Financial Statement

Analysis and Controls

Prepared for Competitive Bikes, Inc.
Horizontal Analysis
Using a horizontal analysis of the income statement for Competitive Bikes, several things
stand out.
Years 6 and 7
Comparing Years 6 and 7, the company did very well. hey saw a !!" increase in net
sales during Year 7, which gave them a !#.$" increase in cost of goods sold. %u&tracting
the dollar amounts of cost of goods sold from net sales yields an increase of !7.'" in
gross profit for Year 7. (ncreasing profit is, of course, the main goal of a company, which
made Competitive Bikes )uite successful in Year 7.
*erhaps part of the reason for the increase in profits was that Competitive Bikes increased
the amount spent on advertising &y !7.'", and had an increase in research and
development of !7.'". +s learned in the %upply Chain ,anagement class given &y
-estern .overnor/s University, &oth an increase in advertising and in research and
development will lead to an increase in profits.
-ith e0tra sales come e0tra e0penses. otal selling e0penses increased &y !!" and
general and admin e0penses increased &y !#.#". his is not a pro&lem, &ecause the
company was still )uite profita&le. hese num&ers would only &e a concern if the
company had not had such an impressive increase in net sales.
(n Year 7, Competitive Bikes saw their net earnings 1ump from 237,374 to 2#46,543,
which figures out to a !#!.3" increase. his means that Competitive Bikes more than
tripled their net earnings in Year 7. his was a very good year for the company.
he horizontal analysis of the &alance sheet for Years 6 and 7 shows that the total assets
for the company increased &y 5.4" in Year 7. -hile this is not a large num&er, it is &etter
than a negative num&er and is not indicative of a pro&lem.
+t first, it can appear concerning that in Year 7, +ccounts and 6otes *aya&le increased &y
#45", or 2#5$,$57. his is a pretty steep lia&ility, and one that is not favora&le for the
company. +ccrued salaries decreased &y 57", &ut it still left the company with a #55.3"
increase in total current lia&ilities. 8owever, lia&ilities are often turned into assets, and it
can &e surmised &y looking at the &alance sheet that this is what has happened here. (n
dollar amounts, the total assets increased &y 2##4,4#3 and the total current lia&ilities
increased &y 2#5$,657.
otal long term lia&ilities decreased &y '.6", which is a good thing. his means that the
company/s mortgage and other long term payments were made. his is possi&le &ecause
the company made enough gross profit to cover these payments.
9etained earnings increased 57" in Year 7. his is good for the company, &ecause it is
investing that money in itself to increase its worth. he total stockholder/s e)uity is
246,543, or an increase of 3.3". +n increase in stockholders e)uity is also a good thing
&ecause it means that the net worth of the company has increased.
:verall, Competitive Bikes was a very successful company in Year 7, &ased on the
horizontal analysis of Years 6 and 7.
Year 7 and $
Year $ was rougher on the company, as the horizontal analysis &etween Years 7 and $
shows.
(n Year $, net sales and cost of goods sold &oth decreased, which resulted in a #6.!"
decrease of gross profits. his in turn leads to a decrease in operating e0penses.
+ccording to the Competition Bikes %toryline, this decrease in sales is due to the poor
economy. 9egardless of reason, a loss of profits is not a desira&le situation for the
company.
+dvertising costs decreased &y #6.!" and research and development decreased &y
#6.!". (t is unknown if these costs decreased simply &ecause money saving measures
were found, or if it was &ecause the company decided to cut money from these programs.
(f the company did decide to cut money from these areas, this might account for some of
the loss in sales.
-hile total operating e0penses declined, .eneral and +dmin e0penses increased &y
#.5". his is somewhat concerning, &ecause the ma1ority of the increase came from
Utilities. his could &e e0plained &y a couple of situations; <ither the utility companies
charged more for the same amount of utilities, or the company mismanaged their utilities
and used too much. <ither way, it is not desira&le to have an increase in costs when there
is a decrease in profits.
