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FI504

Accounting and Finance: Managerial Use

· Sample
Financial Statement Analysis Project

FI504

Accounting and Finance: Managerial Use

Table of Contents

Executive Summary…………………………………………………………..3

Brief Background of HP……………………………………………………...4

Environmental Scanning – SWOT Analysis………………………………...5

Major Competitor IBM……………………………………………………..7

Financial Ratio……………………………………………………………….9

Liquidity Ratio……………………………………………………......9

Activity Ratio…………………………………………………….……9

Solvency Ratio…………………………………………….…...……..10

Profitability………………………………………………………...…11

Overall Analysis and Recommendation……………………………...……..12

Recomendation..……………………………………………..……………….13

References……………………………………………………………….……14

  1. Executive Summary

This report stands from the point of view of Hewlett-Packard (HP), and discusses about its business condition. In order to put up a clear picture of HP’s business level, a comparison in finance is made between HP and one of its biggest competitors, International Business Machines (IBM). The main criteria of this paper are financial analysis which is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to be invested in. The evaluation is done by focusing on the income statement, balance sheet, and cash flow statement. Financial ratio analysis’ purposes are to evaluate HP’s past performance, the “ideal” benchmarks, its performance comparing to IBM and if HP meets its budget. Throughout these analyses, HP’s business state is visible and thus recommendations are given so as to make improvements to improve the negative sides of HP’s.

Briefly, HP’s liquidity is trailing behind IBM; and so is its profitability and inventory turnover. On the other hand its asset turnover and accounts receivable turnover is higher than IBM; similarly, solvency ratios indicate that HP’s ability to cover debt with assets is higher than its competitor IBM.

Overall analysis indicates that, first of all, even though HP has high revenues, but since its cost of goods sold is also high, the profit is reduced. Second of all, HP has a slow proceed of conversion of inventories to cash – which leads generate revenue. Thirdly, although HP has greater assets, there are many creditors claim for same assets. Hence the working capital is less, which in turn gives less production and less sales. Fourthly, the return on every dollar spent by HP for asset is less when compared to IBM. And last but not least, the return on every dollar invested by stock holder is lower while compared to IBM.

And so, applicable recommendations are given: HP should consider a new marketing strategy, increase its net income and decrease its payable liabilities plus bring up treasury stocks.

II. Brief Background of the HP

v History

HP is a technology company that founded in 1939 by Stanford University classmates Bill Hewlett and Dave Packard, built in a Palo Alto garage. It started with an audio oscillator which was an electronic test instrument used by sound engineers. First customer of HP was Walt Disney Studios which purpose was for the movie Fantasia.

v Operations

Now, HP is the one of the largest IT (information technology) operates more than 170 countries with approximately 324,600 employees worldwide. HP provides comprehensive portfolios of hardware, software, and services.

HP’s first products were test and measurement devices of audio oscillator—a device for test sound equipment which introduced in 1938. Later on HP develop their products to test for medical and chemical analysis. HP provides powerful devices for supercomputer installations. Also, HP offer multi-products and services from photography to entertainment and printers. HP's posted net revenue in 2010 was $126.3 billion; in 2009 net revenue was $115 billion, with approximately $40 billion coming from services

v Major Product Lines

HP specialty is in developing and manufacturing computing, data storage, and hardware, software and delivering services. Major product lines are include personal computer, enterprise, and servers, storage devices, networking products, printers, and digital camera. HP provides products to households, small to medium sized business and enterprises. Also, they have strong services and consulting around the world for supporting their products.

III. Environmental Scanning—SWOT Analysis

Environmental scanning, as used in this analysis, refers to the business environment or climate. The primary method used in this analysis is commonly referred to as a SWOT analysis: Strengths, Weaknesses, Opportunities and Threats.

