American Apparel Case Study

TASK
Question 1 (15 points)
Reviewing the available financial statements from 2007-present, as well as past articles, when did the company start declining? And where?
~150 words

1.      http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?lstStatement=CashFlow&symbol=US%3aAPP&stmtView=Ann

2.      http://articles.latimes.com/2011/apr/01/business/la-fi-american-apparel-20110401

3.      http://jezebel.com/#!5717112/a-financial-scandal-at-american-apparel

According to the financial statements that I analyzed, the company started declining in 2008.  According to the cash flow statement, the company suffered a net loss of $7,920.  From that year till 2010, according to the income statement, American Apparel has had terrible financial results as the company has resulted in net losses.  As you can see, that supply of cash in this company is the major issue right now.  Cash is an important asset to have in a business because it is used to pay off company debts and expenses.  The major source of incoming cash into business is revenue.  Between the years 2009 and 2010, according to the income statement, the company has suffered loss in sales.  In 2010, there were sales of $533 million and in 2009 there were sales of $559 million.  There was an overall decrease of $26 million in sales between 2009/2010.  With all that cash lost, the company has lacked liquidity assets and this will soon cause the company some difficulties of paying its debts.  Also prices of cotton prices (raw material expenses) are increasing as well which makes it more difficult for the company to pay for its expenses.  One factor that contributed to the decline in sales was the massive layoffs of employees.  An immigration inspection occurred in the manufacturing industry of American Apparel and many were not authorized to work in the United States.  This created massive layoffs of employees and as a result, production was cut back.  Another reason why the company is lacking cash right now is because in the past few years, Dov Charney, the CEO of American Apparel who is currently holding 53% of the shares of the company, has been charged with sexual harassment on 3 female employees.  It not only affected Charney personally but it also affected the financial statements and the reputation of the business.  The female employees sued Charney and the business in order to regain a huge sum of money from the company.  The company suffered massive losses in cash from these sexual assault cases and also Charney had ruined the reputation of its company.  The image of the brand has been damaged and as a result, consumers started turning away from American Apparels.  As a result, demand for American Apparel goods declined and its share prices decreased by 7%.  Also American Apparel is much known for displaying sex ads on the Internet in order to make its product stand out.  Unfortunately Doy Charney has taken a wrong step in publishing these kinds of ads.  Many people feel very disturbed by these ads.  Ads are suppose to attract more customers into your store but however these ads are presented in a negative manner and many people are starting to turn away from American Apparel products instead of being attracted by them.  Dov Charney is more interested in his sense of fashion than the financial results of the business.  As a result, in 2009, American Apparel was accused of having a financial scandal.  The company did not have effective control over their financial statements.  Deloitte & Touche’s, was the auditor of American Apparel.  Poor management of financial reports had led to the downfall of American Apparel.  Right now retail stores are suffering losses everyday.  Sales are down 16% in all retail shops of American Apparel right now.  This incident is occurring at every American Apparel store worldwide and the answer to the future of American Apparel is questionable right now.

Question 2 (15 points)
Take a look at the recent financial statements (cash flow statement in particular) – with 14 million injected into the company right away, how should the company allocate this money? Into which activities? And why?
~100 words

1.      http://online.wsj.com/article/SB10001424052748703778104576286983268919662.html?mod=googlenews_wsj

Recently, after American Apparel almost went bankrupt, a group of Canadian investors led by Michael Serruya and private-equity firm Delavaco Capital Corporation injected $14.9 million into American Apparel to save it from going into bankruptcy.  However this money is only a temporary bailout for American Apparel as this money can help save the company for a very long period of time.  With this money, the company should first pay off its major debts.  This is a significant step to make because it makes the company’s balance sheet look better with a lower amount of liabilities.  They should recreate their store image by taking down all those sex ads because those ads are part of the reason why many customers are turning away from American Apparel products.  New ads that are less sexual and more appealing to customers are definitely a factor that can help the company capture the market.  Also the company must cut its wasteful spending.  For example, American Apparel expanded too much (more than 260 stores) since 2007.  A company can only expand only if they have a large sum of money in their company.  Also Don Charney must change his attitude towards the financial reports.  He lacks the interest of the financial reports of the business and he cares more about fashion.  This attitude towards finance of the business is causing American Apparel to suffer into major losses.  There is lack management of financial reports which was a major factor to American Apparel’s downfall.  The company should adapt to a slow growth in sales because its image has already been damaged.  It is very difficult to cause a consumer to change his/her mind about the reputation of company, especially if it has a long history of sexual actions that were intolerable.  The only way for the company to stay alive in business is to build up sales and gain the trust of consumers.