+s e0pected &y the loss of gross profits, Year $ saw an $#.6" decrease in net earnings.
:nce again, an ideal situation would &e for the company to increase their net earnings,
not to decrease them. -hen looking at the horizontal analysis as a whole, Years 6=$, the
company has fewer net earnings in Year $ than they did in Year 6. *erforming worse than
they did two years ago is not going to kill the company, &ut it is o&viously not desira&le.
>ooking at the &alance sheet, the horizontal analysis does show some good news for
Competitive Bikes in Year $. otal Current +ssets increased &y #6.'". -ithin this
category, cash and cash e)uivalents increased &y an impressive 57'.3". +ccounts
9eceiva&le did decrease &y #'", likely due to less sales &eing made. -hen factoring in
depreciation and a loss in 6et *roperty and <)uipment, total assets only decreased &y
7.#". his is a pretty insignificant change.
otal current lia&ilities increased &y 5$.'". his is not as &ig of an increase as the
previous year. Considering the loss of sales, this is a good thing. otal long term
lia&ilities decreased &y '.4", which is also good news for the company. hey were once
again a&le to pay their mortgage and other long=term &ills. 6ot &eing a&le to pay these
would spell &ad news for a company. +ll together, total lia&ilities decreased &y #.4",
which makes that part of Year $ successful.
Year $ only saw 2!6,#77, or a !.#" increase, put into retained earnings. his is
significantly less than the previous year, &ut still not &ad. his added a #.6" increase to
stockholder/s e)uity. he stockholders were likely not over=the=moon e0cited a&out this,
&ut at least it wasn/t a loss? :verall, the total >ia&ilities plus <)uity only decreased &y
7.#". his is indicative of a company who simply had a &ad year and will &e &ack on
track shortly.
:verall :&servations
>ooking at the horizontal analysis overall, a few points come up.
Year 7 was an outstanding year, and perhaps not indicative of a normal sales year.
-hile Year $ looks &ad in comparison to Year 7, it looks fairly decent compared
to Year 6.
(t can &e concluded that Competitive Bikes is not in any financial trou&le. hey
did not have to li)uidate assets to pay off lia&ilities and they still made a profit.
Vertical Analysis
(ncome %tatement
(t can &e seen on the vertical analysis sheet that the percentages for cost of goods sold
remains fairly constant during Years 6, 7, and $, at 7!.3", 75.6", and 7!" respectively.
his simply means that for every dollar earned, it costs the company almost @ of that
dollar each year to sell their products. his does not leave a wide profit margin. he
gross profit percentages are 56.6" AYear 6B, 57.3" AYear 7B, and 57" AYear $B.
Cor each year, the total selling e0penses remained steady at 6.7" of net sales. hese
num&ers are perfectly accepta&le. 8owever, .eneral and +dmin costs seem too high, at
#7.#" AYear 6B, #'.'" AYear 7B, and #$.3" AYear $B. :verall, total operating e0penses
are far too high, with each year at appro0imately a )uarter of net sales.
he operating incomes and earnings &efore income ta0es each year are really low, which
leads to the net earnings for the company. Year 6 has a percentage of #.#", Year 7 is
!.!", and Year $ is 7.7". hese num&ers are really low. +ccording to 8orngren,
8arrison, D :liver A5774B, these low num&ers are likely to deter investors from investing
in the company.
Balance %heet
+ vertical analysis of the &alance sheet can tell many things a&out a company. Cor
starters, Competitive Bikes total current assets are 53.'" AYear 6B, !#.4" AYear 7B, and
!7.5" AYear $B. + typical company has current assets of appro0imately !7" A8orngren
et al., 5774B, so Competitive Bikes is in a good position. 6et *roperty and <)uipment
have the highest percentage in the assets category, &ecause Competitive Bikes
manufactures &ikes.
otal lia&ilities are high, with each year coming in at almost half of the assets.
%tockholders e)uity comes in each year at a little over half of the assets. he company
would &e a lot stronger if they were to lower their lia&ilities and increase the
stockholder/s e)uity A8orngren et al., 5774B.
