Microsoft

FINANCIAL STATEMENT ANALYSIS

Paul McConkie | ACCT 2410 | October 10, 2017

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Microsoft Financial Statement Analysis

Based on the following financial statement analysis for Microsoft, I am recommending that your
company invest in Microsoft by purchasing stock in the company. This recommendation is based on
calculating financial statement ratios for the following five categories: profitability, investment/investor
relations, asset efficiency, liquidity/short-term risk, and solvency/long-term risk. Microsofts fiscal-year
2016 ratios were compared to fiscal-year 2015 results and to the industry averages.

PROFITABILITY RATIOS
The following five profitability ratios will be analyzed: return on assets (pre-tax), return on equity (pre-
tax), profit margin, gross profit, and earnings per share.

Return on Assets (pre-tax)

The pre-tax return on assets ratio measures the percentage of income before taxes generated from the
assets.

PROFITABILITY

10.7% 10.6%
12.0%
10.0%
6.0%
8.0%
6.0%
4.0%
RETURN ON ASSETS (pre-tax)

2016 2015 Industry Average

Microsofts 2016 pre-tax return on assets of 10.7%, indicates that for every $1 of an asset, the company
earned 10.7 cents of income before taxes. This was basically the same as the prior years 10.6%. However
when compared to the industry average of 6.0%, Microsoft is significantly more profitable than the
industry.

Return on Equity (pre-tax)

The pre-tax return on equity is again measuring the income before taxes but in relation to the amount
of equity, instead of assets. Microsoft had a significant increase in profitability from 2015 to 2016 based
on the pre-tax return on equity ratio. The 2015s 21.8% pre-tax return on equity improved to 26.0% in
2016. Also when compared to an industry average of 16.6%, the company is extremely more profitable
than the industry.

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PROFITABILITY

26.0%
30.0% 21.8%
25.0% 16.6%
20.0%
15.0%
10.0%
RETURN ON EQUITY (pre-tax)

2016 2015 Industry Average

Profit Margin
The profit margin calculates the companys profit (net income) as a percentage of total revenues.

PROFITABILITY
19.7%

20.0% 13.0%
15.0%

10.0% 4.3%

5.0%

0.0%
PROFIT MARGIN

2016 2015 Industry Average

The 2016 profit margin of 19.7% increased significantly from the prior years 13.0%. Again indicating a
significant increase in profitability, and again extremely surpasses the industry profit margin of 4.3%.

Gross Profit*
The gross profit ratio compares only the cost of the revenues to the revenues. Gross profit is calculated
as revenues minus the cost of the revenues. The gross profit is the percentage of gross profit for each $1
of revenues. In 2016, Microsoft earned 38.4 cents of gross profit for every $1 of revenues, which was up
slightly from 2015s 35.3 cents. Even though the company showed a slight increase in gross profit, they
are significantly less profitable than the industry (when compared to an industry average of 78.7%).
Microsofts cost of revenues is significantly greater than the industry, resulting in significantly lower
gross profits.

* Included the Asset Turnover ratio with the efficiency category as the textbook uses the term efficiently in the description.
Included the Gross Profit Percentage ratio in the profitability category as the textbook uses the term profitability in the
description.

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PROFITABILITY
78.7%

80.0%
38.4% 35.3%
60.0%
40.0%
20.0%
0.0%
GROSS PROFIT

2016 2015 Industry Average

Earnings per Share

The profit of a large company is easier to evaluate when it is represented per each individual share. The
company had a significant increase in profitability based on their earnings per share. The earnings per
share for Microsoft significantly increased in 2016 to $2.12 from $1.49 in 2015. An industry average for
earnings per share couldnt be found. Therefore, I included as a comparison the ratio from Apple (a
major competitor). Using Apples earnings per share as the industry comparison, Microsoft is extremely
less profitable than their competitor. Apple earns $8.35 of profit for every share of stock. Whereas, every
share of Microsoft stock only earns $2.12 of profit. Industry averages are based on the whole industry,
not just one company, so comparing to Apple could be viewed as a skewed result.

