Liquidity and Profitability - Research Paper Example

Liquidity and profitability Introduction Liquidity and profitability are two key measures of the financial position of a business. Liquidity refers to the degree to which any asset or security can be transacted in a market can be bought and sold in a market without having any impact on the price of the asset or the security. Liquidity of a business refers to the ability of the business to quickly convert its assets and securities into cash. Liquidity is also known as marketability. High liquidity is indicative of strong liquidity position of the business and reflects the good financial performance of the business in this respect. Profitability indicates the condition or state of yielding financial profit or gain. Profitability is the primary objective of any business venture. Profitability is necessary for the survival of a business as a business has to make profits both in the short term and the long term to ensure the continuity of the business operations. Therefore, measuring the existing, past and future profitability is necessary for businesses. Also, liquidity and profitability of a business helps to determine the investment attractiveness of a business from the point of view of the shareholders, creditors, suppliers etc. The research is conducted with the aim of discussing and evaluating the liquidity and profitability position of Walmart which is a leading retailer giant in the globe. The financial performances of the company over the last three years, 2012-2014 are studied with focus being given to its profitability and liquidity performances. The research is supported by the references made to relevant literary works. A hypothesis is taken for the research that Walmart is performing well above the expectation and standards of the market. The research is started by the identification of a suitable research question followed by a discussion of the research methodology used for carrying the research work. The financial analyst of Walmart is done through the use of ratio analysis and the report is concluded by giving suitable recommendations to improve the financial performances of the company over the next few years. Theoretical background According to the work of Ehrhardt and Brigham (2013), financial analysis or financial statement analysis is used to analyze the financial position of a company by considering its stability, viability and profitability in the market (Ehrhardt and Brigham, 2013). The financial analysis reports are presented to the senior management as it helps them in their business and corporate decision making processes. Financial analysis involves the use of a number of analysis tools like ratio analysis, vertical analysis and horizontal analysis. Ratio analysis can be considered as the most efficient means of assessing the financial position of a company. Financial analysis is a part of the financial management of a company because it helps in evaluating the management of money with the aim of achieving the objectives of the company. Keown, Martin, Petty and Scott (2011) have stated that Financial analysis assists in taking key decisions regarding the financial and corporate aspects of the business by analyzing the financial statements published by the company (Keown, Martin, Petty and Scott, 2011). Ratio analysis is performed on the line items contained in the financial statements published by a company. These may include the items in the balance sheets, income statements and cash flow statements of a company. Ratio analysis encompasses the quantitative analysis of the information available from the financial statements of a business. Ratio analysis can be done to find out the efficiency, asset utilization, liquidity, profitability and solvency positions of the company. Profitability ratios are used to measure the amount of financial gain made by the company through its sale of goods and services. It is also indicative of how efficient the company is in retaining the earnings within the business itself. The profitability ratios are in line with the earnings retained and the dividends paid by the company. Key ratios like gross profit margin, net profit margin, returns on assets etc. are indicators of the profitability level in a company. A high profit margin and return on assets is indicative of the strong financial position of a company. Profitability ratios are extremely important because all companies operate with the aim of making financial gains. According to Brigham and Houston (2012), while studying profitability ratios it should be kept in mind that some companies experience a high level of seasonality in their sales (Brigham and Houston, 2012). This may impact the profitability in different seasons. For example, the retail companies tend to have high volumes of sales in the Christmas time. Therefore, at this time, the profitability grows multiple times. However, this does not mean that the company is a bad performer in the other seasons. Liquidity of a company refers to its ability of converting its assets to cash. Assets which can be quickly converted into cash and can be bought or sold easily are known as liquid assets. Assets that can be easily converted into cash may include money market securities and blue chip companies from the perspective of the investors. It is always preferable to invest in liquid assets because of the ease of an investor to move his money from the investment at any point of time. Ratios like current ratio and liquid ratio are used to analyze the liquidity position of a company. The ideal value of current ratios and liquid ratios may vary according to the industry in which the company is operating. Ideally, the value of the current ratio should be more than 1 i.e. the current assets of the company should exceed the current liabilities in the company. The ideal quick ratio should also be 1. The efficiency ratios indicate how efficient the management of a company is in the internal management of assets, liabilities