SEPTEMBER TRIMESTER 2022/2023

ACCOUNTING FOR DECISION MAKING

ACC7101

GROUP 5

CASE STUDY 2 – AMERICAN APPAREL

(WORD COUNT: 2302)

NAME MATRIX NO.

ANIS HAFIZA BINTI ISHAK PBS22101064
ELIZABETH ASIRAVATHAM PBS22101042
ERNEST LAU ZHE YANG PBS22101020
ROZIAH BINTI KASSIM PBS22101056

LECTURER:

PROF. DR. ANGELINA YEE SEOW VOON

Table of Contents

1.0 Introduction 2

2.0 Analyses of Problems 4

3.0 Ratio Analyses 5

4.0 Cash Flow Statement Analysis 9

5.0. Summary and Conclusion 11

6.0. References 13

7.0. Appendix 14

List of Figure

Figure 1: Assets vs Liabilities

Figure 2: Long Terms Liabilities vs Equity

Figure 3: Debt Ratio

Figure 4: Current Ratio

Figure 5: Quick Ratio

Figure 6: Inventory Turnover

Figure 7: Gross Profit Margin

List of Table

Table 1: Cash Flow Statement for American Appareal,2009 - 2013

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1.0 Introduction

American Apparel is an apparel retailer founded by Dov Charney, also acting as its

CEO, in 1998 with the mission to make great quality clothing without using cheap

“sweatshop” labour and exploiting workers. The company is based in Los Angeles and

functions as a vertically integrated company who manufactures, distributes, and acts

as a retailer of branded basic fashion apparel and accessories for women, men,

children, and babies.

The initial success of the company was credited to Dov Charney’s strong business

sense and his vertically integrated business model which provided the company with

the flexibility of responding quickly to market changes. The success of the company

is further exemplified in 2006, when the company is listed on the New York Stock

Exchange. The company grew from 147 stores in 2006 to 260 stores in 2008,

expanding both domestically and internationally.

However, this success proved to be short lived. In 2009, the company faced issues

from the federal immigration department, which led to the termination of 2,000

American Apparel factory workers. The global recession which was also happening at

this time further impacted American Apparel. The company went from a net profit of

$1.1 million to a net loss of $86 million between the years of 2009 and 2010,

respectively. The downward spiral of the company is further worsened by the high

interest loan taken by the company in 2011 in the form of investors. As a result,

American Apparel’s long-term debt substantially increased from $170.2 million in

2009 to $411.2 million by the end of 2013.

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Below are the major events that happened at American Apparel within the timeline of

this case study:

● 1998 - company founded by Dov Charney

● 2006 - company listed on the New York Stock Exchange, following its success

● 2008 - company aggressively expanded since 2006, increasing from 147 stores in

2006 to 260 stores in 2008

● 2009 - company had to terminate 2,000 production workers due to immigration

issues

● 2010 - company did not make profit for the first time since its inception

● 2011 - company almost headed towards Chapter 11 bankruptcy, but was able to

mitigate it by borrowing high interest loans

● 2011 - 2013 - company continued expansion and upgrades, accumulating high

interest debts. In 2013, the total liabilities of the company exceeded its total assets

for the first time.

In this case study, we will further analyze the major causes of American Apparel’s

downfall through several ratio analyses and provide our recommended course of

actions that could have been taken to achieve different outcomes for the company.

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2.0 Analyses of Problems

In 2009, as a result of a federal investigation uncovering irregularities in the identity

documents of American Apparel workers, the company was required to terminate the

employment of 2,000 American Apparel workers from its factory, leading to its

inability to both complete orders on time and meet demand. This directly caused a

decrease in the operating profit from $36 million in 2008 to $3 million in 2009 and the

company’s net profit also fell dramatically from $14 million in 2008 to $1 million in

2009.

