Financial Statement Analysis Case

Audit Case Overview of Current Situation' ABC is generally in good health. The income statement shows that the company saw an increase in revenue for 2009, and this translated to an increase in net income. The company's expenses as a percentage of revenue were 13.6%, down from 15.1% the year before. COGS was 69.6% of revenue, versus 78.2% the year before. The company maintained a similar level of works-in-progress inventory over the course of the year, such that the improved operating performance did not derive from a decrease in inventory.

Manufacturing overhead as a percentage of sales also declined. In essence, the improved profit performance comes from incremental improvements in cost control that had the cumulative effect of reducing the overall expenses as a percentage of revenue. The balance sheet shows that the company's overall value has increased. The key increase here is an investment in new equipment. The value of factory equipment has increased by $42,800, and the liabilities increased in the form of a bank note of $45,000.

The purchase of assets was the major use of cash, in particular factory equipment, and the issuance of the debt was the major financing activity. All told, there are no major issues with these financial statements. The company has grown over the past year. This growth in revenues was met with an increase in investment in the company. The timing of that investment is not noted, but it appears that the company has not build in the increase in factory equipment into production or sales levels.

If the investment came late in the year, this would make sense. There are no concerns with either the liquidity or solvency of the company, in particular given the upward trajectory of its revenues and net income at this point in time. Continued Viability ABC is viable at present. The investments that the company has made in growth have been incremental. New factory equipment is allowing the company to meet the sales growth trend. Remember that 2008-2009 was a period of recession where many businesses saw declines in performance.

That ABC was growing during this period is cause to be optimistic. The company's investment is not too large to be of concern -- it appears to be in line with the growth trend. Moreover, the company took out $45,000 in debt to finance its growth. That means that only around half of the new investment in factory equipment came from debt, the other half from equity. The net effect was to increase the debt ratio from 27.2% to 31.8%.

Not only is this an acceptable capital structure for a small but growing company, but the increase in debt is not unreasonable, nor is it unexpected given the ongoing need to finance future growth. The company has at this point chosen a path that should continue to be viable. There are no issues with liquidity nor are there any issues with solvency. ABC is experiencing measured growth, and has adopted a strategy that allows for continued growth going forward.

There are opportunities to build on this growth in the future, either by adding distribution or by adding to the product line. But for the time being, the past year has to be considered a success, and the company has invested back both in its shareholders with an increased dividend but also back into its future growth. It is recommended that ABC continues along its current course. Continual Improvement There is evidence of continual improvement at ABC.

First, there is the fact that the company grew its revenues without a corresponding growth in the expenses. This occurred on multiple fronts. ABC increased its gross margin, which seems to indicate improved manufacturing efficiency. The fact that the company was able to increase its sales, lower its COGS, and only experience a modest increase in its work-in-progress inventories indicates that it has become a more efficient manufacturer.

It is difficult to extrapolate continual improvement from a one-year time sample, but the evidence shows that the company was more efficient in 2009, and that is cause for optimism that it will continue to improve going forward, especially given new investments. The new investments in manufacturing equipment is another good sign. The company can point to this investment in new automated manufacturing equipment as an astute investment with a small amount.