and other resources. Some examples of the key asset utilization ratios that can be used to measure the efficiency of a company are rate of inventory turnover, sales to inventory, accounts payable to sales etc. These ratios are meaningful when they can be compared with respect to the other businesses operating in the same industry. The asset utilization ratios are also known as efficiency ratios and can be used to identify the businesses which are more efficiently managed relative to other businesses. The efficiency ratios are also considered to be important because an improvement in these ratios would mean an improvement in the profitability of the business in the long run. Gearing ratios are used to compare any form of the equity of the owner to the borrowed funds or debts in the company. The debts may include both long term and short term debts. Gearing is used to assess the financial leverage used in a company and indicates the degree to which the activities of a company are financed by the creditors’ funds as compared to the owner’s capital. The gearing ratios commonly used in ratio analysis are debt to equity ratio, debt ratio, equity ratio and times interests earned ratio. An acceptable level of the gearing ratios is determined by comparing these key ratios with those of the competitor companies or other similar sized companies operating in the same industry. A high gearing ratio is considered to be bad for the company because it is indicative of the high vulnerability of the company to the changes in the external environment. A company with high financial leverage may be excessively dependant on debt and may be adversely impacted by the downturns in the business cycle. On the other hand, a low gearing ratio would indicate that the company has a strong equity position which would act as a cushion for the business. Ratio analysis is done for few years to compare the financial and operating performances of a company on a year on year basis. The trend of the ratios from year to year indicates whether the performances of the company is improving or deteriorating over a period of time. Also, the ratios are compared across various companies operating in the same industry to get an idea of the competitive performances and comparative valuations. As discussed by Lasher (2012), Key financial ratios of a company can also be compared with the industry standards to evaluate the performance of a company with respect to the industry in which it belongs (Lasher, 2012). As per the work of Moyer, McGuigan, Rao and Kretlow (2012), ratio analysis forms an important tool for fundamental analysis of a company and is often used by the investors to evaluate the fundamentals of a business for investing purposes (Moyer, McGuigan, Rao and Kretlow, 2012). Ratio analysis can provide with early signs of any potential deterioration on improvement in the financial position or performance of a company. Successful businesses tend to have strong ratios in all the areas of analysis. The maintenance of solid ratios in terms of profitability, liquidity, solvency and efficiency are critical for the maintenance of the stock prices of the company in the capital markets. Certain ratios need to be closely scrutinized for interpretation because of their variation on the basis of the relative industry of operation for the company under consideration. Research methodology  Methodology is the way to find out the result of a given problem. This is the way through which researchers use different techniques to find a solution for their research results. The purpose of the study is to analyze the liquidity and profitability position of Walmart. This research will concentrate on the results of three years of 2012, 2013 and 2014. The research question is Evaluation of liquidity and profitability position of Walmart. In this research paper secondary data will be collected. All the data will be collected from the annual reports of Walmart and from Yahoo Finance sites. The scope of the research is very high. It will help both the management of organization and all stake holders related with the company. This research will give a clear picture about the organization’s profitability and liquidity. This research will help share holders to take a very close look at the liquid conditions of the company. It will help to understand about the company’s profitability scenario. This research will provide a competitive analysis of different financial indicators related with Walmart. During the course of this research different ratios like Current Ratio, Quick Ratio, and Cash Ratio will be calculated. All these ratios will go to describe the liquidity position of the company. These ratios will help to understand how the company is prepared to pay back its all current payables. On the other hand Gross Margin, Operating Margin, Pre-Tax Margin and Net profit Margin will be calculated. These ratios will measure profitability scenario of the organization. The whole empirical analysis will be done on the basis of different ratios. The research is not only very important for share holders but also very important for whole society. An organization like Walmart has very serious contributions towards society. Lots of people from different parts of the world are connected with the company. This research paper will help them to get a feel about the financial position of the company. Here ratios of three years will be calculated. This will give a comparative study about the liquidity and profitability position of the company. This will provide a rough trend about the financial performances of the American giant retailer. Different ratio analysis will help all stakeholders to understand financial performances in a very simple manner which is a very significant scope of this research paper. Modern lives are very busy. People have very less time to find important financial indicators from the annual reports of the company. This research paper will help them to get different important indicators