HP Financial Analysis & Strategic Management Decisions - Case Study Example

HP Financial Analysis & Strategic Management Decisions Student’s Name Institutional Affiliation A. HP’s Strategic Decisions & Impacts on Its Financial Health 1.0 Introduction According to Andrijasevic and Pasic (2014) the use of financial ratios is, by far, the most used technique of establishing the immediate financial condition as well as earning capacity of a given company. In essence, the most fundamental purpose of ratio numbers rests with enabling the evaluation of financial condition or rather the financial health of an entity, and also the trend of changes in the financial situation. It is important to note that financial analysts apply financial ratios in order to determine the exact financial health of a given entity. Financial health of a company refers to its financial situation and profitability (Hasprová & Pur, 2013). It thus goes without saying that a positive financial health means that a company enjoys enormous profitability and financial condition in relation to its liquidity, management of assets as well as market shares. It is crucial to note that in the course of computing and interpreting financial ratios in order to establish the financial health, then it is important to do so in light of the specific industry standards lest resulting to a wrong interpretation altogether Simić, Kovačević, and Simić (2012) ascertains that financial ratio analysis is indeed a stimulus to perfect managerial practice and undertakings and thus, it is applied in numerous corporate appraisals. In essence, it is noted that it is particularly useful in aspects related to strategic management; an area of management that focuses on addressing the future survival of most corporate (Hasprová & Pur, 2013). 2.0 Strategic Decision Made by HP Management Some of the notable strategic decisions made during the period are outlined as below; In its Printing business section, the company ascertains that it is greatly impacted by growth in mobility, weaker consumer demands and a competitive pricing operating environment. To mitigate these challenges, the management has made a decision to execute on fundamental initiatives by focusing on products that are meant for high usage specifics, formulating emerging market opportunities and, also launching newer revenues delivery platforms (HP, 2013, pg.46). The management has embarked on implementing an improved channel execution; pursue new product innovation like the HP Moonshot servers, 3PAR and blade servers as well as wireless networking (HP, 2013, pg.46). The decision is aimed at countering the existing declines in multiple market trends as well as highly competitive pricing operating environment. The management has set to execute on a multi-year turnaround plan that seeks to reduce costs by aligning them with revenues trajectories and, also the management team has resorted to formulation and implementation of improved execution in areas related to sales performance, pricing and contracting practices (HP, 2013, pg.46). The decision is expected to reduce on macroeconomic pressures being experienced by the firm as well as the existing competitive pricing environment. HP management has also resorted to improving on the company’s go-to-market execution model by incorporating a customer related solution framework in order to align it with customer demands hence attain even greater integration on its overall portfolio (HP, 2013, pg.46). The decision also seek to assist with capitalisation of crucial market opportunities especially in areas related to big data, security and mobility (HP, 2013, pg.46). 3.0 Analysis Financial Ratio/Year 2006 2007 2008 2009 2010 2011 2012 Gross margin 24.25 24.36 24.42 23.59 23.76 23.35 23.24 Operating margin 7.16 8.36 8.85 8.85 9.11 7.61 -9.19 ROA (%) 7.78 8.51 8.25 6.72 7.32 5.57 -10.62 ROE (%) 16.46 18.95 21.50 19.28 21.64 17.89 -41.43 Free Cash Flow/ Sales (%) 9.62 6.30 9.80 8.45 6.18 6.37 5.70 Liquidity/Current Ratio 1.35 1.21 0.98 1.22 1.10 1.01 1.09 Inventory turnover 9.49 10.00 11.24 12.50 15.26 13.98 13.38 (Source: http://financials.morningstar.com/ratios/r.html?t=HPQ) From the table above, it can be noted that the company’s profitability ratio reduces significantly in the 8-years period between 2006 and 2013. The decrease in the ratios values like ROA, ROE and operating margin is an indication that the entity sales performance as well as its pricing model is inefficient. In fact, it is due to this that HP management has resulted to formulating emerging market opportunities and, also launching newer revenues delivery platforms in periods after 2013. Free cash flow/sales ratio also decreases within the period, which is an indication that amounts of revenues being translated to cash has also reduced greatly. This can be related to the management’s decision to adopt a multi-year turnaround plan that seeks to reduce costs by aligning them with revenues trajectories and, also the management team has resorted to formulation and implementation of improved execution in areas related to sales performance, pricing and contracting practices. 