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Accounting 1120

FINACIAL STATEMENTS:

Using Ratio Analysis

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There are numerous ways to analyze a businesss financial position. One of

the best and simplest ways is by using ratio analysis. With this analysis we are able

to take numbers listed on the financial statements and create particular ratios. The

ratios can be split into several categories and again into sub categories. I will apply

this analysis to the company IBM. By analyzing only one of the categories we wont

receive the full picture of IBMs financial position. One of the strengths of Ratio

Analysis is that it looks at the company from many different angles. The first

category to analyze or look at is the riskiness of IBM. This will tell us, as an investor

or perhaps a lender, how easily IBM will be able to pay its debt. Next well analyze

their Profitably, which reflects how much money theyre making; Efficiency, which

reflects how efficiently IBM run different parts of their business, and lastly

Stockholders relations, which will help investors decide if IBM would be a good

business to invest in.

Lets first evaluate the risk of IBM. Risk is divided into two subcategories:

Long-term and Short-term. Short-term refers to a one year or less aspect. Long-term

refers to anything greater than one year. The first ratio well use to evaluate IBMs

short-term risk is the current ratio. The current ratio tells us how much resources we

currently have to pay for the debt we have, coming due within one year. IBMs

current ratio for 2013 was 1.28 in 2014 it was 1.25. This means that in 2013 IBM

had $1.28 in resources we currently have to pay for every $1 of debt we have,

coming due within the next year. In 2014 the ratio decreases and now they have

less resources to cover their short-term debts. With this analysis Id say that IBM is

slightly, more risky now than it was in 2014. The industry average for the current

ratio is 1.86. This means IBM is more risky than other companies in the same

industry. Of course in ratio analysis we dont decide the companies riskiness based

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on just one ratio. Next well move onto the Quick Ratio. The Quick ratio tells us how

much quick assets we have to pay for debts coming due within the next year.

Quick assets can be defined as assets that can be turned into cash with ease or

with, according to Shauna Hatfield one phone call. The major difference between

this ratio and the Current ratio is that the Quick ratio doesnt take into account

inventory or expenses that have been paid for in advance of them becoming due. In

2013 IBMs acid test ratio was 1.07. This means that in 2013 IBM had $1.07 in

resources that could be quickly converted into cash, for every $1 of debt IBM has

coming due within the next year. In 2014 the ratio was 1.02. This tells us that IBM is

more risky in 2014 than they were in 2013. The industry average for the quick ratio

is 1.57. This means IBM is more risky than other businesses in the same industry

based on this ratio. IBM, based on both our short-term riskiness ratios, is more risky

this they were in the previous year and more risky than other companies in their

same industry.

Next well look at IBMs long-term risk. These ratio will tell us how risky IBM is

in the long-run. First, well analyze the debt ratio. The debt ratio tells us how much

debt IBM has acquired compared to the amount of resources they have. In 2013

IBMs debt ratio was 82%. This tells us that IBM is highly debt financed. In 2013 IBM

had 82% of all their assets financed with debt. In 2014 IBMs debt ratio even got

worse. In 2014 IBM had 90% of their assets financed with debt. This means that IBM

was highly risky in 2013 but, only got more risky in 2014. The industry average is

59.3%. This means IBM is way more risky than other businesses in the same

industry based on how much debt is financing IBMs assets. Another ratio we can

look at to analyze long-term risk is the debt-to-equity ratio. This ratio compares how

much debt IBM has compared to every dollar of equity put into the company. In

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2013 IBM had a debt-to-equity ratio of 4.5. This tells us they $4.50 of debt for every

$1 of equity. This tells us IBM is highly debt financed. In 2014 IBM again got more

risky. Their debt-to-equity ratio jumped from 4.5 to 8.8. IBM is way more risky in

