John Fuller
Financial Statement Analysis Assignment Part 2
Introduction
The purpose of this paper is to inform an experienced business person about
International Business Machines Corporations profitability, risk factor, and
efficiency. I will be using multiple accounting ratios to demonstrate the answers.
Body
Profitability Ratios
The first profitability ratio analyzed is the gross profit margin ratio. The
gross profit margin for IBM in 2001 was 37% which means, for every dollar of sales
the company has a $0.37 gross profit. This only includes the merchandise sold and
does not consider any services rendered. In the year 2000, the “GPM” was 36%,
therefore, the company had increased the proportion of money left over from
revenues after accounting for the cost of goods sold. The industry average is only
36.84%, as a result, IBM is doing good generating more profit from each sell of the
products in the current year. The company possibly found a cheaper way to produce
the merchandise this year, than last year.
The profit margin is a measure of the amount of profit accruing to a company
from the sale of a product and/or services. IBM’s profit margin for 2000 and 2001
was 9.15% and 8.99% respectively. For every 1 dollar of sales revenue that IBM
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produces they are able to generate approximately 9 cents of net income. The
industry average for this ratio is 4.34%. This demonstrates that even though IBM
had a slight decrease from the prior year it can still generate more than twice as
much as the average business in this industry can.
The return on assets ratio measures (ROA) how profitably a company uses its
assets; this identifies the amount of profit in relation to the average value of the
assets. In 2001, IBM’s ROA was 9% which is a slight decrease from the 10% it was
in 2000. This information shows that IBM’s assets are well managed and used
productively. One can determine from the percentage IBM has in its ROA that for
every dollar of value in an asset IBM is able to earn 9 cents of net income. The
industry average is approximately 5%; therefore, IBM is very profitable and well
managed according to this ratio as IBM’s ratio is nearly double the industry
average.
The return on equity ratio (ROE) measures profitability similar to the
previous one but this ratio differs in that it reveals how much profit a company
generates with the money shareholders have invested. In 2001, IBM’s ROE was
35%; for the prior year it was 40%. This was a significant decrease in the profit
IBM was able to generate from its shareholders equity. This percentage shows that
for every dollar of equity IBM has, that dollar is able to produce $0.35 cents of net
income. The average company in this industry can usually produce about $0.14
cents or has an ROE of 13.5 percent.
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Fully diluted earnings per share (EPA) is a required ratio that indicates a
"worst case" scenario, one that reflects the issuance of stock for all outstanding
options. The diluted securities would reduce earnings per share. IBM had diluted
EPS of $4.35 in 2001 and $4.44 in 2000. The average company in this industry
would only have 86 cents of EPS. This shows that even though IBM has decreased
in the amount which it earns per share from year to year, it is still getting more of a
return from each share then the industry average. According to this ratio, IBM is
pretty successful at producing revenue from stock holder’s equity.
The book value per share formula is used to calculate the per share value of a
company based on its equity available to common shareholders. The book value of
each share for IBM in 2000 it was $13.70 and in 2001 it was $11.56. In Both years
the book value was high enough to surpass the industry average standards of $6.62
but in the current year its shares where worth more than an industry average share
by $7.08.
Based on these profitability ratios IBM is great at generating profit. In each
of these ratios IBM is generating profit better than the industry average.
Risk
Short Term Risk- The first risk ratio examined is the current ratio. This ratio
determines how well a company can meet its short term liabilities. In the year 2001
IBM’s current ratio was $1.21; it was the same for 2000. In 2001, IBM had $1.21 of
resources currently available to pay for every one dollar of debt or obligation coming
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due in the next year. The industry average for this ratio is 1.3 so IBM has a lower
ability to pay off their short term debts. By this information it is more risky than
the average business in this industry which would cause investors to be a little
concerned about investing their money.
The acid test ratio measures a company’s ability to meet its short-term
obligations with its “quick” assets which are its most liquid assets; current assets
like inventory wouldn’t be included in the term “quick assets”. IBM’s ratio was
$0.95 in 2000 and 2001. Every dollar of IBM’s current liabilities is able to be
covered by 95 cents of quick assets. The average company in this industry would
have a $0.90 acid test ratio. This means that IBM is able to cover its short-term
liabilities with quick assets better than the average company in this industry and
less risky to invest in.