Trend Analysis
he historical trend analysis for Competitive Bikes looks strong. Using Year 6 as the
&ase year, Year 7 saw a #!!.!" increase in net sales. Year $ saw a ##!.!" increase in
sales over Year 6. his means that the company had a sharp increase in sales in Year 7,
and a smaller increase over the &ase year in Year $.
By studying these trends, the company has developed a forecasted trend analysis using
Year $ as the &ase year. he company is e0pecting their trend percentages to &e #7!.5"
for Year 4, #77.6" for Year #7, and ###.$" for Year ##. his shows that the company is
e0pecting their sales to steadily grow each year. (t also confirms the idea formulated
during the horizontal analysis; that Year 7 saw an unusual increase in sales. his idea is
confirmed &ecause even the company itself does not e0pect to reach the num&er of sales
that they had in Year 7.
Based on this trend analysis, the company will improve. %ales from Year 7 are not
e0pected to &e reached &efore Year #5, &ut the company does plan on steadily increasing
their net sales each year. %ome pro&lems with this growth may occur if the company
does not ade)uately plan for it.
he company states that they current have the capacity to handle a short=term increase in
production. -ith the pro1ected steady increase in sales, the company is not going to have
the resources to meet the demand unless they open another facility.
+dditionally, the company currently does not have the advertising power to increase sales
in the manner they are pro1ecting. >ack of advertising is a weakness, and the company
should put more money and resources towards advertising their product in order to meet
the pro1ected sales.
:ne concern a&out the trend forecast is that the company is only using the trends from
three years to determine four years of pro1ected sales. :ne of those years, Year 7, had an
a&normally large amount of sales, making it a&normal. (t would &e ideal for the company
to forecast sales &ased on many years worth of history. +dditionally, the company has no
guarantee that the economy will improve, which could skew their forecast.
Eespite that, it is still possi&le for the company to achieve the forecasted sales. he
company has some strengths that will allow for these sales to happen, so long as the
weaknesses are taken care of.
he ma1or strength of the trend forecast is that the pro1ections are not so large that they
are unattaina&le. he num&ers are realistic and not inflated.
+lso in the strength category is that the company has a good )uality product that is
individually customized for the customer. heir product is dura&le and relia&le, and their
research and development team has made some vast improvements on the product. hese
are all strengths for the company, and will allow for the pro1ected sales to &e attained.
atio Analysis
Current 9atio
he current ratio tells if a company is a&le to pay off its lia&ilities. he higher the ratio,
the &etter a&le a company is to pay off the lia&ilities with assets A8orngren et al., 5774B.
Competitive Bikes had a current ratio of '.47 for Year 7 and '.!' for Year $. +lthough
this num&er did decrease in Year $, it is still a very strong num&er. (f the current ratio is
too low, then Competitive Bikes would not &e a&le to pay off their lia&ilities with assets,
and if it were too high, it would &e indicative of assets that were too li)uid A8orngren et
al., 5774B. Competitive Bikes has enough assets to pay off lia&ilities.
Competitive Bikes competitor, wo -heel 9acing, has a current ratio of 3.5 for Year $.
-hile this is also a strong num&er, it is not as strong as that of Competitive Bikes.
+cid=est 9atio
he acid=test ratio is a way to determine if a company could pay off all its current
lia&ilities if they &ecame due immediately. Cor this ratio, a company should strive to
have as high of a num&er as possi&le. + #.7 is considered a FsafeG num&er A8orngren et
al., 5774B.
Competitive Bikes scored a 3.'5 in Year 7 and a 3.5' in Year $. +lthough they had a
slight decrease on the acid=test ratio in Year $, &oth years are still very strong. his
means that the company could pay off all its current lia&ilities if they needed to.
wo -heel 9acing shows an acid=test ratio of !.3 for Year $. his places them
significantly &elow Competitive Bikes, although they are still in a good position.
