Profitability Analysis for Coca-Cola - Essay Example

Profitability Analysis for Coca-Cola Introduction The target company for the report is Coca Cola. Coca Cola has been one of the world’s top most brands in recent years in the beverages industry. With operations in more than 25 countries in the world, Coca Cola has enjoyed lion’s share of the market. One of the accepted ways to evaluate value and performance of a company is to look at its financial statements and derive the financial ratios for the company. These ratios can then be compared with the company’s past performance as well as with industry’s averages in the domain in which the company operates. Coca Cola has been established since a long time and have a strong value and internal performance management system. This study focuses on the financial values of the company by carrying out a ratio analysis for the company and comparing the results with industry averages. Financial Ratio Analysis Financial ratio analysis provides an instant way to evaluate performance of a company by comparing its financial ratios with its own past performance and the industry average in the domain in which the company operates. Hence, it is necessary to perform a comprehensive financial analysis of Coca Cola for us to make an opinion about the company’s value and performance management systems. A brief analysis of Coca Cola with regard to its performance in terms of financial ratios is provided below: Financial Conditions Ratios The financial conditions ratios are used to develop an understanding of the company’s financial health. These include ratios to analyse the liquidity position of the company which represents the ease with which a company can change its current assets into cash to meet its short term liabilities. In addition, the liquidity ratios can be used to find out if the company is vulnerable to short term insolvency which might lead to the company getting bankrupted in the long run. Many ratios can be calculated to find out the liquidity position of the company and hence its financial conditions, but some important ones have been discussed below to provide an insight about Coca Cola’s financial conditions since the last ten years or so. Quick Ratio Quick ratio is given using the formula shown below: (Current Assets – Inventory) / Current Liabilities Coca Cola’s quick ratio for the year 1996 remained at 0.67 which is much smaller than industry’s average of 0.9. This shows that the company was not able to meet its short term obligations using its liquid assets. As per the recent results, the company has improved its performance with its quick ratio now being 0.8 exactly equal to the industry average. This shows a healthier sign than what the company used to be 10 years ago. Current Ratio The current ratio for the company used to be at 0.8 as compared to industry average of 1.20 in 1996. In the year 2006, it increased to 0.9 with an industry average of 1.1. Hence, a slight improvement is seen over the ten years’ figures. Current ratio is given by: Current Assets / Current Liabilities It shows the financial position of the company. The company’s current ratio is showing a very impressive picture about the liquidity of the company. Management Efficiency Ratios The management efficiency ratios are used to find out the level of commitment the top and middle management has towards attaining the company’s goals. This is determined through analysing the management operating philosophies and policies that have been put in place for the conduct of business. In addition, these are used to find out specific instances of management’s lack of interest towards achieving organisational efficiencies and effectiveness. Some of the important management efficiency ratios are discussed below for Coca Cola for the last ten years. Income/ Employee ratio This ratio provides an indication of the return earned by a company per employee. The higher the ratio, the better is the company’s performance with regard to providing better employment opportunities to its employees. The current income/employee of Coca Cola is $73,746 which is much higher than industry average of $46,486. Hence the company is doing great in adding value to its employees’ work experience and is also earning substantial returns per employee. There are thousands of employees in the company and such high income per employee shows that the company is doing really well in this area. Inventory Turnover ratio Inventory turnover is given by the formula: Inventory turnover = Sales / Inventory The inventory turnover ratio for Coca Cola in 1996 was 7.08 which was better than the industry average of 5.0. In 2006, the inventory turnover ratio reduced to 5.0 which is much lower than the industry average of 7.4. This shows that Coca Cola is doing relatively poorly in managing its inventory levels in comparison with the sales that they generate. This might be due to poor management practices or efficiency degradation. The peers of Coca Cola are doing much better in this area as shown by the figures above. Receivable Turnover ratio Receivable turnover ratio provides the indication about the ability of a company to collect its outstanding debt in reasonable period of time to prevent from losses due to bad debts. The ratio is given as: Receivable Turnover Ratio = Sales / Accounts Receivables Coca Cola has a receivable turnover ratio of 10.0 as compared to its peers that are performing at industry average of 10.3. This is reasonable since it is not too low than the industry average for beverage