Financial Analysis for Managers - Case Study Example

Financial Analysis for Managers Atta ur Rehman Academia Research 31 December, 2007 Introduction This comparative study examines the differences in business ratios of two leading business companies i.e. Wal-Mart and Target. The collected data contains the effects of different factors on the performance of these companies. Against the backdrop of various market forces, it highlights the ratio trends as well as the innovative retail formats put in place by such numbers. In this respect, various dimensions of segmentation have been researched e.g. Asset Turnover Ratio, Average Collection Ratio, Inventory Turnover Ratio and Days' Sales Inventories etc. This, in turn, has brought about a clearer perspective on the business strategies adopted by Wal-Mart and Target groups. 1. Profitability Ratios of Wal-Mart & Target Wal-Mart registers nearly $20,000 profit every minute of every day. Last fiscal year, Wal-Mart recorded profits of $10.3 billion. For comparison, Target's profit per minute is $6,084. To say Wal-Mart is a money-making machine would be an understatement. The calculations given as Appendices A, B and C are based on Wal-Mart and Target's past four years annual data from the 10K and Hoovers. Some are calculated by author as well. (Dollars are listed in thousands). (a). Net Profit Margin Net Income Net Profit Margin = Sales Net Profit Margin is an indication of how effective a company is at cost control. The higher the net profit, the more effective the company is at converting revenue into actual profit. Target has greatly improved on this number over the last few years and reached the high number of 3.8 in 2002 from its low of 3.4 in 1999. In comparison to Wal-Mart, it has outperformed it during this period. (b). Operating Profit Margin Net Income + Interest Operating Profit Margin = Sales Operating Profit Margin shows how effective a company controls its cost and expenses associated with the normal business operations. Target's OPM remained consistent from 1999 to 2001 and improved from 2001 to 2002 due to the stronger supplier relationships, restructuring of stores and more effective inventory management. Wal-Mart remained below during the entire period. It has large overhead costs to maintain its many stores. (c). Return on Assets Net Income + Interest Return on Assets = Average Total Assets Return on Assets determines how many dollars of profits can be achieved for each dollar of assets under control. Target's return on assets ranges between $8 to $9 which is compareable to Wal-Mart's ranges. (d). Return on Equity Net Income Return on Equity = Average Equity Return on Equity is one of the most important profitability measures. ROE reveals how much a company earned in comparison to the total amount of the shareholder equity found on the balance sheet. ROE encompasses the three main levers by which the management can better the corporation. These levers are profitability. Asset management and financial leverage. Again although Wal-Mart is ahead of Target during the whole period but the figures are even compareable as walmart ranges from $20 to $23 while Target' figures ranges between $19 to $21. 2. Efficiency ratios of Wal-Mart & Target Efficiency ratios of Wal-Mart & Target are calculated by applying the following formulae. (a). Asset Turnover Ratio Sales Asset Turnover Ratio = Average Total Assets Asset Turnover Ratio measures how efficiently a company uses its average total assets to generate sales. The figures show that Target has gone down in this number over the past four years from a high of 2.054 to 1.665. Sales for Target are not increasing as fast as the number of assets within the corporation. Wal-Mart has outperformed Target in this field as its minimum value was 2.601 in 2000 which is higher than the Target's highest value. (b). Inventory Turnover Ratio Coast of Goods Sold Inventory Turnover Ratio = Average Inventory Inventory Turnover Ratio measures the number of times that the average inventory of finished goods was sold during a year. It is calculated by taking the cost of goods sold divided by the average inventory from the most recent and previous year's balance sheet. A high inventory turnover indicates the firm is efficiently managing its inventory. Target has maintained about the same numbers through the four years at about 6x which is on average less than 1 to the competitor Wal-Mart. (c). Days' Sales Inventories Average Inventory Days' Sales Inventories = Coast of Goods Sold / 365 