In her article, (Noel, 2015) states that American Apparel, like most Los Angeles

factories over the past century, is staunchly anti-union. We think that if American

Apparel were to properly consider its workforce mix and hiring policy, which includes

the consideration of unionizing their workplace, this problem could have been avoided.

The union would have been able to provide a stable supply of workers, and this also

align with American Apparel’s “sweatshop free” business model.

Due to the global recession, it is impossible to recoup the damage that the termination

of labour has done. 2010 marks the beginning of a downward trend in the company's

sales. Charney, who was in desperate need of funds, agreed to take out a loan, despite

the fact that it was overly expensive and would have a negative impact on the

company's financial status, particularly its ability to pay back long-term and short-term

borrowing.

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3.0 Ratio Analyses

American Apparel’s balance sheet indicates that it’s assets grew slightly from 2012 to

2013 by 1.69%. Unfortunately, the total liabilities grew from $ 170,238.00 in 2009 to

$411,156 in 2013 far outpacing the growth in assets. Most of this increase came from

long term liabilities. This resulted in a stockholder loss in equity from $157,341.00 in

2009 to -$77,404 in 2013. The chart below the figure 1 shows the American Apparel’s

assets decreased and their liabilities increased over the over the year of 2009 until

2013.

Assests vs Liabilities

$500,000.00
$400,000.00
$300,000.00
$200,000.00
$100,000.00
$-
2009 2010 2011 2012 2013

Total Assets Total Liabilities

Figure 1: Assets vs Liabilities

American Apparel becomes less profitable specifically after the year 2009 due to their
massive termination of the 2000 employees. The result of this this action lead to the
debts and other expenses massively increase until the liabilities outweigh the assets.
Congruent to that are the stockholders’ equity in the company.

In figure 2 below, stockholders’ equity peaked in 2009 and it began to decline rapidly
until it was negative in between of 2012 and 2013. From the year 2010, the long-term
liabilities increased substantially through 2013.

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 Long Term Liabilities vs Equity
$300,000.00
$250,000.00
$200,000.00
$150,000.00
USD $ $100,000.00
$50,000.00
$-
$(50,000.00) 2009 2010 2011 2012 2013

$(100,000.00)
Year

Total Long Term Liabilities Total Equity

Figure 2: Long Terms Liabilities vs Equity

In the case study report indicated that that American Apparel took out a loan with high

interest rates and strict terms and conditions. One condition being that the debt could

be called back should there be any shakeup in the top management levels, something

that would happen the following year in 2014. Founder Charney was expelled from

the company from his board after being accused of sexual assault and sexual

harassment. Already debt ridden, the company suffered a huge blow, which many

believed to be the final straw. This becomes evident when looking at the graphs below,

in Figure 3 and Figure 4 shows the current ratio and quick ratio for American Apparel.

Knowing that this indicates a company’s likelihood to pay back a creditor within one

year, it become apparent that American Apparel was not likely to do that.

“In general, many investors look for a company to have a debt ratio between 0.3 and

0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better,

while a debt ratio of 0.6 or higher makes it more difficult to borrow money (Ross,

2021).” As per below figure 3 shows that American Apparel debt to asset ratio is 1.23

in 2013 making it a risky business for lenders to extend credit and investors to invest

in. This ultimately resulted in American Apparel taking on high interest loans.

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 Debt Ratio
Debt Ratio

1.40
1.20
1.00
0.80
0.60
0.40
0.20
-
2009 2010 2011 2012 2013

Figure 3: Debt Ratio

“The average current ratio for all industries is 2.0” (Pride et al. 2019), which makes

1.33 a low current ratio. “A low current ratio can be improved by repaying current

liabilities, by reducing dividend payments to stockholders to increase the firm’s cash

balance, or by obtaining additional cash from investors. (Pride et al. 2019).