industry. A variant of receivable turnover ratio is the average collection period which is the number of days it takes for a company to receive its outstanding debts. Coca Cola, in 1996, used to take almost 64 days to recover its debts as compared to the 40 days which was industry average. Hence the management of the company has performed well in this area as well. Asset Turnover ratio Assets turnover ratio provides an indication about the efficiency of management to convert the company’s assets to generate sales and revenue. It is given as: Assets turnover ratio = Sales / Total Assets The asset turnover ratio of Coca Cola used to be at 1.15 while the competitors and peer were doing at 1.4 in 1996. In 2006, however, the company performed at 0.8 with industry average of 1.0. This shows that the asset turnover ratio for the entire industry declined in the last ten years and Coca Cola took a hit as well. Price Ratios Price ratios are used to determine the impact of company’s policies and procedures on its shareholders. These ratios are of particular interests to new and existing shareholders as they provide information about a company’s marketability and its image in the minds of its customers. These ratios revolve around the current price level of the company’s stock, hence are called price ratios. Some of the important price ratios for Coca Cola for its performance in the last ten years have been calculated and discussed below: Price/ Earning Ratio The price / earning or P/E ratio for Coca Cola was 38.26 in 1996 with no industry averages available to compare. However, in 2006, this ratio reduced to 23.1 with industry average of 21.5, hence it shows an improvement over the industry for beverage products. Price to earning ratio provides an estimate of a company’s share prices with the level of earnings a company has. A higher ratio shows that stockholders trust the company and are willing to place a higher price for its stocks. Price/ Sales Ratio The price to sales ratio of a company provides information about the price levels of its stock as compared to the sales that the company has generated in the year. Coca Cola’s price to sales ratio is 4.78 in 2006 against the industry benchmark of 3.39. This shows that Coca Cola has a higher than industry price to sales ratio. This would mean that the shareholders have a positive image of the company and are willing to invest in it. Hence the company is doing relatively good in this front as well. Price/ Book Value ratio This ratio provides information about the company’s current market price of its shares and the book value of its shares. The higher the ratio the more is the acceptance of a company’s shares in the market. Coca Cola’s price to book value ratio is 6.92 which is higher than the industry average of 6.22. This shows better performance by Coca Cola and shows that shareholders value the company and are willingness to invest in the company at higher prices than the book value of the shares. No information could be obtained about price to book value ratio for Coca Cola for the year 2006. Price/ Cash Flow Ratio The price to cash flow ratio for Coca Cola is 19.20 as compared to industry’s average of 16.40. Hence, Coca Cola is operating fine here as well. The price to cash flow ratio provides an indication of the level of trust market shareholders have on the company’s cash flow situation and how do they rate the company’s performance in generating cash flows. The higher the price to cash flow ratio for a company, the better it is for the company’s management. Investment Returns Ratios The investment returns ratios are specifically required to find the company’s investment efficiencies and effectiveness. These provide the needed information about the profitability of a company’s investments in near term and long term instruments. Some of the important investment returns ratios for Coca Cola for the last ten years have been discussed below: Return on Equity ratio The return on equity ratio is given by the following formula: Return on equity ratio = Net profits / Total Equity The return on equity ratio for Coca Cola was 55% in 1996 as compared to industry average of 57%. In 2006, the return on equity ratio for Coca Cola is 32 as compared to industry’s average of 27.8. This shows that the company is generating higher margins and higher returns as compared to the equity that has been put in the company. This situation should be very satisfying and shows that the performance of management has been consistently well. Return on Assets Ratio Return on Assets (ROA) is one of the most important ratios that is used to figure out the profitability of a company. It shows the rate at which assets of the company contribute towards generating income for the company. It is given as: Return on Assets = Net Profit / Total Assets In 1996, return on assets ratio for Coca Cola was 20% which was almost equal to the industry’s average of 22% at that time. In 2006, the company has done extremely well to increase its return on assets ratio beyond the industry average. The return on assets for Coca Cola in 2006 has been 16.6% as compared to 14.5% industry average. Though it has declined than what it was 10 years ago, yet the company has managed to perform considerably better than its competitors and peers in the same industry. Return on Capital ratio The return on capital employed for Coca Cola has been 25.2% which is over and above the industry average of 20.6% in 2006. This again represents a healthier sign and shows good performance of the