PROFITABILITY

$8.35
$10.00
$8.00
$6.00 $2.12 $1.49
$4.00
$2.00
$0.00
EARNINGS PER SHARE

2016 2015 Industry Average

Profitability Conclusion
Overall, Microsoft significantly improved their profitability in 2016 based on the pre-tax return on
equity, profit margin, gross profit, and earnings per share, with a very slight increase in the pre-tax
return on assets. Also, three out of the five profitability ratios (pre-tax return on assets, pre-tax return
on equity, profit margin) are significantly above the industry average. The gross profit and earnings per
share ratios were shown as less profitable than the Apple ratios used (because industry averages were
unavailable) and would not be necessarily viewed as relative ratios for the whole industry.

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INVESTMENT/INVESTOR RELATIONS RATIOS

The following four ratios will be calculated to analyze investment/investor relations: earnings per share,
price-earnings ratio, dividend yield, and dividend payout.

Earnings per Share

The earnings per share ratio is both a profitability and investment/investor relations measurement. As
previously discussed, the significant increase in the earnings per share (from $1.49 to $2.12) validates
Microsofts favorability as an investment purchase.

Price-Earnings Ratio
The price-earnings (P/E) ratio results also supports Microsofts favorability as an investment. The P/E
ratio compares the earnings per share to the market price per share and indicates the market price and
expectation for every $1 of earnings per share.

INVESTMENT/INVESTOR
RELATIONS
29.6
24.1
30.0 13.46
20.0
10.0
-
PRICE-EARNINGS RATIO

2016 2015 Industry Average

Even though there was a decrease in the 2016 P/E ratio (from 29.6 to 24.1), the P/E ratio is still almost
double the industry average (13.46).

Dividend Yield
The dividend yield calculates the percentage of the annual dividends per share to the market price per
share. In both 2016 and 2015, the companys dividend yield was 2.8%. (The 2016s annual dividends of
$1.44 per share were 2.8% of the 2016 market price per share of $51.17. Whereas even though the 2015
annual dividends were only $1.24, they were still 2.8% of the market price for 2015 of $44.15.) The 2.8%
annualized return in cash plus the increase in the market price per share from $44.15 in 2015 to $51.17
establishes Microsoft stock ownership as a favorable investment.

Dividend Payout
The dividend payout ratio shows the amount of annual dividends that were paid out as compared to the
earnings of the company. Therefore Microsofts 2016 dividend payout of 67.9% indicates that Microsofts
$1.44 of dividends was 67.9% of their earnings per share of $2.12, and the 2015 dividends of $1.24 were
83.2% of their 2015 earnings per share of $1.49. So even though Microsofts 2016 dividend payout
decreased from 2015, they are still paying out 67.9% of their earnings, which still makes equity
ownership a favorable investment.

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Investment/Investor Relations Conclusion

Even with the P/E and dividend payout ratios decreasing from the prior year, all of the 2016
investment/investor relations ratios show favorable results for investing in Microsoft stock.

ASSET EFFICIENCY
In this section, I will be analyzing the companys efficiency at managing their assets. Specifically I will
be analyzing Microsofts accounts receivable, or collections, efficiency, their inventory management,
and their overall asset management efficiency.

Accounts Receivable
The days sales in accounts receivable ratio indicates the average number of days it takes to collect on
the accounts owed to them from their credit customers (their receivables).

ASSET EFFICIENCY
93.0
77.4
100.0 73.0

80.0
60.0
40.0
20.0
-
DAYS SALES IN RECEIVABLES

2016 2015 Industry Average

In 2015, it took the company 73 days to collect their receivables. Whereas in 2016 the company actually
took almost 4 days longer to collect (77.4 days). While this increase in days sales in accounts
receivable indicates that the company was slightly less efficient this year than last year at accounts
receivable/collections management, the company is still collecting much faster than the industry
average of 93 days. So the company is still significantly more efficient at collections.