Current Ratio
Current Ratio

3.50
3.00
2.50
2.00
1.50
1.00
0.50
-
2009 2010 2011 2012 2013

Figure 4: Current Ratio

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 Quick Ratio
Quick Ratio

0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
-
2009 2010 2011 2012 2013

Figure 5: Quick Ratio

The apparel industry average turnover is 3.91 (Scilly, 2016). American Apparel had a

turnover ratio of 1.82, which is below industry averages. This ratio shows that

American Apparel has a lot of inventory that is not selling which leads to costs

associated with storage costs, inventory that goes out of style and forces sales of

apparel at lower than anticipated rates.

Inventory Turnover
2.00

1.50

1.00

0.50

-
2009 2010 2011 2012 2013

Inventory Turnover

Figure 6: Inventory Turnover

Gross profit margin in figure 7 below, shows the volumes for the performance and

management of the American Apparel company. Gross profit margins decreased from

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 57% in 2009 to 51% in 2013. This ~6% decrease predicted disaster for the company

and their sales. This indicate it were being mismanaged with too many of liabilities

and the debts are racking up. the sales/profit aren’t enough to meet the demand of the

debt.

Gross Profit Margin

Gross Profit Margin

0.58
0.56
0.54
0.52
0.50
0.48
0.46
2009 2010 2011 2012 2013

Figure 7: Gross Profit Margin

4.0 Cash Flow Statement Analysis

Cash Flow Statement FY 2009 -

2013/YEAR 2009 2010 2011 2012 2013
Net Cash (used in) provided by:
Operating Activities 45,203.00 (32,370.00) 2,305.00 23,589.00 (12,723.00)
Investing Activities (20,889.00) (15,662.00) (10,759.00) (24,853.00) (25,147.00)
Financing Activities (25,471.00) 48,172.00 12,582.00 4,214.00 34,228.00
Effect of Foreign exchange rate
(1,165.00) (1,530.00) (1,491.00) (390.00) (535.00)
changes on cash
Net (decreased) increase in cash (2,322.00) (1,390.00) 2,637.00 2,560.00 (4,177.00)

Table 1: Cash Flow Statement for American Appareal,2009 - 2013

A cash flow statement, also known as statement of cash flows, is a financial statement

that shows the changes in balance sheet accounts and income affect cash and cash

equivalents. It can have projected by breaking the analysis down to operating,

investing and financing activities.

An accounting item indicating the money a company brings in from ongoing, regular

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business activities, such as manufacturing and selling goods or providing a service.

Cash flow from operating activities does not include long-term capital or investment

costs. It does include earnings before interest and taxes plus depreciation minus taxes.

By analysing the cash flow from operating activities, there has been a negative trend

in maintaining operating cash flow. In 2011 and 2012 there was a positive net cash

flow and negative in 2009, 2010 and 2013, which shows a very high fluctuating trend.

The reason of this negativity in net cash flow from operating activities is the negative

balance of account receivables, it could be the reason the clients who has taken services

from the company in credits. There is a negative net cash flow in 2013, which is mainly

due to increase in deferred taxes payments in comparison to last 4 years.

The item on the cash flow statement that reports the aggregate change in a company's

cash position resulting from any gains (or losses) from investments in the financial

markets and operating subsidiaries, and changes resulting from amounts spent on

investments in capital assets such as plant and equipment.

From analysing the cash flow statement from investing activities, it’s been observed

that there has been a continuous negative cash flow. Continuous increase in capital

expenditures by purchasing of fixed assets is the main reason behind this negative cash

flow from investment activities.

In past 5 years company was having a low liquidity ratio and low cash reserves still

the management is investing heavy amount of cash in buying fixed assets and

increasing long-term debts. Since past 5 years they have invested 20,890, 15,700,

11,070, 21,610 and 27,050 because which they maintaining negative cash flow.

A category in a company’s cash flow statement that accounts for external activities

that allow a firm to raise capital and repay investors, such as issuing cash dividends,

adding or changing loans or issuing more stock. Cash flow from financing activities

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shows investors the company’s financial strength.