(nventory urnover
he inventory turnover ratio is a measure of how many times a company sells its average
inventory per year. + higher num&er is &etter for a company, &ecause it means that they
can easily sell their inventory A8orngren et al., 5774B.
Competitive Bikes did not have an inventory turnover ratio, &ecause they sell their items
as soon as they are made. his means that the company keeps no inventory. he
competitor, wo -heel 9acing, has an inventory ratio of !.3 in Year $, which means that
they sell their average amount of inventory a little over three times a year. his is a pretty
good num&er, &ut Competitive Bikes has the advantage, &ecause they have no inventory,
thus reducing inventory costs.
+verage Collection *eriod
he average collection period ratio tells how many days it takes the company to collect
on receiva&les. he smaller the num&er is, the fewer days it takes for the company to get
their cash A8orngren et al., 5774B.
Cor &oth Years 7 and $, Competitive Bikes had an average collection period of 3!.$. wo
-heel 9acing had a num&er of !5.' in Year $. his means that wo -heel 9acing has a
stronger average collection period and gets access to their cash soon than Competitive
Bikes does.
Ee&t 9atio
he de&t ratio is a measure of a company/s a&ility to pay off its de&ts. Cor this ratio, the
lower the num&er is, the &etter of a position the company is in A8orngren et al., 5774B. (n
Year 7, Competitive Bikes had a de&t ratio of 36.7". Year $ saw a de&t ratio of 3'.4".
Competitive Bikes has a very good de&t ratio, as anything under 67" is considered good
A8orngren et al., 5774B. +dditionally, they managed to lower their de&t ratio for Year $,
which means they have improved.
wo -heel 9acing has a de&t ratio of !$" in Year $. his num&er is considera&ly &etter
than Competitive Bike/s ratio, and put the competitor at the advantage.
.ross *rofit ,argin
he gross profit margin is a very important num&er for a company to keep an eye on. +n
increase in this num&er means that the company has had an increase in profits, while a
decrease could signal pro&lems within the company A8orngren et al., 5774B.
Cor Year 7, Competitive Bikes had a gross profit percentage of 57.3". (n Year $, they
saw a decrease to 57". he decrease in this num&er is &ecause Year 7 saw really high
sales and profits in the company, and Year $ didn/t fare as well.
he competitor, wo -heel 9acing, had a gross profit percentage of !5.#7" in Year $.
his num&er is higher than Competitive Bikes, which puts the competition in a &etter
position.
:perating *rofit ,argin
he operating profit margin shows how much a company earns in operating income per
2# of sales. + higher num&er means that the company is making more money per sale, so
a higher num&er is prefera&le A8orngren et al., 5774B.
Competitive Bikes had an operating profit margin of '.!" in Year 7 and #.4" in Year $.
his means that Year 7 saw operating income of 27.7'! per dollar in sales and Year $ saw
27.7#4 of operating income per dollar of sales. his is a significant drop in Year $, and
can &e e0plained &y the drop in sales for Year $.
wo -heels 9acing has a operating profit margin of '.57". Competitive Bikes came
nowhere near this num&er in Year $, which is a concern. Based on the trend analysis and
future forecasts, Year 7 had an a&normally large amount of sales. his num&er of large
sales lead to Competitive Bikes having an operating profit margin of '.!" for Year 7. (f
having an e0ceptional year is the only way they are going to meet the competition/s
operating profit margin, Competitive Bikes is going to remain &ehind wo -heel 9acing
in this area.
6et *rofit ,argin
he net profit margin tells how much of the revenues a company gets to keep after all
costs are taken out A8orngren et al., 5774B.
Cor Year 7, Competitive Bikes had a net profit margin of !.!" and of 7.7" in Year $.
6either of these num&ers are very high, &ut Year 7 is particularly low. he net profit
margin of 7.7" means that Competitive Bikes only kept 7.7" of their revenues after
ta0es. his is not a lot of money.
he competition, wo -heels 9acing, had a Year $ net profit margin of '.#3". his
means that wo -heels 9acing is keeping more of their revenues as profits. Competitive
Bikes should strive to increase their net profit margin in order to keep up with their
competition.