4.0 Critique In my opinion, the financial health of the company was directly linked to its strategies especially in decisions related to improving on its sales performances and introduction of policies needed for countering the existing competitive pricing environment. The impact of these decisions are major since it tackles the different areas related to improving revenues like aligning costs with revenues trajectories. B. Competitors Analysis 1.0 Introduction HP management ascertains that it is exposed to intensive level of competition in almost all areas of their business activities. A competitor is perceived to be an immediate rival for common customers. The firm’s competitors are focused on production and distribution of similar products and services. These competitors also seek to rival the company in relation to its technology, performance mechanisms, and prices, reliability of products as well as distribution channels and infrastructure. HP seeks to remain competitive by way of devising and implementing an efficient pricing model that will focus on increasing sales performance as well as gaining substantial market share. Industrial benchmarking techniques are the core processes that financial analysts use in order to come up with the most efficient performance analysis for entities operating under a given industry or sector (Schefczyk, 1993). For this case, Hewlett Packard Inc operates under the global technology sector. The benchmarking process involves the analysis of financial statements like the income, balance sheet and cash flow statements in order to establish a given operational degree that can later be used for analysing the entities altogether (Sridharan, 2015). 2.0 Background of HP Competitors Most of HP competitors are aligned to different products as described below; In personal systems unit: the Company’s markets for which personal systems operate are deemed to be competitive in nature and are attributed to elements of price competition as well as inventory depreciation. The recently experienced contraction within the PC market as well as the paradigm shift of customers to tablets usage has resulted to even more competition. Under this product category, HP’s main rivals include Lenovo Group Limited, Dell Inc, Acer Inc and Apple Inc. Other notable competitors include; Toshiba and Samsung Electronics Corporations Ltd. In the product line, the company also experiences intensive competition from local companies as well as from generically-branded manufacturers. In its printing unit, HP is subjected to primary competition from such companies as Lexmark, Xerox Corp, and Samsung. In its software business unit, the firm competes with such companies as IBM. In Following the above analysis, it can be noted that the major competitors include; Dell Inc, Samsung, IBM and Apple Inc. Methodology In conducting the financial analysis, the paper makes a comparison of notable financial ratios; liquidity, profitability, efficiency and solvency for three major competing firms (Wang, 2014). The analysis will tackle the major competitors, which are noted above as Apple Inc, Samsung and Dell Incorporation. The first section of the analysis involves gathering ratio values as accessed in one of the most popular and reliable financial analyst database: MorningStar before going forward and making a comparison of these ratios in a three-year minimum period between 2010 and 2012. It is important to note that the analysis seeks to establish the financial health of HP in relation to these three major competitors before making any possible recommendation and conclusion regarding its performance. 1) Liquidity Ratios Year 2010 2011 2012 Current Ratio: HP 1.10 1.01 1.09 Apple 2.01 1.61 1.50 Samsung 1.54 1.61 1.86 Dell 1.28 1.49 1.34 Analysis From the table above, the current ratios for all firms; except Samsung, decreases over the period. However, despite the decrease in the ratios, HP’s ratio value is still positioned below the others indicating that unlike the competitors, it is having difficulties to meet its short-term obligations as and whenever they fall due (Helfert, 2002). Samsung’s is positively high above the rest postulating that it is fairly placed to meet its short term obligations on time. 2) Profitability Ratios Year 2010 2011 2012 ROA: HP 7.32 5.57 -10.62 Apple 22.84 27.07 28.54 Samsung 12.82 9.47 11.96 Dell 4.76 7.29 8.40 Analysis From the table, it can be noted that HP ROA is positioned way below the other firms hence the industry average. In fact, the ratio is negative hence an indication that the firm’s management have not devised effective strategies and models needed for improving the sales performance and thus, revenues (Helfert, 2002). It also means that the firm does not operate an effective and competitive pricing model for its products and services hence more assets are utilised to make insignificant or even less sales over the period (Helfert, 2002). Year 2010 2011 2012 ROE: HP 21.64 17.89 -41.43 Apple 35.28 41.67 42.84 Samsung 20.43 15.03 18.78 