Accounting/Finance
 Profitibility Analysis
 Liquidity Ratios
 Debt/Leverage Analysis
 Stock Price History
 Consolidated Income Statement
Return-on-equity (ROE) and return on net operating income are the best indicators of a
company’s profitability. ROE measures how efficiently a company uses equity to generate
growth. In 2009, Avon’s Return on Equity was 62% demonstrating Avon was able to use
shareholder equity to generate income. RNOA measures the amount of growth that comes from
operating decisions (Burns, 38). RNOA compares the ratio of Net Operating Profit after Tax
(NOPAT) to Average Net Operating Assets (Easton, 3-11). In 2009, Avon’s NOPAT was
$687.81 million giving them an RNOA of 25.1%, higher than the 12% for all publicly traded
companies (Easton, 3-11). However, Avon’s RNOA only accounts for 40.5% of return on equity
with non-operating return making up the remaining 59.5%. This is significantly lower than the
average for publicly traded companies of nearly 80% (Easton, 3-11).
The current ratio and quick ratio have been used to asses Avon’s liquidity. The current ratio
compares current assets to current liabilities. A current ratio greater than 1 means that the
company has positive working capital and that cash inflows are expected to be more than cash
out flows in the short term (Easton,. 4-13). In 2009, Avon had a current ratio of 1.84 implying
that they have more than enough liquid assets to cover short term liabilities. The quick ratio is
considered to be a more accurate test of liquidity because focuses on the most liquid assets
(Easton, 4-13).
In 2009, Avon had a quick ratio of 0.92 implying that they are able to
immediately cover the majority of their short terms debts.
The best way to analyze a firm’s debt is to measure its solvency. Solvency ratios show how
much a company relies on financing from creditors rather than equity, as well its ability to meet
debt obligations (Easton, 4-14). The liability to equity ratio is most commonly used to measure
solvency. The median is slightly less than 1.0 for public traded companies (Easton, 4-14). In
2009, Avon had a ratio of 4.21 which shows that they carry a significantly higher amount of debt
over equity. Investors and creditors tend to view this as a bad sign. The long-term debt to equity
ratio is also used to measure solvency and distinguishes between operating liabilities and debt
obligations. It assumes current liabilities will be paid from current assets (Easton, 4-15). The
liquidity ratios indicate that this is true in Avon’s case. In 2009, Avon’s ratio was 1.76 showing
that the majority of their debt is short term and likely to be covered. However, their long term
debt is still in excess of its equity which may still make investors and creditors anxious.
Financial leverage is the most important measure of leverage (Bhayani, 43). It compares the
ratio of earnings before interest and taxes (EBIT) to net income and measures the percent change
in operating income for each one percent change in net income (Bhayani, 45). In 2009, Avon’s
financial leverage was 1.62. Therefore, an estimated 1.62% increase in operating income is
needed to produce a 1% increase in net income.
A second measure, operating leverage,
determines how significant a company’s fixed costs are in relation to net operating profits and
revenue (Kelly and Sussman, 34). The higher the financial leverage, the more net operating
profits will increase or decrease with revenue. In 2009, Avon’s operating leverage was 6.38
implying that Avon’s profits are very sensitive to changes in sales.
Stock prices have increased over the past three years. However, the amount and rate at
which it has increased has been declining.
Year
2006
2007
2008
2009
Stock Price
$183.5
$184.7
$185.6
$186.1
Consolidated Income Statement:
Year ended December 31 (in millions)
Net Sales
Other revenue
Total revenue
Costs, expenses and other:
Cost of sales
SGA expenses
Operating profit
Interest expense
Interest income
Other expense, net
Total other expenses
Income before taxes
Income taxes
Net income
NI attributable to non-controlling interests
NI attributable to Avon
Earnings per share:
Basic
Diluted
Weighted-average shares outstanding:
Basic
Diluted
2009
$10,284.70
$98.10
$10,382.80
$3,888.30
$5,476.30
$1,018.20
$104.80
$(20.20)
$7.10
$91.70
$926.50
$298.30
$628.20
$ (2.40)
$625.80
$1.45
$1.45
426.90
428.54
References
1. Bhayani, Sanjay J. Impact of Financial Leverage on Cost of Capital and Valuation of
Firm: A Study of Indian Cement Industry. Paradigm. Ghaziabad: Jul-Dec 2009. Vol.
13, Issue. 2, pg. 43-49.
2. Burns, David C., Sale, Timothy, and Stephan, Jen A. A Better Way to Gauge
Profitability. Journal of Accountancy; Aug 2008; 206, 2; pg. 38.
3. Easton, Peter D. Financial Statement Analysis and Valuation. 2nd Edition. Cambridge
Business Publishers: 2010.
4. Kelly, Eamon M. and Sussman, Richard M. Operating Leverage: A Clarification.
National Association of Accountants. NAA Management Accounting (pre-1986). New
York: Oct 1966. Vol. 48, Issue 2, pg. 34.