Accounting 501 (mba) - Interpreting Financial Statements Report

EXECUTIVE SUMMARY

In order to gain a better understanding of how to interpret financial statements as presented in ACCOUNTING 501, we analyzed select data, including Liquidity Ratios, Solvency Ratios, and profitability Ratios from the Coca-Cola Company and PepsiCo, Inc's 2009 financial statements.

The report is divided into four parts. The first part of the report (Part A) focuses on Liquidity Ratios, computing current ratio, receivables turnover, average collection period, inventory turnover, days in inventory, and current cash debt. Part B of the report computes Solvency Ratios including debt to total assets, times interest earned, cash debt coverage, and free cash flow. Part C finds Profitability Ratios such as profit margin, asset turnover, return on assets, and return on common stockholders' equity. Lastly, Part D offers our conclusion.

Here, the ratios are used to make comparisons between Coca-Cola and PepsiCo and provide an insight into each company's competitive position against one another. Here too, financial statement analysis can help answer common questions from creditors, investors, and managers. From the creditor's point of view, questions include, "Can the company pay interest and principal on its debt? From the investor's point of view, common questions might include, "Does the company earn an acceptable return on invested capital?" "Is the gross profit margin growing or shrinking?" "Does the company effectively use non-owner financing?" Management might ask, "Are costs under control?" Are the company's markets growing or shrinking?" "Do observed changes reflect opportunities or threats?" "Is the allocation of investments across different assets too high or too low?"

After analyzing the ratios we noted that (in Part A) both Coke and Pepsi are very similar in most of the liquidity ratios, except where the inventory and inventory turnover ratios favored PepsiCo. This tells us that Pepsi MAY be more efficient and thus better able to meets its obligations than Coca-Cola.

In Part B we found that Coca-Cola has slightly higher ratio of assets to its liabilities; however Pepsi has a better position in ratio of earnings to interest expenses. Pepsi also has better ratio of cash flows from its operations against its debt. But Coca-Cola retains more cash from its operations after dividends and capital expenditures since it has a higher net income.

After analyzing the profitability ratios (Part C), we found that Coca-Cola recorded a higher profit margin than PepsiCo. Further the ratios showed that Coca-Cola manages its cost better than PepsiCo. Higher costs erode earnings. PepsiCo had an edge in generating sales with assets, although both had identical returns on assets. Finally, both companies seem to have similar return on stockholders equity with PepsiCo having a slim edge over Coca-Cola.

LIQUIDITY RATIOS FOR COCA-COLA AND PEPSICO FOR 2009 (Part A)

Liquidity Ratios: A class of financial metrics that is used to determine a company's ability to pay off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts

A.1 CURRENT RATIO

Current Assets / Current Liabilities

Coca-Cola PepsiCo

12094/10971=1.1 8639/6752=1.28

A Current Ratio lets us measure a company's ability to pay short-term obligations. The higher the current ratio, the easier it is for a company to pay its obligations. We can see that both Coke and Pepsi have ratios above one, which indicates each can meet its obligations, though Pepsi is in a tad bit better position than Coke. Investors and management would like the numbers at two or better, but view these numbers as adequate for the soft drink industry.

A.2 ACCOUNT RECEIVABLE TURNOVER RATIO

Net Sales / Average Account Receivables

Coca-Cola PepsiCo

21962/2131=10.31 29261/2915=10.04

The Account Receivable Turnover Ratio lets us measure a company's ability to collect on sales it has provided customers on credit. A high ratio indicates that a company is efficient at collecting its receivables. A low ratio suggests that the company is not collecting it receivables in a timely fashion.

* Day's Sales Outstanding 365/10.31=35.40 days 365/10.04=36.35 days

Converting the ratios into days, we can see that the numbers above, known as Days Sales Outstanding, it takes 35 days for Coke and 36 days for Pepsi to, on average, collect its receivables. It represents the average amount of time that elapses after a sale is made before Coke or Pepsi collects from its customers. Although average, investors see these numbers as reasonable, given most sales are done on credit.

A.3 AVERAGE COLLECTION PERIOD RATIO

365 Days / Accounts Receivable Turnover

Coca-Cola PepsiCo

365/10.31=35.41 days 365/10.04=36.35 days

The Average Collection Period Ratio lets us measure the amount of time it takes for a business to receive payments owed to them. Virtually all businesses have customers who purchase goods or services via credit. However, when extended, the company does not know when it will it will get paid.

Although 35 and 36 days to collect are reasonable (given that most sales in the soft drink industry are done on credit), Investors would like to see the numbers lower rather than higher, as this means the company collects its money sooner rather than later.

A.4 INVENTORY TURNOVER

COGS / Average Inventory

Coca-Cola PepsiCo

7638/1336= 5.72 13406/1477=9.08

The Inventory Turnover Ratio tells us how well a company is turning its inventory into sales. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying. These numbers tell us that Coke turns over its inventory a little more than 5.5 times per year,