in very short period of time. Apart from external customers this research has very important scopes for internal customers also. With the help of this research, management of the organization can forecast and plan their future activities. This research has great scope for communication. Ratios are all empirical evidences. All these empirical evidences will help to communicate different financial performances in a precise and effective way. The research will open huge opportunity in front of the management of Walmart. All these ratios will help the company to take firm control over its different operations. This research has some scopes for Government also. With the help of this research Government can understand the present liquidity and profitability position of Walmart. In modern business demands are unlimited but recourses are very limited. This research will help the organization to allocate their resources properly. This research will act as a mirror from which the company can get the image of their financial performances. This research will play a very important role in measuring financial performances of Walmart. Empirical analysis: calculations, ratios and charts  Here in this research paper empirical analysis will be done on the basis of two different financial aspects. One is on the basis of liquidity and other is on the basis of profitability. Liquidity Analysis Liquidity ratios determine company’s financial capacities to pay back its all short term debts. Liquidity ratios indicate that whether Walmart can convert its short terms assets in to cash if it is required. Year 2014 2013 2012 Liquidity ratios       Current Ratio 0.88 0.83 0.88 Quick Ratio 0.24 0.22 0.23 Cash Ratio 0.10 0.11 0.11 Current ratio of Walmart has been calculated on the basis of its current asset and current liabilities. Calculation and the graph are showing that current ratio of the company is same in 2012 and 2014. In 2013 current ratio of the organization was slightly low. Differences in three years are very low. This ratio is indicating that company has some concern in terms paying back its short term liabilities with the help of short-term assets. The organization has current ratio which is lesser than 1 in consecutive three years. It is a matter of concern for the organization. It is not that the company will face very serious problem regarding liquidity but certainly it is not a very good sign for Walmart. It shows that the organization is facing liquidity crunch. It also indicating that inventory turnover of the company is very high causing this liquidity problem for Walmart. It is a big company so inventories are also very high for the company. This ratio is also a bad sign for its suppliers. The company is facing liquidity problem so, payments to suppliers can be delayed. This ratio indicates Walmart’s ability to pay back its short terms debt with the help of most liquid assets of the company. During the course of quick ratio calculation inventories of the company are being excluded from the list of current assets. Inventories cannot be converted into cash very quickly. Quick ratio applies more conservative approach in terms of Walmart’s liquidity analysis. In these three years the organization has best quick ratio in 2014 and worst quick ratio in 2013. It shows that in 2014 the company was more financially secure than other two years. Generally 1 should be the bench mark ratio. But here in this research it is showing that the organization is no way near in terms of that bench mark. This graph is showing that in 2013 the organization was overleveraged and was facing problems in terms of growing their sales. It also signifies that in 2013 the organization was paying their bills very quickly but bills receiving were very slow. One thing is very clear that in all three years the company has almost very similar quick ratios. It shows that it is the liquidity trend of the company. Cash ratio of Walmart indicates the ability of the company to pay back its all short term debts with help of cash assets only. Cash is the most liquid assets. During the course of this ratio calculation inventories and all bills receivables are excluded from assets. Only cash assets of the company are considered for this ratio. It is very difficult for any company to meet its all short term obligations on the basis of only cash assets. Walmart is also same. Walmart doesn’t hold too much cash assets. Too much holding of cash assets is a sign of poor assets utilization. The above graph is showing that the organization has very low cash ratio in all three years. It signifies that the company has utilized their cash assets up to full extend. Differences in three years are very less. In between that narrow margin of differences in 2013 the organization had best cash ratio. It is not necessary that Walmart have to hold too much cash. It is an intentional ploy of the company, not to hold too much cash. Profitability Analysis Profitability ratios of Walmart signify company’s ability to generate earnings in comparison with its expenses and its different related costs incurred during a specific time period. These ratios will help to understand financial performances of the organization. Year 2014 2013 2012 Profitability Ratios       Gross Margin 0.2482 0.2483 0.2498 Operating profit margin 0.0564 0.0592 0.0593 Pretax profit margin 0.0518 0.0548 0.0545 Net profit margin 0.0336 0.0363 0.0352 Gross profit margin of Walmart has been calculated on the basis of revenue and gross profit of the company. It is a very important profitability ratio. This ratio determines the paying of operating expenses. This ratio indicates financial health of the organization. This ratio explains gross profit of the company in proportion to sales. The ratio indicates that how efficiently Walmart is utilizing its materials and workforces in their whole process. It also tells about the efficiency of USA based company. It is very evident from the research that in these three years gross profit margins