Managing internal cost & Controlling Finances

Competition Bikes, Inc.
Competition Bikes, Inc. makes bicycles for professional and other highly accomplished riders who compete in bike races, biathlons, and triathlons.
Sixty percent of all race winners have been victorious using a Competition Bikes bicycle when at least ten percent of the entrants were also using a Competition Bikes bicycle. This extraordinary success rate consistently is a topic of conversation among racers and this word of mouth advertising has been effective in promoting sales. The company also uses these statistics to promote sales, although its advertising efforts have been quite limited.

The Main Competitor
Two Wheel Racing, Inc. is the only other manufacturer that offers a competitive product in this market space. Their product weighs only a few ounces more than the bikes made by Competition Bikes, but Two Wheel Racing builds a chain driven product.
Two Wheel Racing is also a publicly traded company. Their financial ratios are provided for comparison and analysis.

THE COMPANY AND ITS CENTRAL OPERATIONS
OWNERSHIP
Larry Ferguson formed the company in 2001 in his garage. An avid racer, Larry often heard comments from other riders about how heavy and unreliable their bikes were. Larry identified and sought to remedy this market niche by creating a specialized product that would satisfy the needs of racers. His new company also proved to be a vehicle for financial success.
Early success prompted Larry to take the company public after three years in order to acquire sufficient capital to build the two current manufacturing facilities. His bikes enjoyed high demand and good profit margins. Larry continues to be the CEO of the Competition Bikes, Inc. and retains a 40% interest of company shares.

STANDARD COMPANY OPERATING PROCEDURES
Each of the manufacturing locations for Competition Bikes uses operating procedures based on department and function, as applicable. The following is an excerpt from the operating manual that outlines the process used to order and receive component parts.
“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 supplier’s invoice to accounting and accounting writes a check to pay the invoice.”
Competition Bikes is required to conduct an annual audit since the company shares are traded on the Philadelphia Stock Exchange. The following excerpt was printed in the last annual report issued by the auditors to the shareholders.

“A material weakness is a control deficiency, or a combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.”

SARBANES-OXLEY COMPLIANCE
Management is responsible for ensuring the internal control processes prevent material misstatements from being reported in the financial statements. They also must provide a Report on Internal Control that is published in the annual report. The following excerpt from the Competition Bikes, Inc. yearend report indicates no material weaknesses existed.

“The management of Competition Bikes, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Competition Bikes, Inc. internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

“Competition Bikes, Inc. assessed the effectiveness of the company’s internal control over financial reporting as of December 31, Year 8. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment we believe that, as of December 31, Year 8, the company’s internal control over financial reporting is effective based on those criteria.”

MANUFACTURING LOCATIONS, DISTRIBUTION, AND PRODUCTS
Locations
Competition Bikes currently has facilities in two locations. Company headquarters are in San Diego, CA. There are two manufacturing facilities: one in San Diego and the other is located in an Atlanta, GA suburb. With qualified employees in each location the company has sufficient redundancy to handle a short-term increase in production if one of the locations has too many orders to adequately supply customers while maintaining high customer service standards.
Distribution Network
Competition Bikes currently markets its bicycles through selected, pre-qualified privately owned distributorships. Each manufacturing facility services a group of authorized distributors that were selected to ensure that 95% of the U.S. population is properly served. Each distributor works directly with local specialty bicycle retailers. All product orders are checked and submitted to the factory through one of the distributors.

Product Delivery
All bikes are conveniently delivered to the customer’s ordering location by a common carrier chosen for its reliability and superior handling of the product. Competition Bikes, Inc. has a contract with the carrier. The contract includes a large financial penalty for any damages to delivered orders.