Days' Sales Inventories provides an estimate of the number of days, on average, that it takes to sell inventory. For Target, it has ranged about 56 to 58 days over the four year period. This means that it takes Target about 60 days to sell its inventory and come in with new inventory to sell. Wal-Mart has done better in moving inventory than Target especially in 2001 it had to come in with new inventory just after 46 days. 3. Leverage Ratios of Wal-Mart & Target This ratio shows how much a company has borrowed. A higher ratio shows creditors that the firm has a higher degree of leverage for it has borrowed more to support the company's functions. Target has borrowed more as its leverage ratio is high. (a). Long-Term Debit Ratio Long-Term Debit Long-Term Debit Ratio = Long-Term Debit Ratio + Equity Long-term debit ratio measures the ability of a firm to repay its long-term debt by way of cash flow. A higher value in comparison to competitors demonstrates that the firm has efficiently covered its long term debts. Results demonstrate that Target has improved on its ability to meet its long-term obligations. By far Target the highest CF/Long-term debit compared to Wal-Mart and other market firms which is a definite plus in its favor. (b). Long-Term Equity Ratios Long-Term Debit Long-Term Equity Ratio = Equity This ratio helps to determine the risk of the firm to investors. The higher the number, the more risky the firm becomes for investors and therefore higher return is demanded. The number has increased gradually for Target over the period. The data shows that it has a higher risk and therefore investors will demand a higher rate of return. Against Wal-Mart, it has higher number which means that Wal-Mart is primarily financed through equity. (d). Total Debit Ratio Total Liabilities Total Debit Ratio = Total Assets This measures how much debt a company has compared to how many assets it has. Target remained 66.6% to 67.5% during the said period. As for the competition, Target has maintained numbers that are slightly higher than Wal-Mart ranging 58% to 63%. (e). Cash Coverage Ratio EBIT + Depreciation Cash Coverage Ratio = Interest Payments Cash coverage ratio tells how many times over company can service their debt. Target has declined in this number but with comparable figures. Wal-Mart has outperformed Target by a huge margin. Target ranges $5.5 to $5.9 while Wal-Mart $9.4 to $14.7. The major reason of this huge difference is the massive operational size of Wal-Mart than the Target. Conclusion Target offers relatively strong competition to Wal-Mart due to its equally diversified offerings, competitive pricing and its focus on middle-to-upscale customers. It has a slight competitive edge in terms of product differentiation. Due to its recent merger with Kmart, Sears Holdings is still in the process of restructuring stores, organizational change and defining of new business goals. Therefore, in the short term, Sears Holdings is not a potential threat to Wal-Mart. But taking into consideration its large scale of operations, Sears Holdings would definitely emerge as a strong competitor in the long term. Appendix "A" S.No Target 1999 2000 2001 2002 1 Net profit margin 3.4 3.4 3.4 3.8 2 Operating profit margin 4.6 4.6 4.6 5.1 3 Return on assets 9.4 9.2 8.4 8.5 4 Return on equity 20.4 20.4 19.0 19.1 S.No Wal-Mart 1999 2000 2001 2002 1 Net profit margin 3.2 3.3 3.0 3.3 2 Operating profit margin 3.8 3.8 3.0 3.0 3 Return on assets 10.0 10.1 9.7 10.1 4 Return on equity 22.9 22.0 20.1 21.0 Appendix "B" Target 1999 2000 2001 2002 Total asset turnover 2.054 2.012 1.825 1.665 Inventory turnover 6.404 6.340 6.348 6.521 Days' sales inventories 56.996 57.575 57.495 56.975 Wal-Mart 1999 2000 2001 2002 Total asset turnover 2.772 2.601 2.718 2.767 Inventory turnover 7.034 7.288 7.788 8.077 Days' sales inventories 51.893 50.084 46.865 45.193 Appendix "C" Target 1999 2000 2001 2002 Long-term debit ratio 0.435 0.464 0.507 0.519 Debit equity ratio 0.771 0.764 1.029 1.079 Total debit ratio 0.658 0.666 0.675 0.670 Cash coverage ratio 5.926 5.819 5.666 5.551 Wal-Mart 1999 2000 2001 2002 Long-term debit ratio 0.392 0.333 0.348 0.333 Debit equity ratio 0.645 0.499 0.534 0.498 Total debit ratio 0.633 0.599 0.580 0.585 Cash coverage ratio 9.887 9.465 10.065 14.750 References http://www.business.uiuc.edu/mdyer/chapter/chap17f03.pdf. http://www.financeprofessor.com/fin301/usingfinancialstatements.html Target Corporation Stock Analysis. (November, 11, 2003). Wal-Mart Annual Report (2003). Read More