company. The return on capital employed provides an indication of how well the company is able to utilise the invested funds towards generating revenue and income for the company. Profitability In order to provide an analysis on the profitability of the company, we need to consider various profitability ratios and margins. Based on the results of these ratios, it can be said whether the company is performing well or poorly in the profitability areas. Profitability ratios provide indications about the state of the company with regard to generating profits. Some of the profitability ratios that are important for analysis are discussed below for Coca Cola. Gross Margin Gross margin is given as: Gross margin = Gross profit / Sales This provides an estimate of how well the sales are able to generate profit for the company. The gross profit margin for Coca Cola was 61.5% in 1996 with an industry average of 63.7%. The same in 2006 has been 65.6% with an industry average of 51.5%. This shows a magnitude increase in the profitability of the company in recent years which might be attributed to better performance in terms of reducing costs and inventory expenditures. The company is performing well above the industry benchmarks and this is a point of satisfaction for the company and its management. Pre-Tax Margin The pre-tax profit margin is given as: Pre-tax profit margin = Earning Before Interest and Taxes / Sales The pre-tax profit margin for the company has been high in recent years with 2006 figures showing a pre-tax margin of 27.4% well above the industry average of 19.5%. This is almost 50% more than what the peers of Coca Cola are performing. This shows an extremely profitable result even after deduction of all expenses. Coca Cola has been performing well above the benchmarks. In 1996, the company’s pre-tax profit margin was 24% as compared to industry benchmark of 25% in the same period. Hence, it was almost same as the industry average in that period as well. Net Profit Margin The net profit margin is given as: Net Profit Margin = Net Profit / Sales The net profit margin provides key information about the profitability of a company. It tells about the overall profit of the company after deducting all expenses as a percentage of the revenue that is generated through sales. The better the management of company’s resources the lesser will be gross and operating costs and thus, a higher net profit margin. The net profit margin for Coca Cola in 1996 used to be at 16.6% well below the industry’s average of 18.8%. This shows that the company was not doing very well with regard to its profitability and bottom line. However, in 2006, we see that the net profit margin has grown to 21% well above the industry average of 15%. This shows an enhancement of might proportions. Coca Cola now enjoys the greatest profit margin over all the beverage industry companies. This has been made possible by continuous hard work and dedication of its employees and good policies by top management of the Coca Cola Company. 5-Year Averages In addition to current profitability margins, the company has enjoyed high margins since the last 5 years. As shown in the table below, the gross margin for the last five years has been 64.4% against an industry average of 58% which is better than the peers of the company. Similarly, 5 year pre-tax profit margin for the company has been 28% which is above the industry average of 19.7% for the last five years. The net profit margin for the Coca Cola Company has been 21.1% for the last five years which is again higher than the industry averages for the same period. Industry averages are14.6% for the last 5 year net profit margin. This is summarized in the table below: Metric Coca Cola Industry Benchmark 5 Yr Gross Margin (5-Year Avg.) 64.4 57.9 5 Yr PreTax Margin (5-Year Avg.) 27.9 19.7 5 Yr Net Profit Margin (5-Year Avg.) 21.1 14.6 Conclusion The above analysis was carried out to identify the state of Coca Cola and its performance in recent years in enhancing value and performance for management, employees, shareholders, and stakeholders. The company, Coca Cola, has shown a great improvement in its performance over the years. This is further endorsed by the financial ratios that are calculated and discussed above. The company’s performance has grown exponentially. New and better processes have been implemented, existing processes have been tuned to provide maximum efficiency and effectiveness and competent workforce is hired and maintained by the company. The company is performing well above the benchmarks that have been set by the entire beverage industry. There are visible performance improvements and this trend is likely to continue. In almost all areas, the performance of the company has been above average, though previously, the company was not doing well but the management has introduced policies and systems that have changed the entire picture in the company’s favour tremendously. Hence it can be concluded that Coca Cola has been instrumental in identifying areas of weaknesses in their systems and were quick to eliminate these weaknesses to arrive at a high value and performance management system that is now giving dividends to its investors and other stakeholders. References MSN Money. (2007). Key Financial Ratios: Financial Results – The Coca Cola Company [Internet]. Available from: [Accessed June 10, 2007]. Kuhle, J., Pope, R., Walther, C. (1996). “Teaching the Fundamentals of Fundamental Investment Analysis”. California State University, Sacramento. Read More