Question

Red Flag #3

In your examination of the financial statements, you see that there is a bank loan on the books. The average balance of the loan is $10,000 at the beginning of the prior year, and $6,000 at the end of the prior year. The interest expense on the income statement for the year is $1,740.

• Calculate each red flag’s impact on either revenues or expenses
• Calculate each red flag’s impact on profitability
• Show a potential remedy or solution to address each red flag

Answer 1

Sl. No. Red Flags Red Flag 1 The revenue on snack food decreases every year while the cost of goods sold increases every year. Problem and how lose of money Problem - Insufficient revenue and bottom line might lead to closure of business Recommendation Evaluate the breakdown of cost of goods sold to determine what is attributing to increase. For example, is delivery cost of bringing snack foods from vendors has increased or price of products has increased? If delivery cost is increased then reduce the number of orders count and try to place bulk orders at one go. Lose of Money - decline in revenue and increasing cost might lead to increase in inventory balances and issues associated with it such as expiry of products, space shortage,etc If product prices have increased, check whether the procurements are happening from 1 vendor or multiple vendors. If 1 vendor, whether prices has increased significantly in comparison to previous years and does not seem reasonable. Possibility of kick back by the procurement manager. If multiple vendors, check if consolidating the supply from 2-3 vendors will provide economy of order quantity. Also, evaluate why revenue is decreasing - by doing analysis of volume, price of snack food, understanding whether snack food is cannibalised by introduction of other product in similar price range,etc Red Flag 2 Some of the items in the shop appear Problem - Bad image of the shop Ensure timely cleaning and dusting in the shop and ensure that slow moving items are kept in covered places. dusty and "shopworn." Lose of Money - customer will think that snack food and Display items should be rotated in a timely manner to avoid expiry and also from being dusty and shopworn. other items are being stored for long time and on verge of expiry. They will prefer to purchase from other shops near by. Red Flag 3 In your examination of the financial Problem - Fixed outflow of interest even if no significant Evaluate if company has excess fund then repay the loan and reduce the interest expenses. This will directly statements, you see that there is a bank business growth. impact the bottomline. loan on the books. The average balance of the loan is $10,000 at the beginning of the Lose of Money - Less revenue but fixed interest payment prior year, and $6,000 at the end of the and directly impacting the bottom line prior year. The interest expense on the income statement for the year is $1,740.