Financial health of the company
Analyzing the financial health of a company is quite comprehensive and involving because it involves a lot of comparisons of a number of financial information. The reported financial statements of the company do not give an in depth analysis of the strengths and weaknesses of the company. Therefore, it is necessary to carry out an in depth analysis of the financial analysis of the financial statements so as to have a better view of the company. Further, analysis of the company helps in making informed decision. A tool that is commonly used to analyze the financial health of a company is ratio analysis. Ratio analysis breaks down the financial data into various components for better understanding of the financial strengths and weaknesses of the company. Some of the ratios that will be used to analyze the financial position of the company are profitability ratios, liquidity, activity, and leverage ratios (Eugene, & Michael, 2009).
Profitability
Profitability ratios give an indication of the earning capacity of an entity. The ratios measure the effectiveness of a company in meeting the profit objectives both in the long run and short run. The ratios show how well a company employs its resources to generate returns. The gross profit margin of the company is 56.88%. The ratio is quite low considering that operating cost has not been deducted. However, the gross profit margin of the company is higher than the industry average which is 38%. The return on investment of the company was 29.98%. This was similarly higher than the industry average which is 7%.
Liquidity
Liquidity ratios show the ability of an organization to maintain positive cash flow while satisfying immediate obligations, that is, the availability of cash to pay current debt. The common ratios used to analyze liquidity are current and quick ratio. It is necessary to maintain optimal liquidity ratios since either low or very high ratios are not favorable. The working capital ratio for the company was 5.10:1. This implies that the current assets of the company can cover the current liabilities five times. It is a good indication. However, it also shows that the company holds quite a large amount of assets in unproductive current assets. The company needs to convert some of the current assets to long term assets that can be used to generate sales. Similarly, the quick ratio was also high at 4.039 (Holmes & Sugden, 2008).
Activity
Efficiency ratios focus on the internal operations of the company. These ratios show the level of activity in a company, that is, how well a company manages resources to generate sales. Commonly used turnover ratios are fixed asset turnover ratios, asset turnover ratios, stock turnover ratios, debtor collection period, and creditor payment period. Asset turnover ratio was computed to evaluate the level of activity of the company. The ratio was 1.622. This implies that a unit of average assets yields $1.622 worth of sales.
Leverage
A company’s leverage is explained by the amount of debt financing it holds. The ratios are vital since they show the investor the extent of exposure of equity financing. A commonly used ratio is the debt to equity ratio. A high leverage ratio is not favorable since it scares away capital providers. It is because high ratios imply an increase in interest expense. This reduces the income attributable to shareholders. On the other hand, very low ratios are not favorable since it shows that the management of the company are not willing to exploit the potentials of the company. Two ratios are used to assess leverage of the company these are debt ratio and debt to equity ratio. The debt ratio was 0.1748 while debt to equity ratio was 0.04159. The leverage ratios for the company are quite low. The ratios are favorable (McLaney & Atrill, 2008).
How capital market responds to the company
Analysis of capital structure shows that the company has low amount of debt in the capital structure. This has attracted a significant amount of shareholders. Besides, the shares of the company are trading at a value higher than the intrinsic value. The current share price is $68.48. This implies that the capital market responds positively to the company.
Quality of earnings
From the financial statements of the company summarized in the appendices, it is evident that the sales, net income, and total assets of the company grew over the years. For instance, the net income increased by 51.06% from 2011 to 2012. This could be an indication that the products of the company are competitive and are gaining more market share. Thus, we can conclude that the company is in a sound financial position.
How earnings compare with the rest of the industry
The key competitors of the company are Adidas AG, Nike Inc., and Under Armour, Inc. The performance of the company comes third after Nike Inc. and Adidas AG based on the amount of sales. It is also evident that the financial health of the company is better than those of the competitors. For instance, the gross profit margin and operating profit margin of the company are greater than those of the competitors. The table below summarizes a comparison of the profitability ratios of the companies.
Allocation of audit according to geographical regions
The company operates in a number of regions. These regions are Canada, United States, Australia, and New Zealand. The table below summarizes the total number of stores in the regions.
Based on the geographical regions, US has the highest number of stores that is, 108 stores. It is followed by Canada which had 47 stores, Australia which had 18 stores and New Zealand has one store. Besides, the highest amount of sales was generated from the US region followed by Canada. When preparing the audit plan, effort should be apportioned based on the number of stores. Regions with a large number of stores should be allocated more audit effort. Thus, the US region should be allocated more audit effort while New Zealand should be allocated the least. The audit effort should be allocated based on the percentage of the number of regions.
The company should also apportion audit effort based on the amount of sale generated. These are “consumer segment, franchise sales, wholesale accounts, sales from company – operated showrooms, and warehouse sales & outlet” (Lululemon Athletica Inc., 2013). The consumer segment generated the highest amount of sales. Therefore, more audit effort should be allocated to the consumer segment. Based on this criterion, audit efforts should be allocated to segments that generate a high amount of sales while less audit effort should be allocated to segment that generated the least amount of sales. Further, allocation of audit should not only be based on the size of the regions but also on the risk. Regions that pose a high risk to the financial of the organization should be allocated more time (Lululemon Athletica Inc., 2013).
References
ABC New Network. (2013). Lululemon Athletica Inc. Web.
Eugene, B., & Michael, J. (2009). Financial Management Theory and Practice. USA: South-Western Cengage Learning.
Holmes, G., & Sugden, A. (2008). Interpreting Company Reports. New York: Harlow.
Lululemon Athletica Inc. (2013). Annual Report . Web.
McLaney, E., & Atrill. P. (2008). Financial Accounting for Decision Makers. London: Harlow.
Appendices
Profitability ratios
Gross profit margin = gross profit / Net sales
= 569,270 / 1,000,839
= 56.88%
Return on investments = Net income / average total assets
= 184,063 / (734,634 + 499,302)/2
= 184,063 / 616,968
= 29.98%
Liquidity ratios
Current ratio (working capital ratio) = current assets / current liabilities
= 527,093 / 103,439
= 5.10:1
Quick ratio = (current assets – inventory – accounts receivable) / current liabilities
= (527,093 – 5,202 – 104,097) / 103,439
= 417,794/103,439
=4.039:1
Activity
Asset turnover = Net sales / average total assets
= 1,000,839 / (734,634 + 499,302)/2
= 1,000,839 / 616,968
= 1.622
Leverage ratios
Debt ratio = total liabilities / total assets
= 128,453 / 734,634
= 0.1748
Debt to equity ratio = debt / equity
= 25,014 / 601,376
= 0.04159