of the organization were almost same. In 2012 gross profit margin of the company was slightly high. It states that in 2012 Walmart has utilized its workforces and material slightly effectively than other two researched years. It shows that there are very little differences in last three years in terms of company’s manufacturing and distribution efficiencies. It also shows that company has managed its production costs better in 2012 than in other two years. Gross profit margin trend is showing that in these three years company’s production efficiencies were almost similar. Operating profit margin ratio of Walmart has calculated on the basis of operating income and total revenue of the company. It shows how much company’s revenue is left after making all payments related with overheads and direct costs. With the help of this ratio company’s operating efficiency and pricing strategy can be measured. It provides one clear idea about how much money Walmart makes on every dollar of sales. Generally high operating margin is preferable. Results in this research are showing that operating margin of the organization is decreasing. In 2014 the company recorded lowest operating margin in compare to last two years. It shows that company’s earnings from per dollar sales have reduced in 2014. This is not at all a good financial indicator for the organization. It clarifies that in 2014 fixed costs of the company were highest in respect to sales or production volume of that year. In 2012 and 2013 operating profit margins were almost similar. The above research result and graph states that volume of sales and production has direct impact on Walmart’s Operating profit margin. Pretax profit margin has been calculated on the basis of income before tax and total revenue of the Walmart. It indicates Walmart’s earnings before tax with respect to the revenue of the organization. Higher pretax profit margin is a good financial indicator. Higher the pretax profit margin signifies good profitability of the company. Lower pretax profit margin is an indicator of lower profitability. This is a very important financial indicator for Walmart to keep track in which direction their profitability is going. This ratio helps to analyze that how efficiently the organization is earning profits before paying its all taxes on the basis of current sales volume. The company can manipulate different taxes in different ways. Higher pretax profit margin symbolizes operation costs of the company is low. The results of this research are showing that Walmart registered lowest pretax profit margin in 2014. In other two years the ratios were almost same. It tells that profitability of the organization has reduced in 2014. It is a worrying sign for the company. Net profit margin of the organization has been calculated on the basis of net income and revenue of the company. It is one of the most important profitability ratios of a company. It indicates a fact that how the company is translating per dollar earnings into profitability. High net profit margin is very important and desirable for Walmart. Low profit margin is a serious risk for the company. Higher profit margin indicates greater control of the company over different costs. This ratio is very important for the shareholders of the company. It gives share holders a clear picture about the company’s ability to convert revenues into profitability. In 2013 net profit margin of the company was highest in compare to other two years. In 2014 net profit margin of the company has decreased significantly. It is not a very good indication for shareholders and Walmart. Lowering trend in net profit margin can be a serious matter of concern for the organization. Conclusion & recommendations Modern day business is ever-changing. Change is the only constant thing in this world. The above research is showing that company’s overall liquidity ratio and profitability ratio is not very impressive. Being a large company the organization has very large inventories. Which is disturbing company’s liquidity position. The organization is in retail industry. Walmart is a global player. Its large operational areas are hampering company’s profitability scenario. Different mathematical ratios are concluding that Walmart has huge scope of improvement as far as liquidity and profitability is concerned. The research is indicating that in last three years organization’s liquidity and profitability situation has not changed that much. There were very little changes. Financial performances in these three years are not very encouraging for all of its stake holders and management. Walmart has to reduce its inventory turnover. The organization has to delay its payments and must seek for higher credit periods from its suppliers. The company must try to reduce its operating costs. It must utilize its all non performing assets very efficiently. The organization must concentrate towards its efficiency. Productivity of the company must be increased. It should focus on its overhead costs to increase profitability. Walmart must increase its volume of sales and production. The organization must reduce its lead time. The company can down size the number of employees. It can divest long time nonperforming business centers for higher profitability. Walmart has to be very much proactive in terms of their financial strategies or decisions. There is no scope of complacency for the company. References Brigham, E. F. & Houston, J. F. (2012). Fundamentals of Financial Management, 7th Edition. Nashville: South Western. Ehrhardt, M. C. & Brigham, E. F. (2013). Financial Management: Theory and Practice, 13 Ed. Nashville: South Western. Keown, A. J., Martin, J. D. Petty, J. W. & Scott, B. (2011). Foundations of Finance. New Jersey: Prentice- Hall. Lasher, W. R. (2012). Practical Financial Management. Nashville: South Western. Moyer, R. C., McGuigan, J. R., Rao, R. P. & Kretlow, W. J. (2012). Contemporary Financial Management, 12th Edition. Hampshire: Cengage Learning. Read More