2014 than they were in 2013. Also, compared to the industry average, IBM is way

more risky because the industry average is 1.46 compared to IBMs 8.8. The last

ratio well look at in the riskiness category is the times interest earned ratio. A

company with a high times interest earned ratio will be better prepared to pay their

interest due on their debts just in case revenues decline. In 2013 IBM had a 34

times interest earned ratio. In 2014 IBM become slightly more risky and dropped the

ratio to 30. The industry average is 2.9. That means that even though IBM became

more risky, based on the times interest earned ratio, they still are way less risky

than the industry average. Based on these three long-term risk ratios I would say

that even though IBM seemed extremely risky compared to other companies in the

industry, based on the debt and debt-to-equity ratios, they are less risky, overall

because of the incredible high times interest earned ratio. These ratios show us that

even though IBM is very highly debt financed, they are still making more than

enough revenues to cover their interest expense on their debt.

Next, we can analyze IBMs profitability. To measure its profitability lets use

five different Ratios. First well use the Profit Margin Ratio. In 2013 IBMs profit

margin was 16.8%. That means that for every 1$ of revenues they had, they had

about $0.17 of Income. In 2014 IBM wasnt quite as profitable and their profit

margin dropped to 13%. Even though IBM became less profitable in 2014 theyre

still way ahead of the industry average of 1%. Theyre way more profitable than the

average company in their same industry. Another profitability ratio we could use is

the Gross Margin Ratio. In 2013 IBMs gross margin ratio was 49.5%. This tells us

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that for every dollar of revenues IBM will have they will have just over $0.49 of

gross profit. In 2014 IBM became more profitable, based on this ratio, and increased

their Gross margin ratio to 50%. Since the industry average is 80.1% IBM is less

profitable than the average company in its industry. The Return on Assets ratio is

another profitability ratio. In 2013 IBMs return on assets ratio was 13.8%. This

means that for every dollar of assets IBM has, they earn about $0.14. In 2014 their

return on assets dropped to 10.3%. The industry average for return on assets is

1.6%. This means that even though IBM is less profitable at using resources to

generate income they are incredibly more profitable than the industry average for

either year. Next we can look at the Return of Equity. In 2013 IBMs return of equity

was 31.9%. This tell us that for every one dollar of equity was put into the business

IBM can produce about $0.32 of net income. In 2014 IBM became less profitable and

dropped down to 22.8%. This is quite a big drop but, still IBM is way more profitable

than the industry average of 3.94%. Next lets look at the Earnings per Share also

called EPS. Earnings per share is a pre-calculated ratio that is required to be shown

on businesss financial statements. In 2013 IBMs EPS was $16.64. In 2014 it

dropped slightly to $16.53. This means that in 2014 IBM became slightly less

profitable and they earn $16.53 for every share in the business. IBM is way more

profitable than the industry average which is only $2.66. Even though our gross

margin ratio tells us IBM was more profitable in 2014, all our other profitability ratios

tell us they were less profitable. Overall we could conclude that IBM was less

profitable in 2014 than they were in 2013 but, they are still way more profitable that

the industry average.

Next well look at Efficiency. Efficiency has four different sub-categories,

Inventory, collections, Asset management, and Cash Flow efficiency. First well look

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at IBMs Inventory efficiency which is broken up again into two sub-categories. The

first well look at is called the Inventory turnover. In 2013 IBMs inventory turnover

was 21.62. This means that IBM would sell or turnover their inventory 21.62 times a

year. In 2014 they became slightly less efficient at managing their inventory and

dropped down to 21.02 times. Since the industry average is only 17.56 times we

could conclude that IBM is more efficient at managing their inventory than the

average company in their industry. Another ratio that helps determine how well a

company is managing its inventory is the Days Sales in Inventory. This tells us how

long it take us to sell our inventory. In 2013 IBMs ratio was at 16.88 days. This

means that every 16.88 days IBM would have to get new stuff to offer or sale. In

2014 they became a little less efficient at managing their inventory and increased

their ratio to 17.36. This is still more efficient that the industry average of 20.79

days. Based on these numbers IBM is more efficient at managing its inventory than

the industry average but, they still arent as efficient as they were in 2013.

Next well analyze how efficient IBM is at managing its collections. This tells

how well IBM is at making sure its getting paid within a reasonable amount of time.

