom Snowboards had a gross profit margin percentage of 30.4%. It would be ideal if this number had increased, but a steady number is better than a loss. The competitor, Winter Sports, had a gross profit margin of 32.10%. This puts the competitor in a better position than Custom Snowboards in Year 14, but just barely. The investment banker is not likely going to be encouraged by the lack of growth in gross profit margin, but since it is not a loss, it will probably not deter him from giving Custom Snowboards a loan. A growth in the gross profit margin would have indicated to the banker that the company is increasing its profits, which make it a good investment for the banker. The fact that the number has remained steady does not make this a bad investment, but it’s not a great one either.

Operating Profit Margin

The operating profit margin shows how much a company earns in operating income per $1 of sales. A higher number means that the company is making more money per sale, so a higher number is preferable (Horngren et al., 2009).

Custom Snowboards had an operating profit margin of 3.3% in Year 13 and 2.6% in Year 14. Winter Sports had an operating profit margin of 5.20% for Year 14.

As previously discussed, Custom Snowboards’ operating income has decreased due to increases in administrative salaries and executive compensation. Showing the banker that the company is taking steps to increase operating income by lowering salaries or executive compensation will ease any concerns the banker may have about the operating profit margin. Taking these steps will also allow Custom Snowboards to catch up with Winter Sports’ Year 14 operating profit margin of 5.20%. The operating profit margin will be of interest to the banker, because a company that makes more profit will be able to better pay off their debts.

Net Profit Margin

The net profit margin tells how much of the revenues a company gets to keep after all costs are taken out (Horngren et al., 2009).

Custom Snowboards had a net profit margin of 1.6% in Year 13 and 1.2% in Year 14. This decrease in Year 14 is once again a result of a decreased operating income, which should be corrected by the company by following the previous recommendations. The net profit margin for Winter Sports is 5.14%, which is considerably better than Custom Snowboards.

Once Custom Snowboards increases their operating income, they will see their net profit margin increase. The investment banker likely will not be too concerned about the current net profit margin, because the company is still profitable and will makes strives to improve. The profit margin is important though, because it tells the banker if the company is managing their expenses properly and if they are profitable. A company that is not profitable will have a much harder time paying back a loan.

Earnings Per Share

Earning per share is a measurement of the amount of income earned for each share of a company’s outstanding common stock. Ideally, this number will increase each year (Horngren et al., 2009).

Custom Snowboards had earnings per share of 0.13 in Year 13 and 0.09 in Year 14. This is the opposite of what the company wants to see happen. Winter Sports had earnings per share of 0.08. This shows that Custom Snowboards is still doing better than the industry average, despite the decrease.

The banker will care about the earnings per share because they help determine stock prices. The decrease that Custom Snowboards saw in earnings per share likely means that their stock prices dropped as well, providing less return for investors. However, since they are still above the industry average, the banker will likely not be too concerned about this. Custom Snowboards should attempt to increase their EPS in the next year by increasing their profits.

Return on Total Assets

The return on total assets tells if a company is using their assets to earn a profit or not. For this number, it is ideal to have a larger number than the industry average (Horngren et al., 2009).

Custom Snowboards had a return on total assets of 6.2% in Year 13 and 4.4% in Year 14. Winter Sports had a return on total assets of 4.80% in Year 14.

This information will tell the banker that once again the decreased operating income has impacted a ratio. The decreased operating income lowered the amount of earnings before income taxes, which lowered the ratio for Year 14. Even still, the 4.4% ratio is not that much lower than the competitor, and if Custom Snowboards lowers their operating expenses, they should be able to easily exceed the competition in the next year. The banker needs to look at this ratio to determine if the company is managing their assets properly to earn a profit. A company who is unable to do this would not be a good choice to loan money to.

Return on Common Equity

The return on common equity can tell a company has much income is earned for each dollar that is invested in common equity (Horngren et al., 2009).

The return on common equity for Custom Snowboards in Year 13 was 12.9% and in Year 14 was 8.5%. For both of these years, this number is higher than the number for the return on total assets. This indicates that Custom Snowboards has been trading on equity. This is not a problem for the company, since their debt ratio is still in the “safe zone”. However, trading on equity has a tendency to compound a company’s losses in bad years (Horngren et al., 2009)

Winter Sports is in the same position as Custom Snowboards. They, too, are trading on equity, as can be seen by comparing their Year 14 return on common equity of 8.10% to their debt ratio. However, Winter Sports has the benefit of having a smaller debt ratio, making their return on common equity less concerning.

The banker will be interested in this information about Custom Snowboards because if the company has losses in future years, those losses will be compounded. This will make it unlikely that Custom Snowboards would be able to make loans payments in those years, if this problem occurs.

Price/Earnings Ratio

The price/earnings ratio shows the market price of a share of common stock to $1 of earnings. This ratio is mainly used for factual information instead of for creating a plan of action, as market prices of shares are not controlled by the company (Horngren et al., 2009).

The price/earnings ratio for Custom Snowboards in Year 13 was 79.71, and was 35.77 in Year 14. This decrease is not good. It indicates that investors are not willing to pay as much, because they are losing faith in the company’s future. The price/earnings ratio for Winter Sports in Year 14 was 29. This shows that despite the decrease, inventors still have more faith in Custom Snowboards than they do in their competitor.

This information could prove to be important to the banker, although he could look at it two different ways. If investors are losing faith in Custom Snowboards, it could be an indication that the company is headed downhill and shouldn’t be given a loan. However, since Custom Snowboards is doing better than the industry average, it could mean that the company is in no trouble whatsoever. It is unlikely that the banker will consider this information too much though, as it is not controllable by the company.

Times Interest Earned

The times interest ratio is a measure of how many times a company’s interest expense can be paid with operating income. Higher numbers are preferable, because it means that the company can easily pay its interest expenses (Horngren et al., 2009).

Custom Snowboards had a times interest earned ratio of 2.80 for Year 13 and 2.41 for Year 14. The drop in Year 14 is not a concern, because it is not a significant drop. Custom Snowboards still has enough operating income to pay their interest expenses.

Winter Sports has a times interest earned ratio of 5.1 in Year 14. This number shows that for Year 14, Winter Sports was at a considerable advantage over Custom Snowboards, because they had more ability to pay off their interest expenses.

The banker will be very interested in these numbers, as he will need to judge the ability of Custom Snowboards to make interest payments on any loan he might approve. Although the company decreased their Times Interest Earned ratio, and did they near that of their competitor, Custom Snowboards is still able to pay their interest expenses. This is good news for Custom Snowboards, because the banker will not want to loan money to a company without the ability to do so.

Conclusion

Custom Snowboards should be prepared to provide the investment banker with all financial documents pertaining to the company, including the different types of analysis, the trend forecast and future predictions, and the financial ratio analysis. Further, the company should be prepared to answer any concerns the banker might have about risks with the company. The company should also come with a plan for the banker about how they plan on paying back the five-year loan. Doing so will allow the banker to review the company information in order to make his determination.

Works Cited

Horngren, C., Harrison, W., & Oliver, M. (2009). Accounting (8th ed.). Prentice Hall. ISBN 0136072976.

2