Strengths

Weaknesses

  1. Hewlett-Packard’s primary strength is its business position. The enterprise has a large amount of cash in hand about $10 billion.
  2. Hewlett Packard is operating in more than 170 countries including both developed as well as under-developed.
  3. Being a global dealer of computer hardware, it gives HP many advantages like dominating printers market, both laser and inkjet. 
  4. The company competes both at local and international level. It has increased its competitiveness through policies and strategies that supports free-market economies
  1. The company was in a long term debt for many years which kept it from investing in different growth opportunities
  2. A major problem and complaint about the hardware supplies of HP is its touch pads. The touch pads of the notebooks of Hewlett Packard like the dv series, dm3, and Envy lines needs improvement. These touch pads are either finicky, unreliable, or are difficult to use because of friction.
  3. The past acquisition of Peregrine made the HP’s portfolio even more diverse and complete but HP Open View’s lack of mainframe management capabilities created several problems.

Opportunities

Threats

  1. The recent acquisition of EDS puts HP at a strong position in the computer market and makes it portfolio more impressive.
  2. Hewlett-Packard was able to generate large number of revenues and profits from its different deals and raised more than six billion which it can use to pay off its debts as well as invest in different research and development activities.
  1. If the products by the company are supplied at reasonable prices, there will be more chances of growth as the demand would increase.
  1. Operating in global market means many competitors and therefore, the company has to be at the forefront of changing technologies as well as addressing the changing customer demands and needs.
  2. The global economic recession is also a threat for the company’s sales and profits. The prices have also fallen as the stock markets are at historic low positions.
  3. Many other competitors including Dell are entering the printer business whereas IBM has become a market leader.

IV. Major Competitor IBM

vHistory

June 16, 1911, International Business Machines (IBM) was established by the merge of the four companies: the Tabulating Machine Company, the International Time Recording Company, the Computing Scale Corporation, and the Bundy Manufacturing Company,and sincethen, the IBM has beenrun as the Computing Tabulating Recording Corporation. IBM’s headquarter is in Armonk, New York, United States. It is a global public manufacture company

vProducts

IBM specializes in technology field, providing products of infrastructure, computer’s software and hardware and consulting services from mainframe computers to nanotechnology areas. IBM has been putting efforts in improvements and starting to roam globally and so becoming one of the biggest competitors of Hp.

vOperations

Almost 100 years doing business, in 2011, IBM was ranked by Fortune the 18thlargest firm in the U.S and also was the 7thprofitable; in this same year, 2011, IBM ranks at the 31stlargest company by Forbes; in addition, there are others rankings in 2010 include 2ndbest global brand, 18thmost innovative company and etc.

IBM’s current employee population is at 105,000 workers in the US and 75,000 people in India. IBM’s employee management has been effectively put efforts in productiveness. IBM provides a friendly team-work environment by creating team sports team, hosting family outings and company employee band.

vFinancial

Financially, IBM’s annual reports present a growing and on-going business of technology. In the last five years, IBM’s net income as follow:

Year

2006

2007

2008

2009

2010

Revenue

($ in millions)

$91,424

$98,786

$103,630

$95,758

$99,871

Net Income

($ in millions)

$9,492

$10,418

$12,334

$13,425

$14,833

According to Google Finance, IBM’s stock price is at $164.64, earning per share $11.52, total debt to assets 25.23 and expecting to be growing more. Currently, in Funds category, Vanguard 500 Index Investor is the one which holds the biggest share of IBM – 11,037,111 – representing .91% shares held. Other biggest funds come from Vanguard Institutional Index Instl ,SPDR S&P 500 or Vanguard Winsor II Investor. Institutionally, State Street Corporation is holding 64,751,996 – which is 5.31% shares held, and so give State Street Corporation the biggest share of IBM in general.

V. Financial Ratio Analysis

  1.   Liquidity Ratio

Liquidity Ratio

HP

IBM

Current Ratio

1.09

1.18

Quick Asset Ratio

0.96

1.00

Working Capital

4,781,000

7,137,000

v Analysis:

Liquidity ratio is nothing but cash raising capacity of the company, which can be used to keep the business active, or to pay creditors, or to further invest in assets. When we analyze these ratios we realize that HP is trailing behind IBM. Though HP has more current assets when compared to IBM, it equally has greater claims for the assets, thus bringing down the ratios as well as the working capital. Hence HP has lesser funds to operate it business activities which in future may reduce sales.