Inventory
The number of days of inventory held by a company is calculated using the days sales in inventory
ratio. Obviously holding less number of days of inventory is cost beneficial to the company. Microsofts
number of days sales in inventory slightly increased from 47.4 days in 2015 to 52.6 days in 2016
indicating that they were less efficient in 2016. Also, now they are holding about three times more
inventory than the industry. Thus, they are extremely less efficient than the industry with regards to
inventory management.

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ASSET EFFICIENCY

52.6
47.4
60.0
50.0
40.0
18.6
30.0
20.0
10.0
-
DAYS SALES IN INVENTORY

2016 2015 Industry Average

Total Assets*
The asset turnover ratio measures the efficiency of managing the companys total assets. For both years
2016 and 2015, Microsofts asset turnover was 0.5. A 0.5 asset turnover can be restated as follows: every $1
of an asset generates $0.50 of revenue. While their asset efficiency was steady between 2015 and 2016,
they are significantly less efficient than the industry that has an asset turnover of 0.9 (every $1 of an
asset generates $0.90 of revenue).

ASSET EFFICIENCY

0.9
1.0

0.8 0.5
0.5
0.6

0.4

0.2

-
ASSET TURNOVER

2016 2015 Industry Average

Asset Efficiency Conclusion

Microsoft was more efficient than the industry with their accounts receivable management, even with a
slight decrease in efficiency this year. However, they were less efficient than the industry with their
inventory management (with a slight decrease this year) and total asset management.

* Included the Asset Turnover ratio with the efficiency category as the textbook uses the term efficiently in the description.
Included the Gross Profit Percentage ratio in the profitability category as the textbook uses the term profitability in the
description.

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LIQUIDITY/SHORT-TERM RISK
Two very popular ratio measurements for liquidity, also known as short-term risk, are the current ratio
and the acid-test ratio. These ratios are both measuring the ability of the company to satisfy their debts
and/or obligations that are coming due within the next year.

Current Ratio
The current ratio compares all resources available within the next year to the debts/obligations due
within the next year. Microsofts 2016 current ratio of 2.4 says that they have $2.40 of resources available
to pay for every $1 of debts/obligations coming due within the next year. This decreased very slightly
from their prior year 2.5 current ratio. This is still a very healthy current ratio especially when compared
to the industry average of 1.8.

LIQUIDITY/SHORT-TERM RISK
2.4 2.5
2.3 2.3
2.5 1.8
1.5
2.0
1.5
1.0
0.5
-
Current Ratio Acid-test Ratio

2016 2015 Industry Average

Acid-test Ratio
The acid-test ratio is also measuring the ability to pay the debts/obligations coming due within the next
year, but using a more stringent definition of resources available which excludes the inventory amount.
Excluding the inventory from the calculation, Microsoft still has $2.30 to pay for every $1 of
debts/obligations coming due next year (2015 ratio was also 2.3). Again, they show a very healthy acid-
test ratio compared to an industry average of 1.5.

Liquidity/Short-term Risk Conclusion

Measuring liquidity using the current ratio, and even the more stringent acid-test ratio, the company is
significantly less risky with regards to the short-term than the industry average. From 2015 to 2016, their
acid-test ratio was constant and their current ratio showed a very minimal decrease.

SOLVENCY/LONG-TERM RISK
Whereas, liquidity measures the companys ability to satisfy obligations due within the next year,
solvency measures the companys ability to satisfy all obligations. The debt ratio, debt-to-equity, and
times interest earned ratios are all solvency measurements.

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Debt Ratio
The debt ratio compares the total liabilities of the company to its total assets. In 2015, Microsoft had 54.1
cents of debts for every $1 of assets (54.1% debt ratio). In 2016, their debt ratio had increased to 62.8%,
which is a significant increase. Thus they are significantly more risky (less solvent) this year than they
were last year. When compared to an industry average of 28.2%, Microsoft is extremely more risky in
their ability to pay off their liabilities, based only on the debt ratio.