Well also split this up into two categories. First well look at their Receivables

Turnover ratio. In 2013 their ratio was 3.15 times. In 2014 they were less efficient

and dropped to 2.91 times. This mean that in 2014 IBM circulated their receivables

accounts only 2.91 times. The industry average for this ratio is 5.89 times. This tells

us that IBM isnt as efficient with their receivables as the industry average. The next

ratio well use to evaluate their collections efficiency is the Days Sales in

Receivables. In 2013 it was 70 days. Unfortunately in 2014 it increased to 80 days.

That means that IBM has become less efficient at managing how long they allow

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people to have debt. This could be a red flag for investors because the industry

average is much lower at 62 day.

The next area we can look at when evaluating their efficiency is their asset

efficiency. How efficiently is IBM using its assets to generate revenues? The ratio we

use to answer this question is called the Asset Turnover ratio. In 2013 IBM asset

turnover was 0.80. In 2014 they dropped to 0.76. This means that IBM only turn

their assets into revenue only .76 time in 2014. IBM is less efficient at managing

their assets, than the industry average, which is 1.6.

The last were going to look at are the cash flow efficiency. This tells us how

efficiently IBM is using its cash. Well divide this into three subcategories. The first

one well look at is called the Cash to Total Assets. This tells us how much cash IBM

is producing through its regular operations compared to its total resources. In 2013

IBMs cash flow to asset was $13,427. In 2014 IBM was less efficient at managing

their cash and it dropped to 12,603. The next ratio we can use to test Cash

efficiency is the Cash Flow per Share. This tells us how much cash IBM has from

operating, compared to their number of shares. In 2013 their cash flow per share

was $0.03. In 2014 in dropped to a -$0.66. Next lets look at the Price to free cash

flow ratio. This ratio tells us how much cash we are making though normal operation

compared to the price per share. In 2013 we had 31.5. In 2014 we had 32.3. This

tells us that IBM is less efficient this year than they were last year. They are also

less efficient than the industry average of 30.2. Based on these ratios IBM is less

efficient with their cash this year than they were in 2013.

The last area well look at in our ratio analysis is the Stockholders relations

category. This could be the most important section for a potential investor or

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current stockholder. This section will tell us how well IBM treats in stockholders from

a monetary aspect. First well look at IBMs Price-Earnings ratio. This will tell us how

much each stock costs compared to our previously stated EPS ratio. In 2013 IBM

Price-Earnings ratio was 11.77. In 2014 it went up to 12.98. This could either be a

good thing or a bad thing. It depends on if investors are willing to pay $12.98 for

every dollar of profit per year. The industry average is 19.3. IBM is in a good position

with its stock prices compared to the industry average. Its not way lower than the

average and its not was higher. Next well look at the Dividend yield. This tell

stockholders or potential stock holders how much money they will receive yearly

from each share they hold in IBM. In 2013 IBMs Dividend yield was 2.2%. In 2014 it

went up to 2.7%. This tells us that IBM is treating its stockholders better than it did

in 2013. Its also passed up the industry average of 2.2%. IBM would be a better

than average company to invest in based on this ratio. Last we can look at Dividend

Payout. Dividend payout tells us how much earnings IBM makes compared to its

money it pays annually to its stockholders. In 2013 IBMs Dividend payout was

12.2%. In 2014 it went up to 16.1%. Just as we saw with the dividend yield IBM is

treating its stockholders better in 2014 than they were in 2013. Unfortunately, they

are treating them worse than the industry average of 42.1%. Overall IBM would be

an average company to invest in.

Like most companies, IBM has some strengths, but they also have some

weaknesses. They are a high risk company but, they are incredibly profitable. They

are an average company with their efficiency and stockholders relations. If I were

an investor or a debtor I would be very cautious with IBM. They look really good

when you look at their profit but, they are incredible risky because they are so

8

highly debt financed. The biggest red flag is that almost all their numbers were

moving in the wrong direction. IBM is a profitable and risky business.

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