Chapter 5 Blog- “Capstone Reports Record Revenue and Strong Earnings for 2010”

Link: http://www.prnewswire.com/news-releases/capstone-reports-record-revenue-and-strong-earnings-for-2010-117974954.html

Summary:

The Capstone Mining Corporation announced its final results for the year 2010.  In 2010 the Capstone Mining Corporation earned a total of $301.3 million in gross sales revenue.  The company sold 72.8 million pounds of copper, 15.0 million pounds of zinc, 9.4 pounds of lead, 25,460 ounces of gold and 1,582,033 pounds of silver.  Overall the company earned a net income of $72.6 million and it was recorded in the operating activities section of the cash flow statement.  The total amount of cash flow in the operating activities section is $86.3 million including net income.  So as you can see the net income is responsible for most of the cash flow coming into the mining company.  Capstone Mining Corporation produced a total of 73 million pounds of copper at a cost of $1.40 / pound in 2010 where in 2009 the company produced a total of 86.6 million pounds of copper at $1.03 / pound.  In January 2011, the Capstone Mining Corporation fully repaid its debt of $17.4 million owing to Yukon Energy Corporation and to the main power lines serving the Minto mine, 7 years ahead of time.  In the report, Capstone predicts that in 2011, production will range between 80 - 85 million pounds of copper at a total cost per pound of $1.30 - $1.35 per pound.  This coming year is sure going to be a successful one for the Capstone Mining Corporation. 

Connection:

The company that I analyzed was the Capstone Mining Corporation, comparing the operating activities in 2009 and 2010.  Between 2009 and 2010 there was a decrease in cash from the operating activities of the cash flow statement.  In 2009 there was a total of $112.1 million cash flowing in the operating activities section and in 2010, the amount from the operating activities decreased to $86.3 million.  In the operating activities section, the net income in $72.6 million from selling copper while in 2009 there was a net loss of $18.3 million.  Also there was a decrease in amount of inventory.  In 2010 there was 73.0 million pounds of inventory and in 2009 there was 86.6 million pounds.  When there is a decrease in inventory, the company spends less money on it, which indicates there is a positive cash flow.  Also in January 2011, the Capstone Mining Corporation paid a major debt of $17.4 million owing to Yukon Energy and main powering lines serving the Minto mine.  Since the debt (liability) is being paid off, the debt is decreasing which means that the cash flow also decreases.  If you click on this link http://capstonemining.com/i/pdf/2011-03-CS-YearEnd-Financials.pdf, you will find its financial statements including the balance sheet and its balance sheet which is required to produce the cash flow statement.  In the balance sheet you will see there is an increase in accounts payable.  In 2010 the accounts receivable was $16,392 and in 2009 the accounts receivable was $6,946.  Between those two years, the accounts receivable increased by $9,446.  Since it is an increase in an asset, there is a decrease in cash flow in the operating activities section.  Also in the liabilities section, you will see that there was an increase in accounts payable.  In 2010 the accounts payable was $22,277 and in 2009 the accounts payable was $19,782.  The overall increase is $2,495 in accounts payable.  Since accounts payable is a current liability, there was an increase in cash flow because when current liabilities increase, cash flow also increases as well.  As a result, the company did incredibly better in 2010 than 2009.  The results are indicated in the cash amount of the balance sheet.  Overall there was an increase in cash flow in the year 2010.  The Cash amount in 2010 was $165,945 and the cash amount in 2009 was $115,931.  The overall increase in cash during the 2009/2010 year is $50,014.