SOLVENCY/LONG-TERM RISK

62.8%
70.0% 54.1%
60.0%
50.0%
40.0% 28.2%

30.0%
20.0%
DEBT RATIO

2016 2015 Industry Average

Debt-to-Equity Ratio
The debt-to-equity ratio measures whether a company is financing more of their assets with debt (going
into debt) or equity (selling stock and/or earning profit retained within the company). A debt-to-equity
ratio of 1 indicates that a company is financing exactly half of their assets with debt and the other half
with equity. Whereas a ratio of more than 1 indicates more debt financing than equity financing. A ratio
of less than 1 indicates more equity financing than debt financing.

SOLVENCY/LONG-TERM RISK

1.7 1.8

2.0
1.2
1.5

1.0

0.5

-
DEBT-TO-EQUITY RATIO

2016 2015 Industry Average

In 2015, the company had $1.20 of debt financing for every $1 of equity financing. In 2016, that ratio had
increased to $1.70 of debt financing for every $1 of equity financing. Microsoft is relying more on debt to
finance their increase in assets. This can be seen as a positive result for the stockholders because

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Microsoft wants to leave more of their profits either for dividends or retained within the company. Even
though Microsoft now has a debt-to-equity ratio of 1.7, they are only now at the industry average of 1.8.
So the increase in the debt-to-equity ratio says that Microsoft is more risky this year over last year, but
they are now about equal with the industry.

Times Interest Earned Ratio

This ratio result tells the number of times over than the company could have paid their interest expense
amount with their amount of income before interest and taxes.

SOLVENCY/LONG-TERM RISK

24.7
30.0 16.9

20.0 5.1
10.0
-
TIMES INTEREST EARNED RATIO

2016 2015 Industry Average

Last year, the company was able to pay its interest expense 24.7 times over. This year, it fell to 16.9 times
(more risky this year than last year). However when compared to an industry average of 5.1, the
company is significantly less risky than the industry.

Solvency/Long-term Risk Conclusion

The significant increase in the debt ratio, increase in the debt-to-equity ratio, and decrease in the times
interest earned ratio indicates that Microsoft is more risky this year as compared to the prior year. Their
2016 debt ratio indicates that they are significantly more risky than the industry. Only the times interest
earned ratio for 2016 indicates that they were less risky than the industry (debt-to-equity now being
equal with the industry). Thus overall, I would have to conclude that they are more risky this year and
significantly more risky than the industry. Thus investing at this time in their debt would not be
advisable.

FINANCIAL STATEMENT ANALYSIS AND INVESTMENT RECOMMENDATION

A debt ratio of 62.8% is a relatively high ratio. With a debt ratio of 62.8% and long-term risk viewed as
more risky this year, I would not recommend investing in the debt of the company at this time.
Whereas, the companys dividend yield of 2.8% along with the appreciation of the market price and
their dividend payout of 67.9% indicates strong support for investing the companys stock.

REFLECTION
This project was a lot of work and to prepare a professional report I needed to utilize skills learned from
other courses. But I think that being able to dissect the financial statements of a company to find areas
of strengths (that need to be continued) and weaknesses (that need to be improved) is a valuable skill.
Another valuable skill is to be able to put those thoughts into words. In my career, I will need to be able
to verbalize my recommendations and conclusions and provide appropriate and accurate support.
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APPENDIX A: MICROSOFT 2016 FINANCIAL STATEMENTS

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(Microsoft 2015 Balance Sheet needed to average assets)

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APPENDIX B: RATIO CALCULATIONS

Microsoft Corp. Ratio Calculations

(numbers in millions)

2016 2015
LIQUIDITY/SHORT-TERM RISK
1 Working Capital
Current Assets 139,660 122,797
Current Liabilities (57,357) (49,647)
Working Capital $82,303 $73,150

2 Current Ratio
Current Assets 139,660 122,797
Current Liabilities 57,357 49,647
Current Ratio 2.4 2.5

3 Acid-test Ratio
Cash/Cash Equivalents 6,510 5,595
Short-term Investments 106,730 90,931
Short-term Receivables 18,277 17,908
Quick Assets 131,517 114,434
Current Liabilities 57,357 49,647
Acid-test Ratio 2.3 2.3

4 Cash Ratio
Cash/Cash Equivalents 6,510 5,595
Current Liabilities 57,357 49,647
Current Ratio 0.1 0.1

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Microsoft Corp. Ratio Calculations

