Financial Analysis 5

Posted: September 5th, 2013

Financial Analysis 5

Name

Institution

Financial Analysis 5

To: Chief Financial Officer Custom Snowboards Inc.

Our entity, Custom Snowboards Inc., needs to acquire funds for its intended expansion into the European market due to the viability of the market. Hence, the entity puts forth the viability of the proposed investment and its ability to service the said funds if presented with the adequate funding from your bank. Our entity regards entry into the European market as high priority project due to the potential of the market to grow exponentially.

Summary of issues

• The entity shows a constant decline in profits for three consecutive periods from the beginning of the financial year 12 to the period through the financial year 14. This might be an indication to the chief financial officer that the entity’s profitability level is on the decline. Thus, the officer might be forced to reject the plea for the loan to avid default from the entity, as it might be unable to complete repayment of the loan from its residual funds after the deduction of operational costs.

• In addition, there was a significant increase in general costs and administration expenses within the organization. This might be accrued from the increase in costs of doing business. However, from another perspective, administration costs might also be accrued from mismanagement of the organizational resources.

Analysis of data and Errors

Analyses of financial ratios in terms of loan repayment include:

•           Debt Ratio                    =          Total Debt/Total Assets

$750,000/$1,781,546  =          0.42 or 42/100

The entity has a very healthy debt ratio. This proves that the organization could be able to undertake more debts for other purposes. In addition, the entry into the new market would also accrue more revenues.

• Current Ratio =          Current Assets : Current Liabilities

$781,546: $127,720

= 6:1

The current assets ratio is an indication that the company could be able to take up more liabilities. Hence, another loan would be supported, as there is adequate liquidity in repayment of debts.

• Quick Ratio   = (currents Assets – Stock/finished goods stock + raw materials stock)/current liabilities

($781,546-$(135,744+36,360)) / $127,720

= 4.77

The quick ratio achieved is an indication that the organization has the ability to repay its debts or loans with ample speed or in a required period.

Discussion and interpretation

The risks outlined by the financial officer might be approached differently to ensure that they are solved adequately with the attention they deserve. The increased costs of business might be reduced by ensuring good management practices within the organization. Most of the profits realized by the organization can be attributed to the general and administration costs. With reduction of such costs, the organization would be guaranteed an automatic reduction in its expenditures.

The general view from the outlined ratios is an indication that the organization from the latest financial information possesses the ability to pay off additional debts, as it has relatively good standing in terms of credit. Hence, the loan could be paid without strain (Jackson, Sawyers, & Jenkins, 2009).

Risks Identified

Risks associated with bank loans are not limited to only one business; they are usually synonymous in the business world because all entities are aimed at making profit, which are never guaranteed for any financial period.

• Custom Snowboards, Inc. might find it difficult to repay the bank loan at the given interest rates due to its reduced rate of earnings, which has been on the decline over the three years, year 12, year 13 and year 14. It might thus be a futile effort to prove to the bank that the entity possesses the ability of repaying the loan. The provision of funds from the bank might provide the organization with a diverse market for its products, thus increasing its revenues base.

• In addition, the venture into Europe might prove to be unprofitable resulting in failure. This is because startups are usually un-forecasted and entities thus do not possess adequate or precise information about the future, leading to lack of achievement of the set goals and thus collapse of the venture by an organization.

• Credit worthy of the entity also determines the ability of the entity in acquisition of credit from financial institutions, as well as individuals seeking to invest in an entity. This is determined by past incidences of credit from other institutions, which are an indication of the ability of the organization to repay loans acquired. In addition, the entity has a long-term mortgage loan, which could be useful in convincing the bank to accept the terms as the organization will be able to service its loan (Sease, & Prestbo, 1994).

To: Chief Executive Officer, Custom Snowboards Inc.

Introduction

Our organization is resented with a predicament with the new option of financing our venture into the European market. The venture into a new market requires adequate funds which we do not posses, thus the option available was to solicit for funds from our trading bank. The future performance of the organization is bent on an increase in the operational costs of the business. Hence, to improve our ability to repay, the loan management will be prompted to act to reduce costs of operation, which have negative reflection on our creditworthiness and management approaches.

1. Analysis of historical performance

Analysis of historical analysis

There has been a significant decline in the net returns accrued for the entity over the periods of three years. However, there are reductions in the liabilities for the entity. This might prove to be a favorable aspect in getting funding. The reduced liabilities might be due to reduced amounts of creditors due to the payment of the debts accrued by the entity. Reduction of liabilities proves to be a great force in bargaining for the loan, as it is an indication that the organization is up to date in repayment of its debts and other obligations to its creditors.

2. Improved Cost controls

Cost controls available to the organization are numerous and vary form one another. The available cost controls to the organization are:

• Value analysis can be used to reduce costs of operation by the business. This approach uses basic costing steps in evaluating the costs of production by the organization. The revenues accrued in a specific period should be compared with the costs of operation to appraise the operations, in addition to whether the costs are relevant to the revenues accrued by the business.