Reflection:

Overall in my opinion I think the Capstone Mining Corporation will see prosperity and success in the future.  The results of the cash flow statement indicated that the company was more successful in 2010 than 2009.  First of all in the cash flow statement, the net income in 2010 was relatively higher than 2009.  In 2010 there was a total net income of $72.6 million.  This indicates that revenue exceeded expenses.  Much of the contribution came from the high gross revenues this year earned which reached $301.3 million.  In 2009 there was a net loss of $18.3 million.  The difference in the net income with the net loss is $54.3 million.  This indicates that expenses exceeded revenue.  The gross sales revenue in 2009 was $250.4 million.  The difference in gross sales revenues between 2010 and 2009 are by $50.9 million.  That is a really big increase in one year and you can see the different effects by the difference in revenue.  Right now when there is a high sales volume, we can assume that there is a really high demand for copper and these other valuable minerals which are used to create raw materials to produce products.  Prices of minerals are increasing from year to year due to the high demand for this mineral.  As a result, the company is now earning money with a net income instead of losing money with a net loss.  As a result, the boost in net income has made a significant increase in operating activities.  These financial results will likely attract investors due to its recent success and I believe that after Capstone Mining Corporation’s recent downfall in 2009, the business has made a strong push to make its business more profitable and more attractive to investors.  I personally believe that this business has made a lot of progress to become a successful mining and manufacturing company.

Chapter 3 Blog- “Illinois Tax Hikes will Hurt Companies"

Link: http://money.cnn.com/2011/01/13/news/economy/illinois_corporate_tax_hike/

Summary:

This article is about how Illinois’s budget crisis is reaching high levels of deficit and how Illinois has raised its corporate income taxes in businesses and raised income taxes from the citizens in order to pay off this deficit..  Corporate income taxes were previously 4.8% and have now increased to 7%.  Corporate taxes are taxes calculated on the company’s final net income.  The original income tax rate of Illinois was 3% and it has now risen to 5.25%.  Right now, Illinois is facing a deficit of approximately $13 million and $6 million of that are unpaid bills to social service agency, schools, and funeral homes.  Companies have angry responded to this crisis because many companies in Illinois are still recovering from the effects of the recent depression.  Now with these high corporate taxes this will cause a lot of negative effects to the companies.  Now companies will have a lower net income after the calculation of corporate taxes which mean they will have a lower margin than it used to be.  As a result less people will be hired in the future creating a higher unemployment rate.  Before the increase in income tax, Illinois was ranked 21^st for highest tax rates and now Illinois is one of the top states with one of the highest tax rates in the United States being ranked 3^rd right now.  There are many reasons why Illinois is in this deficit which forced them to increase corporate taxes.  The government isn’t paying its vendors and it isn’t corporate tax refund checks back to the government.  As a result, the Illinois government owes companies around $1 million in refunds.  Therefore this increase in income tax and corporate tax rates is not getting a good response from the citizens and companies and it seems like these increases in taxes are doing more harm than good to the economy.

Connection:

This article is related to chapter 3 because it mostly talks about how corporate income taxes can affect the net income of a company.   With increasing corporate income taxes, companies will have to pay more taxes off their sales and revenue, depending on the amount they earn in one accounting period.  Since companies lose money from corporate taxes, companies will treat it as an expense.  So, this article is also related to corporate income tax expense of chapter 3.  Corporate income tax expense is calculated on the net of all the sources of income including income from operations, non-operating sources and income from unusual or infrequent events.  If you take the company, JK Creative Printers & Mailing for example, they earned close to around $4 million in revenue and let’s say for example they had around $2 million worth of expenses.  Their net income is $2 million.  If we were to calculate the corporate income tax in Illinois, we would take the net income and multiply it by the corporate income tax rate.  The corporate tax rate in Illinois is 7%.  The tax that the company would have to pay is $140,000.  If you take a look at the previous tax rate, it was 4.8%.  If there was no increase in corporate taxes, the income would only have to pay $96,000.  It may seem that an increase of 2.2% of corporate tax rates may not be that high, but when dealing with really high numbers, it can make a big difference.  You can see why companies are really upset about this increase in corporate tax rate.  When the government increases corporate tax rates, the businesses will have to increase their sales tax rates as well.  With higher sales taxes less people would want to buy the goods and therefore result in a loss of sales.  This article also relates to deficit in chapter 3.  A deficit is when a corporation has more expenses than revenue.  In other words, in this case, the government is spending more money than money being earned and right now the government has a net loss.  Therefore by increasing the corporate tax rate, the government is earning more revenue but companies are receiving more expenses as a result from this cause.    