(numbers in millions)

2016 2015
ASSET EFFICIENCY
1 Asset Turnover
Total Revenue 85,320 93,580
Average Total Assets 184,083 174,304
Asset Turnover 0.5 0.5

2 Inventory Turnover
Cost of Goods Sold 17,880 21,410
Average Inventory 2,577 2,781
Inventory Turnover 6.9 7.7

3 Days Sales in Inventory

Days in a Year 365 365
Inventory Turnover 6.94 7.70
Days Sales in Inventory 52.6 47.4

4 Accounts Receivable Turnover

Total Revenue 85,320 93,580
Average Net Receivables 18,093 18,726
Receivables Turnover 4.7 5.0

5 Days Sales in Receivables

Days in a Year 365 365
Receivables Turnover 4.72 5.00
Days Sales in Receivables 77.4 73.0

* Included the Asset Turnover ratio with the efficiency category as the textbook uses the term efficiently in the description.
Included the Gross Profit Percentage ratio in the profitability category as the textbook uses the term profitability in the
description.

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Microsoft Corp. Ratio Calculations

(numbers in millions)

2016 2015
SOLVENCY/LONG-TERM RISK
1 Debt Ratio
Total Liabilities 121,697 94,389
Total Assets 193,694 174,472
Debt Ratio 62.8% 54.1%

2 Times Interest Earned Ratio

Net Income 16,798 12,193
Interest Expense 1,243 781
Provision for income taxes 2,953 6,314
Quick Assets 20,994 19,288
Interest Expense 1,243 781
Times Interest Earned 16.9 24.7

3 Debt-to-Equity Ratio
Total Liabilities 121,697 94,389
Total Equity 71,997 80,083
Debt-to-Equity 1.7 1.2

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Microsoft Corp. Ratio Calculations

(numbers in millions)

2016 2015
PROFITABILITY
1 Gross Profit Percentage
Cost of Revenue 32,780 33,038
Total Revenue 85,320 93,580
Gross Margin 38.4% 35.3%

2 Profit Margin
Net Income 16,798 12,193
Total Revenue 85,320 93,580
Price-Earnings 19.7% 13.0%

3 Earnings per Share

Net Income 16,798 12,193
Common Shares 7,925 8,177
Earnings per Share $2.12 $1.49

4 Return on Assets
Net Income 16,798 12,193
Average Total Assets 184,083 174,304
Return on Assets 9.1% 7.0%

5 Pre-tax Return on Assets

Income Before Taxes 19,751 18,507
Average Total Assets 184,083 174,304
Return on Assets(pre-tax) 10.7% 10.6%

6 Return on Equity
Net Income 16,798 12,193
Average Total Equity 76,040 84,934
Return on Equity 22.1% 14.4%

7 Pre-tax Return on Equity

Income Before Taxes 19,751 18,507
Average Total Equity 76,040 84,934
Return on Equity(pre-tax) 26.0% 21.8%

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Microsoft Corp. Ratio Calculations

(numbers in millions)

2016 2015
INVESTMENT/INVESTOR RELATIONS
1 Earnings per Share
Net Income 16,798 12,193
Common Shares 7,925 8,177
Earnings per Share $2.12 $1.49

2 Price-Earnings Ratio
Market Price per Share 51.17 44.15
Earnings per Share 2.12 1.49
Price-Earnings 24.14 29.61

3 Dividend Yield
Annual Dividends 1.44 1.24
Market Price per Share 51.17 44.15
Dividend Yield 2.8% 2.8%

4 Dividend Payout
Annual Dividends 1.44 1.24
Earnings per Share 2.12 1.49
Dividend Payout 67.9% 83.2%

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APPENDIX C: MICROSOFT SELECTED RATIOS AND INDUSTRY AVERAGES

* Some ratio results shown above differed slightly from those calculated using the financial statements.
However, I elected to use my own calculations (using the book formulas) because I know that some
ratios have optional modifications, and I felt confident in the ratios as I had calculated them.

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