<arnings per %hare
<arning per share is a measurement of the amount of income earned for each share of a
company/s outstanding common stock. (deally, this num&er will increase each year
A8orngren et al., 5774B.
Cor Year 7, Competitive Bikes had an earning per share ratio of 7.57, and for Year $ it
was 7.73. his is the opposite of what a company wants to happen. 9ather than have this
num&er decrease, Competitive Bikes should aim to increase it each year. (ncreasing their
profit in Year 4 will help them achieve a higher earnings per share.
(n comparison to the competitor, Competitive Bikes fell &ehind in Year $. wo -heels
9acing has an earnings per share ratio of 7.7$. his means that the competitor was
earning more income for each share of outstanding common stock.
9eturn on otal +ssets
he return on total assets tells if a company is using their assets to earn a profit or not.
Cor this num&er, it is ideal to have a larger num&er than the industry average A8orngren et
al., 5774B.
Competitive Bikes had a return on total assets of 3.'" in Year 7 and 7.$" in Year $. his
is another significant decline for the company, once again a result of Year $ not
performing as well as Year 7.
wo -heels 9acing has a return on total assets of 3.$7" in Year $. his num&er tells
that Competitive Bikes has not met the return on total assets of their competitors in the
past year, and should work harder to use their assets to return a profit.
9eturn on Common <)uity
he return on common e)uity can tell a company has much income is earned for each
dollar that is invested in common e)uity A8orngren et al., 5774B.
he return on common e)uity for Competitive Bikes in Year 7 was $.'" and in Year $
was #.'". Cor &oth of these years, this num&er is higher than the num&er for the return
on total assets. his indicates that Competitive Bikes has &een trading on e)uity. his is
not a pro&lem for the company, since their de&t ratio is still in the Fsafe zoneG. 8owever,
trading on e)uity has a tendency to compound a company/s losses in &ad years A8orngren
et al., 5774B.
wo -heels 9acing is in the same position as Competitive Bikes. hey, too, are trading
on e)uity, as can &e seen &y comparing their Year $ return on common e)uity of $.#7"
with their de&t ratio. heir &enefit is that their de&t ratio is lower than that of
Competitive Bikes.
*riceH<arnings 9atio
he priceHearnings ratio shows the market price of a share of common stock to 2# of
earnings. his ratio is mainly used for factual information instead of for creating a plan
of action, as market prices of shares are not controlled &y the company A8orngren et al.,
5774B.
he priceHearnings ration for Competitive Bikes in Year 7 was 34.67, and was $!.7! in
Year $. his increase is good, &ecause it means in Year $, the company/s stock was
selling for $!.7! times the company earnings. his indicates that investors are willing to
pay so much &ecause they have high hopes for the company/s future.
he priceHearnings ratio of wo -heels 9acing in Year $ was 54. his num&er shows
that investors are more willing to spend more money on Competitive Bikes than they are
on wo -heels 9acing.
imes (nterest <arned
he times interest ratio is a measure of how many times a company/s interest e0pense can
&e paid with operating income. 8igher num&ers are prefera&le, &ecause it means that the
company can easily pay its interest e0penses A8orngren et al., 5774B.
Competitive Bikes had a times interest earned ratio of '.57 for Year 7 and #.77 for Year $.
he drop in Year $ is concerning &ecause it is such a large drop. 8owever, it still shows
that Competitive Bikes has enough operating income to pay their interest e0penses.
wo -heels 9acing has a times interest earned ratio of 3.53 in Year $. his num&er
shows that for Year $, wo -heels 9acing was at a considera&le advantage over
Competitive Bikes, &ecause they had more a&ility to pay off their interest e0penses.