  1.   Activity Ratio

Activity Ratio

HP

IBM

Accounts Receivable Turnover

4.76

3.49

AR Days Level

76.68

104.58

Inventory Turnover

14.63

21.78

Inventory Days Level

24.94

16.75

Asset Turnover

1.06

0.88

vAnalysis:

The activity ratios are basically the cash conversion capacity of a company. The cash is the king, and the two important assets that determine this are receivables and inventories. Hence shorter the cycle better the cash position. So when we analyze the inventory ratios of both companies, we realize that though HP has appreciable sales revenue, the cost for it is more thus reducing the inventory turnover when compared to IBM. Added to this we can also see that HP working capital is blocked for more days in inventory when compared to IBM.

On the contrary account receivable ratios are favorable for HP. These numbers signifies that receivables are converted into cash much faster than receivables in IBM Company. Hence faster the collection cycle better is liquidity position.

  1.   Solvency Ratio

Solvency

HP

IBM

Debt to Total Asset Ratio

67.5%

79.3%

Times Interest Earned

22.73%

45.92%

vAnalysis:

From these ratios we can evaluate that the solvency ratio (long term debt paying ability) of HP is better than the IBM. The numbers signifies that on HP Company the stock holders have more hold than creditors. This is due to lower liabilities of HP Company, which is result of zero deferred long term liabilities charges. On the other hand times interest earned ratio, which is the interest paying ability of IBM, is better than HP.

  1.   Profitability Ratio

Profitability

HP

IBM

Gross Profit Ratio

24.41%

50.90%

Net Profit Margin

7.21%

14.85%

Return on Asset

7.65%

11.60%

Return on Equity

21.71%

67.20%

vAnalysis:

Profitability ratios are key factors in analyzing the success of a company. When we go through the profit ratios of HP we realize that though the net sales of HP are greater than IBM, the profit ratios are lower. This is due to cost of sales is also greater which brings the gross profit as well as the profit margin down. The return on assets and return on equity is also lower for HP when compared to IBM. As we mentioned earlier though the net sales of HP is greater than IBM, its net income is lower. This is due to cost of sales and other operating expenses, which brings down the income and hence the return on assets. In case of return on equity, HP has earned lesser return on equity due to lower net income. Even the greater stock holder’s equity in HP (compared to IBM) has resulted in lesser return. IBM has lesser stock holder’s equity because it owns lot of treasury stocks while HP doesn’t own treasury stock.

VI. Analysis and Recommendation

When we analyze the various financial ratios of HP Company we come out with various following findings.

  1. The first and fore most thing we realize is that though the HP Company has significant sales revenue, the cost for revenue is also very high. Hence the profit is reduced. This situation will not be interesting for any investors to make any investment.
  2. The second finding is the cash conversion cycle from inventory to cash is slower in HP Company. The inventories are taking more time to generate revenue. Though the inventories are assets, but until they generate revenue there will be no cash rotation for operating activities.
  3. The third finding is HP has greater assets, but on the other hand greater creditors claim for same assets. Hence the working capital is less, which in turn leads to less production and less sales.
  4. The fourth finding is the return on every dollar spent by HP for asset is less when compared to IBM. This is mainly due to the cost of revenue which is greater reducing the net income and in turn reducing the return on asset.
  5. The fifth finding is the return on every dollar invested by stock holder is lower while compared to IBM. This is because HP stock holder’s equity is more than of IBM.

VII. Recommendation

So after seeing all the above mentioned negative aspects of financial status we have following recommendations for HP to make it number one company.

  1. The company should improve its net income either by reducing the cost of revenue or by increasing the net sales. Thus thegross profitimproves, which in turn increase thegross profit rateand profit margin ratio.
  2. The company should introduce new sales strategy, to fasten sales thus cutting down the days of retained inventory. By this cash conversion cycleprogresses resulting cash for business operations.
  3. The HP Company should bring down the current payable liabilities so that it can increase its working capital. This can be done by repaying the short term debts.
  4. To enhance return on asset the company as above mentioned should increase its net income or should reduce their assets which are not productive. Hence by doing so gain on selling will be recorded, this in turn improves the net income.
  5. The last but not least is, HP should plan of having some treasury stocks thus bringing down the stock holder’s equity. Hence by doing so return on equity will improve. The other option they must consider is not declare dividends until there is some increase in net income. 

References:

http://services.corporate-ir.net/SEC.Enhanced/SecCapsule.aspx?c=71087&fid=7267010

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