By analyzing the cash flow from financing activities, it been a fluctuating trend in

maintaining the cash flowing from all the financing activities. There has been increase

in the bowings of the company, which has resulted in increased long-term debts. This

is the reason behind the unstable financial position of the company. There is no

negative trend in cash flow from financing activities but the borrowings are constantly

rising.

5.0. Summary and Conclusion

Their slogan implies that American Apparel is globally sourced, ethically made and

still sweatshop free. We would like to recommend the following to the board of

directors to prevent the company from incurring additional debt and to keep the

company competitive.

3.1 For American Apparel to be capable of paying its debt payments and covering

its operational expenses, the company's sales volume needs to increase. The

implementation of new marketing strategies will assist the company in not only

boosting sales but also expanding its market share in the industry in which it competes.

We are confident that if American Apparel designates an ambassador for the brand and

executes an effective advertising strategy, they will be able to reach a new audience.

Also, instead of building a new store, American Apparel could focus on growing its

online shopping platform to reach more customers.

3.2 American Apparel has been struggling with lower profits for a long time now,

and the only way for them to really fix that is by lowering their production costs. They

can do this by outsourcing the manufacturing process altogether. One way they can
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reduce production costs is by outsourcing their manufacturing processes to countries

where labour is cheaper, like Bangladesh and India. Labour costs are among all

manufacturing companies’ largest costs. We believe outsourcing parts of the

production line to a third party leads to a significant decrease in production costs. In

recent years, there has been a global trend of automation involving the use of machines

to replace human labour. Alternatively, one of the best ways to make the workforce

more efficient is by using artificial intelligence. It can be used for repetitive tasks, and

it frees the company's human workforce to focus on other things and make the

company more productive.

3.3 Restructuring the company to improve its public image. Corporate branding

and social responsibility are two new approaches that will involve employees, the

community, and stakeholder engagement in designing a positive company image. The

company began to portray a positive, pro-social, and pro-environmental image in the

marketplace. This is also an effective method for attracting the interest of stakeholders,

which can help increase the share price and attract more investors.

3.4 Building positive brand equity will have a direct effect on sales volume,

increase contribution margin and make the loss lower. This is because it allows a

company to charge more for a product than a competitor. When the brand becomes

more valuable, more people will recognize it. The majority of brand equity is based on

customer experience, with customers referring their friends and family to the brands

they enjoy

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REFERENCES

1. Marshall, D., McManus, W., & Viele, D. (2022). ISE Accounting: What the
Numbers Mean (13th ed.). McGraw-Hill Education.
2. Mehta, A. (2016) American Apparel: Drowning in Debt? Ivey Publishing,
W16208
3. Ross, S. (2021). What is a good debt ratio? Investopedia.
https://www.investopedia.com/ask/answers/021215/what-good-
debtratio-and-what-bad-debt-ratio.asp.
4. Noel, H. (2015). Branding Guilt: American Apparel Inc. and Latina Labor in
Los Angeles. Diálogo, 18(2), 37-52
https://core.ac.uk/download/pdf/232974294.pdf

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 APPENDIX

ACTIVITY
2013 2012 2011 2010 2009
RATIOS/YEARS
Current Ratio 1.33 1.39 1.61 1.01 2.87
Quick Ratio 0.28 0.31 0.31 0.18 0.69
Total Asset Turnover 1.92 1.89 1.68 1.63 1.69
Receivable Turnover 29.04 28.12 29.09 31.73 33.51
Average Collection Period 12.57 12.98 12.55 11.50 10.89
Current Ratio 1.82 1.61 1.39 1.59 1.65
Days in Inventory 200.31 226.60 263.02 230.24 221.10
Debt Ratio 1.23 0.93 0.85 0.77 0.52
Debt-to-Equity Ratio (5.31) 13.86 5.75 3.37 1.08
Gross Profit Margin 0.51 0.53 0.54 0.53 0.57
Net Profit Margin (0.17) (0.06) (0.07) (0.16) 0.00

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