Reflection:

If I was put into this situation I would disagree with the idea of raising corporate tax rates because although the government is earning more revenue, it is harming the businesses too.  So, the increase in corporate tax rates has positive and negative effects.  The positive effect is that the government can collect enough revenue and pay off its bills and to its accounts payables to get out of the deficit.  However, on the negative side, businesses will lose more income, resulting in a lower margin.  Businesses will have to charge higher sales taxes which will cause a lower demand in their good with an increase in price.  More workers will get laid off since some businesses cannot afford to pay their salary with this increase in corporate taxes.  Therefore this will cause a higher unemployment rate which will worsen the economy.  Long-term effects may include lower sales because since more and more people become jobless, they will be less likely to buy goods which will lower business sales causing negative effects to the economy.  As you can see that the increase in corporate tax rates is doing more harm than good.  There are other solutions that the government can use instead of raising tax rates.  I thin the best solution is for the government to lower its spending.  Since United States is a capitalist country, there is little government involvement and really low tax rates.  Therefore the government isn’t receiving a lot of income from the citizens.  In other words, the government has a very low budget and it must be very careful of trying not to overspend its budget or it may result in a deficit like this one.  With lowering the spending, the government can avoid having more expenses than revenue and businesses won’t be hurt from the increase in corporate tax rates.

Chapter 2 Blog- “Microsoft Sales Rise 25% to $16 Billion”

Link: http://money.cnn.com/2010/10/28/technology/microsoft_earnings/index.htm

Summary:

In this article, by observing Microsoft’s first-quarter sales, we can say Microsoft is prospering.  Thanks to the recent releases of Office 2010, Windows 7, and Xbox 360, Microsoft have reached sales around16.2 billion which is a 25% increase in profits since last year and had a net income that increased 51%.  Sales of around $1.5 billion came from the new release of Windows 7 last year but had to be excluded to recognize the revenue and follow the GAAP of revenue recognition criteria.  Revenue comparing to last year, rose 15% thanks to the new release of Microsoft Office 2010.  Sales of the new Xbox 360 and its PCs are growing and out competing other companies in sales of their new electronic devices.  Microsoft online services including msn and search engine Bing are making a lot of revenue, increasing services by 8% comparing to last year.  However, Apple has increasing sales and for the first time, Apple had sales that topped Microsoft’s sales.  As you can see, we can expect a bit of rivalry between the two companies, and they will start competing each other for sales.

Connection:

In terms of accounting, this article relates mostly to revenue and how the revenue recognition criteria is applied in situations like this.  When sales are made in an accounting period, Microsoft has to record all the sales collected in order for the revenue to be recognized in the same period.  This will also bring up another GAAP mentioned in chapter 2, which is the matching concept.  Whenever there is revenue gained, there must be expenses that are related to the revenue.  For example, advertising may be known as an expense because advertising helps Microsoft bring its products to the public and show the world what goods they have to meet the demands of the wants and needs of the people.  These expenses must be matched by being recorded in the same accounting period as the revenue gained.  When the company has to record these transactions, such as the revenue gained, the business has to record cash / accounts receivable as a debit and record sales as a credit in the journal.  If the company is recording the entries for its expenses such as advertising expense, the company will put advertising expense as a debit and the cash / accounts payable will be recorded as a credit in the accounting journal.  In the article, it states that Microsoft received $16.1 billion worth of sales and as a result of these high sales, Microsoft received $5.41 billion of net income.  With these two pieces of information, we can calculate the profit margin ratio by dividing net income by the revenue produced by the profit.  As a result of the calculation, the profit margin ratio for Microsoft’s earnings is 33.6%.  In other words, this means that Microsoft earned as profit, 33.6% of the amount of its revenues.  As a result of high profit in Microsoft, the net income of the income statement will rise significantly and this will cause the shareholders’ equity at the end of the accounting period to increase.

Reflection:

After reading this article, I realized what techniques are required to used to attract more consumers to buy one’s goods or services.  In the past few years, just by examining Microsoft’s financial statements, we can say that Microsoft has been very successful in business.  Microsoft has made brought many advanced technological changes to our world.  Its PC, Xbox 360, Microsoft Office, and Windows 7 have all reached top sellers in the past few years with little competition.  However recently Apple, a few days ago, just reached an all-time sales record of $20 billion, which is even greater than Microsoft’s sales.  I strongly believe that both businesses in the future will be rivals to strive for success in business by competing in their sales.  Now it all depends which company has better marketing skills by seeing who attracts more consumers.  I believe that successful advertising, the media, and public speaking are the main factors I would advise them to take in consideration, if they wish to continue their successful progress in the future.

