Bella Company Market Performance - Report Example

PART A Ratio analysis Profitability – the company’s profitability improved in 2010 when it achieved a gross margin of 28.35% and a net margin of 3.97% compared to 2009 when it had a gross margin of 27.7% and a net margin of 3.55%. Financial efficiency- the company’s financial efficiency improved from an inventory turnover of 3.0 in 2009 to 3.4 in 2010 implying improvement in its selling efforts. Liquidity – the company’s liquidity declined from a current ratio of 4.0 in 2009 to that of 3.86 in 2010. Gearing- though the company is generally poorly geared as it is heavily financed through debt, this improved slightly in 2010 when it attained a debt/equity ratio of 1.73 compared to 1.98 in 2009. Competitor Analysis Profitability –though there has been improvement in the company’s profitability during the two years as depicted by a rise of net profit margin from 3.55% in 2009 to 3.97% in 2010, and a gross margin of 27.7% in 2009 to 28.35% in 2010, the company seems to be performing poorly when compared to its competitor which had a net profit margin of21.56% in 2009 and 13.74% in 2010 and respective gross margins of 45.50% and 46.99%. This calls for the company to look for ways of minimizing both the costs of its inputs and operations. Financial efficiency – the company is less financially efficient when compared to its competitor since it had turned over its inventory 3.0 and 3.4 times in 2009 and 2010 respectively compared with its competitor which had turned over its inventory 4.1 times on average during the two years. This call for the company to intensify its marketing efforts and look at other factors it can alter in order to improve its efficiency. Liquidity – the company seems to be more liquid than its competitor when current ratios are compared. This is because it had a current ratio of 4.0 and 3.86 in 2009 and 2010 respectively as compared to its competitor which had a current ratio of 1.9 and 2.1 in 2009 and 2010 respectively. Gearing ratio – the company is very poorly geared when compared with its competitor. It is substantially financed using debt since it had a debt to equity ratio of 2 and 1.7 in 2009 and 2010 respectively as compared to its competitor which had a gearing ratio of 0.58 and 0.56 in 2009 and 2010 respectively. This calls for the company to consider increasing its equity in order to avert the risk of liquidation or take over. The likelihood of failure of Bella Confectionery Bella Company seems to have improved in 2010 in all the areas of consideration from its performance in 2009. The company recorded improvement in profitability, financial efficiency and liquidity and gearing. A look at the financial reports also reveals an improvement in financial returns. This is a good sign as far as its future survival is concerned but only if the trend is to be continued. Despite this improvement, Bella confectionary’s likelihood of failure is still high and something needs to be done to continue the improvement trend and hence reduce the company’s chances of failure. The company’s likelihood of failure is depicted in the following areas; i) Despite the company’s improved performance in 2010, the company’s performance is still very low when compared to similar companies/ competitors as established in the ratio analysis above. ii) Most of the company’s current assets are either receivable or inventory leaving very little cash to cater for day today operations. This implies that should there be emergency requiring cash; the company’s operations might be hampered as all the cash available is directed to the emergency hence increasing the company’s likelihood of failure. iii) The company has a very high debt to equity ratio. The company is to a large extent financed through debt. This implies that should the lenders opt to withdraw their funds; the company will not even be able to pay all of them. This exposes the company to the risk of liquidation incase its unable to generate enough money to pay the principal and interest. The threat of takeover and liquidation would interfere with its operations and hence increases its chances of failure. iv) The company is not generating enough profit margins implying it may be unable to meet their financial obligation in future which is a threat to its continued existence. PART A CONTINUED BELLA CONFECTIONERY Fresh Food Industries (FFI Holdings limited) 20X0 20X9 2010 2009 Ratios Current Ratio Current assets 51,026 49,895 9,453,036 7,571,986 Current Liabilities 13,216 12,350 4,502,836 3,919,400 3.861 4.040 2.099 1.932 Debt to equity Debt 38,904 40,362 13,033,418 12,191,292 Equity 22,463 20,429 23,221,338 20,850,095 1.732 1.976 0.561 0.585 Profit before tax/sales Profit before tax 5,681 4,659 4,473, 530 5,871,737 Sales 143,086 131,226 32,562,219 27,231,115 3.97% 3.55% 13.74% 21.56% Gross margin Gross profit 40,565 36,350 15,301,745 12,391,324 Sales 143,086 131,226 32,562,219 27,231,115 28.35% 27.70% 46.99% 45.50% Inventory turnover Cost of goods sold 103,241 94,876 17,260, 474 14,839,791 Average inventory 29,865 31,600 4,222,865 3,578,671 3.457 3.002 4.087 4.147 PART B 1. The potential Audit and Engagement Risk involved for the auditor of Bella Confectionery Engagement risk is the overall risk that the auditor will be exposed to by agreeing to audit Bella Confectionary. This includes Bella’s business risk, the auditor’s business risk and the audit risk. There seems to be a very high entity business risk involved in auditing Bella Company. The company may get into financial problems any time in future and hence be unable to realise its profit targets. This is because the company is highly indebted with a debt equity ratio of 1.732 in 2010 and close to 2 in 2009. As such, there is a high risk of takeover in case the company’s operations and profitability are affected and hence the company is unable to pay the debt owed from the little equity available. This is worsened by the fact that most of the company’s current assets are either receivable or inventories. Should there be an emergency, the company will have no cash to attend to the emergency and hence will be forced to either stop operations or borrow more hence heightening the threat of take over. This is a big threat to the company’s operations and hence profitability. This is an engagement risk that the auditor would have to contend with