Dell 28.91 39.31 41.86 Analysis From the table above, it can be seen that HP’s return on equity (ROE) is positioned below the competitors over the three-period. In fact, the ratio decreases significant to a negative value while the rivals enjoy a positive value that sits above 18.78% (Samsung’s ROE). This is an indication that the firm: HP, in comparison to its rivals is not placed fairly to generate enough returns for each of the shareholders equity invested. This is particularly true because the management has taken strides to ensure that they reduce the costs by aligning them with revenue trajectories in a bid to increase overall revenues (Helfert, 2002). Notably, it is noted that the company has suffered weaker consumer demand while still facing a challenge with the underlying competitive pricing operational environment that has resulted to reduced sales revenue growth over the period. Year 2010 2011 2012 Operating Margin: HP 9.11 7.61 -9.19 Apple 28.12 31.22 35.30 Samsung 11.19 9.85 14.44 Dell 4.11 5.58 7.48 Analysis From the table above, it can be seen that HP’s ratio value decreases over the three-year period while its rivals enjoys an improvement on the same. In fact, while other ratio values all remain to be positive over the period, HP’s ratio is negative. This is indication that the firm suffers from insufficient revenues needed for covering non-operating expenses like interest expenses in the future (Helfert, 2002). It does not possess the capacity to translate income into operating income given that it is downtrodden by variable costs in the course of daily operations. 3) Efficiency Ratios Year 2010 2011 2012 Inventory Turnover: HP 15.26 13.98 13.38 Apple 52.51 70.53 112.12 Samsung 8.85 7.71 7.57 Dell 45.51 42.60 35.68 From the table above, it can be seen that HP’s inventory turnover ratio is only positioned above that of Samsung but sits way below Apple and Dell. It therefore goes without saying that it is only HP and Samsung that has a lower capacity to sell their stocks and replace them faster within the period, which fairly explains its poor sales performance and decreased revenues over the period (Helfert, 2002). It also means that the underlying management team is somehow inefficient in developing policies necessary for executing enough sales (Helfert, 2002). This is the reason behind the strategic decision of formulation a go-to-market business model that seeks to improve on demand and, also the emphasis of product innovation for newer products like HP Moonshot Servers and 3PAR. Year 2010 2011 2012 Asset Turnover: HP 1.05 1.00 1.01 Apple 1.00 1.13 1.07 Samsung 1.25 1.14 1.19 Dell 1.76 1.70 1.49 Analysis From the table above, it can be noted that all of the companies have an asset turnover ratio above 1. However, HP’s ratio sits below its competitors in the three-year period. The lowly-placed ratio is an indication that HP’s, unlike its competitors, is unable to efficiently use its existing asset-base to generate enough sales (Helfert, 2002). This can be greatly attributed to the inefficiency in management policies in relation to sales performance. It is also a result of poor pricing mechanism of the company’s products and services. 4) Solvency Ratios Year 2010 2011 2012 Debt/Equity: HP 0.38 0.58 0.97 Apple - - - Samsung 0.01 0.05 0.05 Dell 0.61 0.61 0.72 Analysis From the ratio table above, it can be seen that HP’s debt to equity ratio increases over the period and sits above its rivals hence industry averages. It means that the entity has resorted to increasing its overall debt funds in comparison to its rivals and this indicates a bad financial health for the firm. The risks associated with increasing debt funds over time as opposed to making efforts to strike a balance is likely to result to huge interest expense burden over the years (Benninga & Oded,1997). In fact, with the increase in the ratio, the company seems to utilise most of its income to pay-off interest costs resulting to poor net income. 4.0 Future Prospects of HP in Relation to Competitors In regards to solvency, HP is likely to engage more in debt funds as opposed to equity finance, which poses a future risk of using much of its revenues to pay-off interests and, another possibility of losing its control capacity to suppliers (Fisher, Heinkel & Zechner, 1989). The company’s profitability lies in the balance perhaps because of the current competitive pricing environment as well as weaker consumer demand for personal systems, which forms a significant section of its business activity. It is thus fair that the management resort to implementing the strategic decisions in a bid to counter the aggressive competition being witnessed in the market. C. Recommendations 1.0 Introduction Financial improvement is a term used to denote the ability of a company to decrease its underlying costs in order to increase on its revenues. It means cutting down any unnecessary variable costs in order to improve on its operating income. Subsequently, reasonable financial objectives indicate the possible recommendations upon which an entity should