!orkin" Capital
-orking capital, or the a&ility of a company to pay off its short=term o&ligations with
assets, is measured &y su&tracting current lia&ilities from current assets. Eata from the
working capital are used to calculate &oth the current ratio and the acid=test ratio
A8orngren et al., 5774B.
-orking capital is e)ual to current assets minus current lia&ilities. otal current assets
for Competitive Bikes in Year $ were valued at 2#,676,$#7. otal current lia&ilities for
the company in Year $ were 2!77,577. his gives Competitive Bikes a working capital
of 2#,!76,6#7 for that year.
his is a good working capital for Competitive Bikes. (f the company had a negative
amount for working capital, then they would &e under financial strain. (nstead they have
a positive num&er, which means that they have Fe0traG money.
(t is important that a company does not have money 1ust sitting around, not earning a
return. his is why Competitive Bikes should find a way to invest this money in their
company. his can &e done &y using the funds to provide employee training or to give
out employee &onuses. (t could &e used to &uy more e)uipment, land, or other items
needed for their company. (deally, since Competitive Bikes currently has limited
advertising, the e0cess working capital should &e put towards promoting and advertising
their &ikes. (nvesting the e0cess working capital &ack into the company will increase
profits in the long run.
(mproving working capital in future years will allow for Competitive Bikes to have more
money to grow their company. here are several ways to increase working capital. he
idea is to either increase assets, lower lia&ilities, or &oth. herefore, the following will
result in an increase in the working capital.
Increase #et Profits. ,ore net profits will increase assets A+nderson,
57#7B.
Increase Sales. ,ore sales lead to more profit, which is an asset
A+nderson, 57#7B.
ed$ce Costs. Costs are a lia&ility, so they should &e reduced as much as
possi&le Awithout comprising the )uality of the productB. his can &e
achieved &y getting rid of unnecessary e0penses or temporarily
suspending an e0pense A+nderson, 57#7B.
%liminate &ns$ccessf$l Prod$cts. (f a company has a product that is not
selling well, the company should eliminate that product in order to
relocate those resources to a successful product. his will ideally lead to
an increase in sales and profit A+nderson, 57#7B.
Increase Cas' Flo(. (ncreasing the cash flow will keep money coming
into the &usiness. he company should take steps to ensure that payments
are &eing made in a timely manner, &oth to and from the company
A+nderson, 57#7B.
Internal Controls
(nternal controls are the measures that are set into place in order to protect a company/s
assets, to encourage employees to follow the company policies, to encourage efficiency
in operations, and to ensure accurate accounting records. +ll pu&lic companies are
re)uired to have and to follow a set of internal controls A8orngren et al., 5774B
Corrective +ction
Competitive Bikes has some corrective action they need to take to improve their internal
controls in the purchasing system.
he pro&lem with the purchasing system is that the purchasing department has too much
power. he purchasing department is responsi&le for sending the purchase order to the
supplier, choosing the lowest &idder to &e the supplier, sending the purchase order, and
then sending the invoice to accounting. his places the purchasing department within
each step of the purchasing process. -hile this may seem like the logical thing to do, it
opens the company up for risk.
he whole purchasing process needs to &e redesigned to lower the risks to the company.
o &egin with, the monthly &udget pro1ections should not &e completed &y the purchasing
department. ,anagement, or a small &udgeting team, would &e &etter suited to this
responsi&ility.
+fter this step is completed, the purchasing department can retain the responsi&ility of
selecting the supplier. 8owever, they should have someone who oversees this selection.
he company should appoint a manager or other higher=level employee to ensure that the
correct supplier has &een chosen on the )ualifications that are specified. Cor Competitive
Bikes, those )ualifications are Flowest &idderG and Fsimilar )uality productsG &etween the
suppliers.
he supplies should not &e delivered to the purchasing department. 9ather, they should
&e sent to a receiving department for check=in and delivery to the production line. +t the
end of the month, when the e0tra supplies are sent to raw materials inventory, the
inventory management department should &e responsi&le.
>astly, the invoices should not &e sent to the purchasing department. hey should &e sent
straight to the accounting department, where they will get recorded. hey should also &e
sent to the finance department, who will make payment on the invoice.