Chapter 1-"New Accounting Rules Ruffle the Leasing Market"

Link: http://www.nytimes.com/2010/06/23/realestate/commercial/23fasb.html?_r=1&ref=financial_accounting_standards_board

Summary:

The Financial Accounting Standards Board, which sets American accounting guidelines, has been working with International Accounting Standards Board to combine its generally accepted accounting principles with international standards.  The Financial Accounting Standards Board and the International Accounting Standards Board have come up with a new accounting standard that is planned to be finished next year and will be in effect in 2013.  The new standard requires companies to book leases as assets and liabilities on the business balance sheets.  Now, companies have to put around $1.3 trillion in leases of assets and liabilities on their balance sheets.  In the year 2013, all companies will record much higher rent as part of their liabilities on their balance sheets.  They’re balance sheets are going to be a huge liability that makes it looks ugly.  This could have a serious impact on weakening companies because with such a huge liability on their balance sheets, other investors will become uninterested working with those companies.  Commercial banks will be struck in 2013, especially if they are still recovering from the recent recession.  Many companies are strategizing of how to counteract this standard.  Many companies are buying out their offices and property in order to avoid the problem of recording leases on their balance sheets.  Some companies may shrink the number of years on their lease because this will decrease the size of the liability so the balance sheets won’t give the companies a poor reputation.  Some industries decided to sign contingent rents instead of signing leases.  The costs of contingent rent depend on the percentage of the sales of the company.  This method also helps the company avoid the problem of recording leases on balance sheets.  Starting in 2013 companies will have to deal with the problem of having to record rent as a major liability but this debt will reduce over the terms of the lease.

Connection:

This article is connected to the concepts of which organizations are responsible for the development of accounting standards.  In chapter 1, it discusses that Canadian accounting standards are being converged into international accounting standards in January 2006.  In this article it reports that the Financial Accounting Standards Board, the organization who sets accounting standards for American corporations have decided to merge its accounting standards with the International Accounting Standards Board at the end of this year.  The two boards combined to come up with a new standard, which requires all companies in the United States to record leases on their business balance sheets.  Balance sheet brings up another connection with chapter 1.  Balance sheets are heavily effected in this article because companies are required to record their rent expense as a major liability instead of treated as an expense in the income statement and they will record their right to use the land as an asset.  This will affect the reputation of the business balance sheet because leases are huge liabilities that will be recorded on the balance sheet.  Other companies who may want to work with this company but they see that this company has a large amount of liabilities and this factor may affect their decision of working with that company or not.  Companies may want to borrow some money from the bank, for expanding their business.  Banks will look at the companies’ balance sheets and they will see a huge liability on the balance sheet.  Banks may decide not to lend any money to business after seeing their huge amount of liabilities on the balance sheets.  This new accounting standard will have a huge impact on future companies in Canada and the United States because the reputation of the company will depend on the efficiency of their balance sheet.

Reflection:

In my opinion, I think this is an unfair accounting standard for the companies because many companies will end up having to pay higher rent than usual, especially since the United States have not completely recovered from the recent worldwide economic downfall.  I think this new accounting standard may ruin the reputation of many businesses in the United States because since now companies are required to record leases on their balance sheets; the business balance sheet will have to carry more liabilities which do not give external users of financial statements a good reputation.  In my opinion, I think the best solution to counteract this accounting standard is to buy the offices, land, and property that you are using so companies can avoid the problem of having to record leases on the business balance sheet.  However, if some companies do not have enough cash to buy the land they are using, I suggest they should sign short term leases because long term leases are very costly.  I recommend that businesses should not rely on renewing leases because renewing can be more costly than long term leases because companies have to pay the original terms of lease plus the renewal of the lease.  I think this accounting standard should have been developed when the economy has been prospering for a long period of time in the United States because even though, the company has a very high amount of liabilities, the company will gain lots of profit increasing it’s cash value which means it will also increase the asset value of the business balance sheet and this will help even out the huge amount of liabilities, but overall I think the new accounting standard should not have been developed in the first place because I think it’s making the businesses look bad with its huge amount of liabilities.  In the future, businesses may have a tough time dealing with the leases on their liabilities.  Weakened businesses may end up having a higher liability value than their asset value since their asset value isn’t that high.  I think the accounting boards should negotiate this idea a bit more to be sure this affect will not cause disaster in the world of business.