strive to accomplish in order to improve on its financial position. These objectives are termed to be reasonable because they should be realistic and achievable at the same time. A performance gap analysis is a formal way for which organisations and individual personnel use to identify the correct gaps that exist between a desired level and the actual levels of performance (Chevalier, 2010). In fact, entities use a performance gap analysis model to compare its current conditions and undertakings so that they can effectively identify areas that vehemently need great improvements with relation to compliance to industry standards and expectations (Chevalier, 2010). A gap analysis allows the immediate review of operations in regards to adequacy, suitability, effectiveness and compliance. 2.0 Analysis Year 2012 (in millions) 2017(Expected) (in millions) Expected % Vs Actual Net revenues 77,887 90,000 13.5% Total Revenues 120,357 150,000 19.8% Total Operating Expenses 131,414 130,000 (1.1)% Net earnings (loss) (12,650) 20,000 258.1% Total current assets 50,637 100,000 97.48% Total current liabilities 46,666 40,000 (14.3%) Long term debt 21,789 10,000 (54.1)% Total stockholders’ Equity 22,833 30,000 31.4% 3.0 Recommendations The 19.8% total revenues performance gap can be successfully closed by the company through adopting effective pricing policies like allowing possible discounts to customers in order to trigger enormous sales revenues. HP can also embark on embracing rigorous marketing campaigns aimed at sensitising even more potential clients into consuming the already available products and services. The effort needed in ensuring that there is a steady flow of customer should be related to improving on consumer-based solutions so that these products and services are manufactured with the sole purpose of meeting customer’s immediate demands. The current efforts being made by the company in relation to extensive product innovation will ensure act towards improving revenues as it will help attract new customers into purchasing products they need. Consequently, the company can ensure to cut down on the existing total expenses to a manageable level. It is recommended that HP make effort to cut down on unnecessary expenses that do not result to sales. For instance, it should eliminate inefficient administrative costs by restructuring its organisations levels. It should also cut down on interest expense by emphasising on equity funds as opposed to debt funds, which attract unreasonable amounts. Subsequently, it is recommended that the company make efforts to reduce the current level of long term debt from $21M to at least $10M. This can be achieved by encouraging other forms of equity funds like rights issue. It is important to note that unlike equity funds, debt finance attracts lots of interest expense, which is one of the causes of the rather lower net earnings within the three-year period. Additionally, it is important that the company increase on its underlying stockholder’s equity by at least 31.4% in the five-year period ending 2017. In order to achieve this, management should make sure to eliminate unnecessary liabilities like accrued restricting and other accrued liabilities that seem to make a huge percentage of the overall total liabilities within the period. References Andrijasevic, M., & Pasic, V. (2014). A Blueprint of Ratio Analysis as Information Basis of Corporation Financial Management. Problems of Management in the 21St Century, 9(2), 117-123. Benninga, S, & Oded S. (1997). Corporate finance: A Valuation Approach, McGraw-Hill, New York. Chevalier, R. (2010). Gap analysis revisited. Performance Improvement, 49(7), 5-7. Fisher, E, Heinkel, R and Zechner, J. (1989). Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19–40 Helfert, E. A. (2002). Techniques of financial analysis: A guide to value creation (11th ed.), New York, McGraw-Hill/Irwin. Hasprová, O., & Pur, D. (2013). Going Concern Assumption and Financial Analysis. Research Papers Of the Wroclaw University of Economics / Prace Naukowe Uniwersytetu Ekonomicznego We Wroclawiu, (302), 57-72 HP. (2013). 10K-Form. Retrieved on February 16, 2015 from http://api40.10kwizard.com/cgi/convert/pdf/HPQ-20131230-10K-20131031.pdf?ipage=9296204&xml=1&quest=1&rid=23§ion=1&sequence=-1&pdf=1&dn=1 MorningStar. (2016). HP Inc: Key Ratios. Retrieved on February 16, 2016 from http://financials.morningstar.com/ratios/r.html?t=HPQ Simić, D., Kovačević, I., & Simić, S. (2012). Insolvency prediction for assessing corporate financial health. Logic Journal of the IGPL, 20(3), 536-549. Sridharan, S. A. (2015). Volatility Forecasting Using Financial Statement Information. Accounting Review, 90(5), 2079-2106. Doi: 10.2308/accr-51025 Schefczyk, M. (1993). Industrial benchmarking: A case study of performance analysis techniques. International Journal of Production Economics, 32(1), 1-11. Wang, C. (2014). Accounting Standards Harmonization and Financial Statement Comparability: Evidence from Transnational Information Transfer. Journal of Accounting Research, 52(4), 955-992 Read More