Product Line
Competition Bikes aims to provide the most durable, reliable, light weight bike frame and component set possible. Competition Bikes, Inc. realizes that other companies make great components so their research and development department licenses these products and makes improvements where necessary to lighten the component. Care is taken to ensure that durability and reliability are maintained. The current product, CarbonLite, is a light weight, customized bike built based on the customer’s unique physical attributes. CarbonLite was also the first bicycle to offer drive shaft technology.
Local distributors who represent Competition Bikes are responsible for properly measuring the rider and placing the order with the factory. Some distributors allow their bicycle shop retail outlet clients to do their own measurements but the distributor is contractually committed to the order once it is placed. The factory constructs the bike frame according to these measurements and adds the approved braking, gearing, and other miscellaneous components as specified in the order. Each bike is completely built at the factory. Quality control checks are conducted, and each new bike is test ridden to fully check all functional attributes of the product prior to shipment to the distribution network.

MANUFACTURING COSTS

CarbonLite Production Standards
Direct materials:
Each bike frame requires an average of 42 (2 as a production scrap allowance) carbon strips which cost $9/strip. The component package costs $275.

Direct Labor:
Each bike requires a total of 15 hours of direct labor. The average $20 labor costs are relatively high due to the high skill level required in manufacturing the product. Retention of the quality labor force has not been a problem.
Variable Manufacturing Overhead:
Variable manufacturing overhead is currently applied at $94.529/unit.

PRODUCT SALES AND THE MARKET Sales Summary – last three years Company Sales in Units
Model CarbonLite
Sales Price $2,990
Trade Discount to Distributors 50%
Current Year – 2008 3,400
Last Year – 2007 4,000
Two Years Ago – 2006 3,000

SALES FORECAST

Global Economic Impact
Competition Bikes experienced a 15% sales decline in the most recent year based on the current economic situation. Many of the customers who place orders are sponsored professional riders. Some of the sponsors have cut back on the funding levels to their riders. Sales trends in the product mix (illustrated in the chart above) have remained consistent in spite of significant overall sales decline from professional riders who prefer the CarbonLite model. This trend is expected to continue for the next three years.

Sales Forecasts for the Next Three Budget Years:
The company expects to recover from the current year sales decline over the next three years. Current Sales Forecasts by Year
Year Sales in Units
9 3,510
10 3,660
11 3,800

WORKING CAPITAL & CASH FLOW

Operating Cycle factors:
• Competition Bikes sends the distributor a monthly invoice for all bike frames and component sets ordered with terms of net/30 days.
• Inventory is paid for in the month following production. All inventory ordered for the month is used during the month with ending inventory remaining at a very consistent level. The average time in inventory is 25 days.

Cash Conversion Cycle factors:
• The suppliers invoice Competition Bikes at the end of the month for orders that month with terms of net/15. Competition Bikes pays the invoices on the 15th of the month following the order. The checks are usually cashed on the 20th by the suppliers.

Free Cash Flow factors:
• The corporation’s marginal tax rate is 35%.
• Depreciation in the data is recognized in both manufacturing overhead and as depreciation expense depending on the asset being depreciated.

FINANCIAL PERFORMANCE HISTORY AND OTHER MATTERS
The financial statements from CarbonLite’s annual reports for the last three years have been provided for analysis on the course template in TaskStream. The company stock is traded on the Philadelphia Stock Exchange. At the end of the Year 8 fiscal year the stock is trading at $0.70/share.

TASK 1 – FINANCIAL STATEMENT ANALYSIS AND CONTROLS
Requirements for Task 1:

A. Prepare a summary report in which you do the following:
1. Evaluate the company’s operational strengths and weaknesses based on the following:
a. Review the horizontal analysis, analyze the results, and discuss operational areas of concern.
b. Review the vertical analysis, analyze the results, and discuss operational areas of concern.
c. Review the trend analysis, analyze the results, and discuss operational areas of concern.
d. Review the ratio analysis, analyze the results, and discuss operational areas of concern.
2. Analyze the working capital of Competition Bikes, Inc. Consider the following in your analysis:
a. Ways to improve the working capital
b. Ways to use excess working capital to generate an increase in profits
3. Evaluate the internal controls for the Competition Bikes, Inc. purchasing system.
a. Recommend corrective actions for any weaknesses.
b. Identify the risks to the company.
i. Discuss how to mitigate the risks arising from internal control weaknesses.
4. Analyze compliance with Sarbanes-Oxley requirements.
a. Recommend corrective actions for noncompliant areas. Ways to use excess working capital to generate an increase in profits

 

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