• Setting out predetermined costs in terms of the operational costs of the entity should be given priority. This can be achieved by ensuring adherence to set out strategies by the management in achievement of the identified costs for reduction. Budgeting is one way of improving costs, so that management acts as oversight authority in management of expenses and ensuring strict adherence to the set out expenditures.

• Comparison of the set out targets for the expenses by the business and the actual costs is an essential tool in ensuring that the organization is able to rectify the factors of deviation from the set out targets. This acts as a preemptive tool in cost overruns by the business. Deviations should be mapped out and ensured that they are looked into or taken care of by the relevant authority with the supervision of the management.

• Remedial measures should be taken adequately to ensure that the standards are met and that the organization is able to prevent similar happenings in terms of variances in the budgeted costs and actual costs. Mitigation of risks such as costs should be evaluated periodically because there are external market forces, which might affect the business negatively.

3. Acquisition of the SnowFun Inc. would ensure that the organization is able to acquire the market of the SnowFun Inc. This would enable the organization to maintain the employees and management of SnowFun while, at the same time, eliminating competition, which is posed by the SnowFun Inc. organization if it is left to operate independently (Sease, & Prestbo, 1994).

Internal risks

• Despite the identical product line, the entity might be new to the strategies and business ideals in the acquired firm. Hence, there might be differences in terms of the ways of conducting operations, leading to loss of market share to competitors, as well as loss of loyal customers.

• There are inadequate skills and knowledge in coping and operating within the market without expertise from the immediate staff of the acquired entity.

External Risks

• The market might prove to be very volatile, leaving the organization at a vulnerable position in terms of its spending and sales. In addition, the organization might find its existence within the market expensive before it makes any substantial headway into the market.

Recommended strategies

• Reduction of executive compensation would contribute significantly to reduction of the costs of operation, coupled by the decrease in administration costs, which contribute significantly to the reduced earnings, as they eat into the profits of the organization.

The risks associated with acquisitions are identified as follows:

• In acquisitions, the organization’s tactics might be inadequate in negotiation of favorable terms and conditions of the firm purchase. The organization should evaluate the value of the business and its related assets and liabilities.

• To maintain within the same product line, the organization can opt to maintain the staff of the acquired entity, as they are in possession of knowledge, which is essential for navigating within the market.

4. Returns of the selected financing option

• Ensures that the organization still maintains its ownership after acquisition of a new loan, in comparison to emission of new shares, where ownership is shared with the new owners. Hence, the organization would maintain its independence.

• Ensures that the organization accrues manageable liability, which will not affect the profitability of the organization negatively

• Reduced rates of loan repayment would favor the organization, as it would see a decline in its liabilities gradually.

5. Summary of Expansion Options

A merger with an entity such as SnowFun Inc., which is involved in production of low quality snowboards, would damage the image of the company as one, which produces similar low quality products. Furthermore, despite the mutual corporation as partners the entity might result to efforts of economic sabotage and competition as they try to outdo each other within the market.

In addition, acquisition of the entity would ensure that the organization reduces startup costs which would be used from the intended construction of anew plant and related startup costs. On the other hand, construction of a new entity would consume many costs in terms of start up costs, such as equipment, operation costs, such as labor, wages, indirect manufacturing, marketing, legal fees for operation, and other related costs.

Thus, out of the availed options, the decision to acquire a loan from a financial institution proves to be the appropriate financing option, as the organization would be able to undertake the proposed entry into a new market and, at the same time, withhold its independence as a separate entity. The future of the organization looks bleak because of the recent trends in revenues reduction and increased costs of management. This could mean that the organization is paying out too much to its managers or executives within the organization, despite its reduced liabilities and costs of operation for the three previous consecutive financial periods.

6. Final Financing Option

Repayment of a loan would accrue more liabilities for the entity, resulting in reduced incomes. Repayment of loans is, however, a better option, as after the completion of payment of the loans the organization would retain its ownership, in comparison to emission of shares, where the ownership is automatically transferred unless in instances of redeemable shares issued. In addition, another option of floating shares to the public is viable, as it would accrue more funds for the entity. However, the repayment of shares would accrue long lasting liabilities, as the entity would be forced to pay the shareholders each financial year.

Hence a loan would ensure that the organization possess a liability for only five years until full repayment of the loan. The full repayment of the loan at the end of the five years would ensure that the business has available funds at the end of each financial year for other useful projects (Sease, & Prestbo, 1994).

References

Jackson, S., Sawyers, R., & Jenkins, G. J. (2009). Managerial accounting: A focus on ethical decision-making. Australia: South-Western Cengage Learning.

Sease, D., & Prestbo, J. A. (1994). Barron’s guide to making investment decisions. Englewood Cliffs, NJ: Prentice Hall.