9isks
he current pro&lems with internal controls within Competitive Bikes purchasing
procedures strongly increase the risk of theft, collusion, and unethical &ehavior.
he purchasing department should not &e in charge of the monthly pro1ected &udget.
his could allow for the purchasing department and the supplier to work together in a
way that would &enefit them &oth, instead of the company.
his is also why the purchasing department needs to have someone who oversees the
decision of what supplier to use. (f a supplier were a good friend of an employee, or even
offered that employee some kick&acks, the purchasing department could easily choose
that supplier over another, even if they do not meet the company/s criteria.
%upplies should not &e sent to the purchasing department, &ecause it gives employees the
opportunity to steal supplies, especially if they have access to an invoice and can change
the num&ers. %ending the supplies to the receiving department will lessen the chances for
theft to go unnoticed. +t the end of the month, having an inventory management
department handle the goods &eing transported to raw materials inventory will also help
lessen the possi&ility of unnoticed theft.
Currently, the purchasing department is not only placing the order, they are receiving the
invoice. (f an employee from the purchasing department felt so inclined, it would &e a
simple matter for them to steal a product and then alter the invoice. (t would also allow
for purchasing employees to change the amount on an invoice to Fhelp outG a supplier
who might also &e a friend. his is why Competitive Bikes needs to have their supplier
invoices sent directly to the accounting and finance departments.
he finance department, who should also receive the invoice, will &e a&le to pay for the
supplies. his will prevent accounting from altering num&ers on the payout to &enefit
them or the supplier. +ccounting should record the amount of the invoice in their &ooks,
and if a pro&lem does occur, management will &e a&le to compare the records from
accounting and finance to see who was responsi&le for the transgression.
(mproving the internal controls within Competitive Bikes will lessen all the possi&le risks
to the company. (nternal control is a&out keeping responsi&ilities and departments
separate, to lessen the chance of the company e0periencing pro&lems. (f Competitive
Bikes implements the suggested actions, their company will &e much safer from theft,
collusion, and unethical &ehavior.
Sar)anes*+,ley
he %ar&anes=:0ley act was created in 5775 as a way to ensure that companies are
accurately reporting their finances. his act set out guidelines for internal and e0ternal
auditing of a company/s financial documents A8ilton, 57##B.
Compliance
+ material weakness is what happens when a company/s internal controls fail, making it
possi&le for that company/s financial reports to &e inaccurate AI,aterial weakness,I
57##B. he letter from Competitive Bikes that will accompany the financial statements is
an inaccurate letter, &ecause a material weakness is present within the company. he
material weakness present, discussed a&ove in the F(nternal Controls; Corrective +ctionG
section, is that of the purchasing department having the a&ility to alter invoices from
suppliers. (f these invoices were to &e altered, it would make for flawed financial
reporting. (n order to &e in compliance with the %ar&anes=:0ley +ct, Competitive Bikes
needs to develop a &etter system of internal controls, &ecause the one they have now
presents unreasona&le risks for the company.
Corrective +ctions
Competitive Bikes is currently non=compliant with the %ar&anes=:0ley +ct. here are a
couple of things that need to &e done in order to comply.
Cirst, the company must develop a &etter set of internal controls for their purchasing
department. his needs to &e done in order to prevent theft of products, fraud, or even
cover=ups of mistakes.
%econdly, Competitive Bikes needs to &ring in an e0ternal auditor to evaluate the
company/s internal controls. his will ensure that the company is in compliance with that
portion of the %ar&anes=:0ley +ct &y having a non=partial entity review the internal
controls.
(t is not &elieved that Competitive Bikes was intentionally incorrect with their statement.
9ather, the company did not realize that the internal controls it has in place are
ineffective. Changing the internal controls and having someone from the outside access
them will provide the company with a strong set of internal controls that will &oth protect
the company and &ring it into compliance with the %ar&anes=:0ley +ct.
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