before accepting the offer since the company’s ability to pay the audit fees would also be at stake as well as the firm’s reputation in case of a takeover or stopping of operations. The company’s future would also be affected by the law suit in case the results are adverse although the management believes otherwise. The auditing firm would also have to contend with a substantial audit risk by accepting the offer to audit Bella confectionary. Audit risk a) Detection risk This is the risk that the audit firm will unknowingly fail to discover errors in the financial statements and hence fail to modify the opinion expressed in the financial statement as being materially misstated. In this case, the audit firm faces three kinds of audit risk; Overstatements in the financial statements There is always a considerable risk that there could be general overstatements in the company’s financial statements intentionally in order to paint a better picture for the company than it is actually. However, the auditor could avoid this by carefully examination of sample account balances. In addition, the auditor should ensure that all necessary disclosures have been made and are adequate and informative hence providing sufficient information for the users. Inventory Bella Company being a food processing company, there is potential for misstating inventories. Given that the amount of inventories is relatively high in both years, there is need for the auditor to survey physical stock take in a bid to verify its existence in addition to determining the appropriateness of the inventory valuation used. The auditor should also ensure that any receipt of goods during the period of engagement is carefully monitored including subsequent adjustment of data in the system in a bid to establish whether receipts are usually recorded in a proper manner. Compliance with legal requirements Bella confectionary being a company dealing with food and perishable goods, the auditor should examine its compliance with regulations set forth by the government on food. There is a risk for non compliance which could subject the company to lawsuit from consumer rights bodies. This could affect its operations as well as the auditor’s reputation. b) Detection risk There is the risk that despite the fact that Bella has put in place internal control measures, the measures may fail to prevent material misstatement from occurring in the statements. It is also the risk that the internal controls will not prevent material error or fraud from occurring. As such, the auditor should adequately convince himself that internal controls have been put in place to prevent such misstatements or errors. He should also assure himself that the internal control measures are effective. Even that being the case, he should still test some samples before making his conclusions so that he can minimise control risk. Owing to the above risks, the auditor is exposed to ‘his’ business risk. Failure to discover material misstatements in the financial statements and hence failing to qualify them would lead to the wrong decisions being made by those who rely on his opinion. As such, the auditor will be exposed to the risk of injury to his practice through adverse publicity or litigation and similar events that would arise from his opinion on the statements. There auditor could also incur costs in case of audit failure and related costs due to loss of clients following bad publicity. In addition, the auditor may not be able to realise his audit fee in case Bella Confectionary is unable to pay due to its many financial obligations. 2. Discuss the Inherent Risk associated with Bella Confectionery Company Every accounting system including that of Bella confectionary no matter how fool proof it is has chances in the absent of related controls of inherent risks creeping into financial information . Bella’s management may make materially wrong assertions in the company’s financial statements due to misstatements arising from absence of internal controls to guard against misstatements. Bella Confectionary’s failure to have checks for ensuring accuracy of its financial information can make financial statements and assertions thereof wrong. Bella Confectionary’s inherent risk can result from; a) Environment and external factors- these includes; -Rapid Change - Bella Confectionary being a company dealing with perishable goods or goods that rapidly become obsolete could have high levels of inherent risk. - General economic status- the general economic status is an external factor that affects all businesses including Bella confectionary. -Financing availability – from the financial statements provided by Bella Confectionary, cash makes a very small portion of its current assets hence affecting its liquidity. It is also highly indebted hence affecting its ability to stay in business in future. This increases the inherent risk. b) Misstatements In case Bella had made insignificant misstatements in prior periods, the errors are still present in the financial statements and hence there is need for aggregating prior period misstatements with current misstatements to establish the need for requesting the management to adjust the specific account for the total misstatement. Further misstatements may occur from the nature of Bella confectionary’s business. For instance, since the confectionaries are edible, some staff may have stolen and sold some of them. Secondly, the raw materials as well as finished goods are all perishable. This means that they could go bad any time hence significantly altering the inventories figure. As such, this is a risk of misstatement inherent in the nature of Bella Confectionary’s business. c) Susceptibility to theft and fraud The kinds of items dealt with by the company are highly susceptible to theft. Cash which is a common form of payment in this industry is also highly susceptible to fraud and theft. Cash accounts of the company are therefore susceptible to theft or fraud due to its nature. Inventory in the industry is also highly susceptible to theft and hence the inventory account is inherently risky and hence the auditor needs to be very careful when auditing them. References: Johnson, M2011, Basic auditing principles, London, Rutledge. Mornoey, R, Campbell, F & Hamilton J 2011, Auditing a practical approach, 1st edn, John Wiley & Sons Australia, Milton. Read More