Analysis and Interpretation of Company Profitability exercise



Analysis and Interpretation of Company Profitability exercise

Balance sheets and income statements for Procter & Gamble follow. Refer to these financial statements of P&G to answer the requirements below.

|Balance Sheets |

|($ millions) |6/30/2003 |6/30/2002 |6/30/2001 |6/30/2000 |

|Cash |$ 5,912 |$ 3,427 |$ 2,306 |$ 1,415 |

|Marketable securities |300 |196 |212 |185 |

|Accounts receivable |3,038 |3,090 |2,931 |2,910 |

|Inventories |3,640 |3,456 |3,384 |3,490 |

|Other current assets | 2,330 | 1,997 | 2,056 | 2,146 |

|Total current assets |15,220 |12,166 |10,889 |10,146 |

|Plant assets |23,542 |23,070 |22,821 |23,221 |

|Accumulated depreciation |10,438 |9,721 |9,726 |9,529 |

|Plant assets, net |13,104 |13,349 |13,095 |13,692 |

|Intangibles |13,507 |13,430 |8,300 |8,786 |

|Deposits and other assets | 1,875 | 1,831 | 2,103 | 1,742 |

|Total assets |$43,706 |$40,776 |$34,387 |$34,366 |

| | | | | |

|Accounts payable |$ 2,795 |$ 2,205 |$ 2,075 |$ 2,209 |

|Current portion of long-term debt |2,172 |3,731 |2,233 |3,241 |

|Accrued expenses | 7,391 | 6,768 | 5,538 | 4,691 |

|Total current liabilities |12,358 |12,704 |9,846 |10,141 |

|Deferred charges (income) |1,396 |1,077 |894 |625 |

|Long-term debt |11,475 |11,201 |9,792 |9,012 |

|Other long-term liabilities | 2,291 | 2,088 | 1,845 | 2,301 |

|Total liabilities |27,520 |27,070 |22,377 |22,079 |

|Preferred stock |1,580 |1,634 |1,701 |1,737 |

|Common stock, net |1,297 |1,301 |1,296 |1,306 |

|Capital surplus |2,931 |2,490 |2,057 |1,794 |

|Retained earnings |13,692 |11,980 |10,451 |10,710 |

|Other equities | (3,314) | (3,699) | (3,495) | (3,260) |

|Shareholders’ equity | 16,186 | 13,706 | 12,010 | 12,287 |

|Total liabilities and equity |$43,706 |$40,776 |$34,387 |$34,366 |

| | | | | |

|Income Statements ($ millions) |

|For fiscal years |2003 |2002 |2001 |2000 |

|Net sales |$43,377 |$40,238 |$39,244 |$39,951 |

|Cost of goods sold | 22,141 | 20,989 | 22,102 | 21,514 |

|Gross profit |21,236 |19,249 |17,142 |18,437 |

|Selling, general & admin expense | 13,383 | 12,571 | 12,406 | 12,483 |

|Income before deprec & amort |7,853 |6,678 |4,736 |5,954 |

|Non-operating income |238 |308 |674 |304 |

|Interest expense | 561 | 603 | 794 | 722 |

|Income before taxes |7,530 |6,383 |4,616 |5,536 |

|Provision for taxes | 2,344 | 2,031 | 1,694 | 1,994 |

|Net income |$ 5,186 |$ 4,352 |$ 2,922 |$ 3,542 |

Analysis and Interpretation of Profitability Ratios

1. Compute the following profitability ratios for each year shown:

a. Gross profit margin (GPM)

b. Selling, general & administrative expense as a percent of sales (SGA%)

c. Net operating profit margin (PM)

d. Net profit margin.

2. Your results in part 1 should have revealed an increase in net profit margin.

a. Is this increase due to an increase in the gross profit margin or a decrease in selling, general, & administrative expense, or both? Provide evidence and explain your answer.

b. Consider how much control that companies have or do not have over gross profit margins. What factors must exist to allow them to increase selling prices of their products? In what ways can they improve gross profit margins by lowering product manufacturing costs? Explain.

c. What are the usual components of selling, general and administrative expense for a company like Procter and Gamble? For which of these components are companies likely able to achieve expense reductions? To what extent are these expense reductions a short-term gain at the cost of long-term performance? Explain.

Analysis and Interpretation of Asset Turnover Ratios

1. Compute the following turnover ratios for 2001 through 2003:

a. Accounts receivable turnover and the average collection period.

b. Inventory turnover and average inventory days outstanding.

c. Plant asset turnover.

2. Results from part 1 should reveal a slight improvement in receivables turnover from 2001 to 2003. How can a company like P&G realize an improvement in this ratio? Explain.

3. Results from part 1 should reveal no discernable improvement in inventory turnover from 2001 to 2003. How can a manufacturer like P&G realize an improvement in its inventory turnover? Explain.

4. Results from part 1 should reveal a slight decline in plant asset turnover from 2001 to 2003. Why is this ratio so difficult for companies to impact? Can you think of ways in which a company can achieve an improvement in this ratio? Explain.

Disaggregation and Interpretation of Company ROE

1. Compute the following for 2001 through 2003:

a. Net operating profit margin (PM).

b. Return on net operating assets (RNOA).

c. Financial leverage (LEV).

d. Net borrowing costs (NBC)

e. Spread

f. Return on equity (ROE).

g. ROE from the formula: ROE = RNOA + (LEV×Spread). Confirm that this amount equals that computed in part f.

2. Drawing on results from part 1, does P&G depend more on operations (RNOA) or financial leverage to drive its ROE? Explain.

3. Drawing on results from part 1, is P&G’s level of ROE sufficient to attract capital? Explain. What benchmark do you believe is appropriate in answering that question? Explain.

Analysis and Interpretation of Liquidity and Solvency Measures

1. Compute its current ratio and quick ratio for 2001 through 2003. Do the trends, if any, in these ratios indicate that P&G is becoming more or less liquid? Use computations to support your analysis and inferences.

2. Compute P&G’s financial leverage (LEV) and times interest earned for 2001 through 2003. Do these ratios indicate that P&G is becoming more or less solvent? Explain.

3. A well-known model of financial distress is Altman’s Z-score. Altman’s Z-score uses multiple ratios to get a predictor of distress. This predictor classifies or predicts the likelihood of bankruptcy or nonbankruptcy. Five financial ratios makeup the Z-score:

X1 = Working capital / Total assets

X2 = Retained earnings / Total assets

X3 = Earnings before interest and taxes / Total assets

X4 = Shareholders’ equity / Total liabilities

X5 = Sales / Total assets.

In brief, X1 reflects liquidity, X2 reflects cumulative profitability that has been retained, X3 reflects profitability, X4 reflects financial leverage, and X5 reflects total asset turnover.

The Altman Z-score is computed as:

Z-score = (0.717 × X1) + (0.847 × X2) + (3.107 × X3) + (0.420 × X4) + (0.998 × X5)

The Z-score is then interpreted as follows:

Z-score < 1.20 ( high probability of bankruptcy

Z-score > 2.90 ( low probability of bankruptcy

1.20 ≤ Z-score ≤ 2.90 ( gray or ambiguous area.

Compute the Altman Z-Score of P&G for 2003. Does this score indicate any concerns about P&G’s solvency? Explain.

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