Long Term Risk - What the debt ratio does is measures the extent of a
company’s leverage. The debt ratio is defined as the ratio of total debt to total assets
stated in a percentage. The percentage represents how much a company is debt
financed. IBM’s debt ratio for 2000 and 2001 was 77% and 73% respectively. This
means that for every one dollar of total assets it has, it would have taken 73 cents of
that to pay off its liabilities. It decreased the amount that it was debt financed from
the prior year but because the industry average is 62 %. IBM is still at a greater
risk and its investors would have a hard time wanting to continue investing in the
company.
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Times interest earned (TIE) ratio calculates how many times that the
business has earned its interest. In the year 2001, IBM has a TIE ratio of 47.02
which means that it was able to earn its interest 47.02 times during this period
which is a good improvement from the prior year that was 34.23. In 2000, IBM was
more risky because it wasn’t able to generate as much interest as the industry
average which is 46.3. But then, in 2001, IBM exceeded the industry average and
now according to this ratio is no longer risky.
Dividends per share ratio tell us the amount of dividends for each share of
stock. In 2000, dividend per share was $0.52 and 2001 was $0.55. The industry
average is 19 cents, therefore, IBM has a higher rate on its dividends than the
industry average.
Even though a few ratios in both the current and long-term sections are a
little above the industry average the company overall still is more risk than the
average company in this industry.
Efficiency
Below, is the analysis of efficiency beginning with the day’s sales uncollected
ratio. This ratio is pretty much how it sounds; it measures the average number of
days that a company takes to collect revenue after a sale has been made. A low
number means that it takes the company fewer days to collect its accounts
receivable. A high number shows that a company is selling its product and taking
longer to collect money. IBM’s average days for sales to be collected in 2000 were
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120 days and in 2001 it was 123 days. This shows a decrease in their collecting
efficiency because now it is taking longer to collect. Not only is it taking longer than
before it is taking longer than the industry average which is only 84.85 days. IMB is
very inefficient in the collections department.
The accounts receivable turnover actually goes right along with days sales
uncollected because it calculates how much times a year your receivables turnover.
By way of example, if IBM takes 123 day to collect and there is only 365 days in a
year, IBM turns over there account receivables approximately 3 times a year. Once
again the industry average takes 84.85 days. Therefore, IBM should be turning
accounts receivable over about 4 times a year. The collection department is not
operating efficiently
The inventory turnover ratio shows how many times a company's inventory is
sold and replaced. In 2001, inventory was replaced 5.8 times which was a
disappointing decrease in selling efficiency from the prior year which was 6.09
times. Still, even the higher year was not enough to meet the average industry rate
which was 9.1 times a year.
Just like the sales uncollected ratio went with the accounts receivable
turnover, the “day’s sales in inventory” goes with the inventory turnover. The days
sales in inventory measures how long it takes to sale and replenish our inventory.
The days it took IBM to sale and replenish their inventory in 2001 was 62.7 days.
Just like IBM’s inventor turnover demonstrates a disappointing decrease in selling
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efficiency so does the day’s sales inventory. In 2000, the day’s sales inventory was
60 days. Just as before, the better year (2000) was not fast enough to compare to the
industry average of only 40 days.
The Asset Turnover ratio evaluates how well a company is utilizing its assets
to produce revenue. IBM turned over its assets 1.005 times in 2000 and only .97
times in 2001; which means IBM is getting worse at utilizing its assets. The
industry average was 1.3. IBM isn’t using its asset to produce revenue as good as
the average company in this industry. An interesting note, in 2001 IBM didn’t
really make enough sales to cover their average total assets even one time.
The cash flow to assets ratio indicates the cash a company can generate in
relation to its size. In 2001, for every one dollar of an asset that IBM has that one
dollar is able to generate 16 cents of cash by operating activities. The prior year it
generated about 11 cents of cash by operating activities. The industry average is 10
cents to $1. According to this ratio IBM is operating efficiently. The higher the
amount the higher the ability to efficiently operate a business and generate cash is.
The cash flow per share represents the portion of a company's cash flow
allocated to each share outstanding. For every share outstanding in the year 2000
the company was able to generate $5.26 and in 2001 each share produced $8.28.
Therefore, there was an increase in the ability to generate cash. In both years IBM
produced more than the industry average, which stood at $1.89, making them
efficient at producing cash.
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IBM is working really efficiently in some areas average or worse in others.
From all these ratios I would have to determine that IBM is not running efficient as
the industry average and can improve in many areas.
Conclusion
The information above demonstrates that International Business Machines
Corporations is able to generate profit better than the average businesses in this
industry. It also has a higher risk factor than the average business does which
would cause them to loose investors. IBM is able to efficiently produce cash. It isn’t
efficiently utilizing its assets or running its collection and sales departments.
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