Ratio analysis is a tool in financial management that enables users of financial records to make informed decision regarding the financial records of a company. It displays the comparison of the components of the financial records with one another, thereby enabling us to relate he figures more objectively. Ratio analysis also enables us to compare the performance of the company over a period as well as with other similar companies.
Financial ratio analysis is an important task of a financial manager in any organization. The financial records and ratios of Hewlett Packard and Dell Limited, both of who are competitors in the information technology industry have been analyzed over a period of 5 years. By so doing, the performance of both companies is compared and explained in the following report. The main ratios compared and analyzed include liquidity ratios, asset management ratios, profitability ratios, debt management ratios and market value ratios.We will write a custom Company Analysis: Hewlett Packard and Dell specifically for you
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The liquidity ratios are described by Bragg (2003) as a measure of the company’s ability to meet current obligations with its liquid assets (current assets). According to (Fabozzi et al, 2007), the current ratio displays the number of times the current assets can cover the current liabilities. High current ratio denotes financial safety in the short term. However, it is a sign that liquid assets are idle, thus increasing implicit and explicit costs to the company.
The current ratio of Hewlett Packard (HP) has remained stable and sufficient over the period. At a range of 1:1, the company has maintained a position in which the short term obligations are well catered for. As compared to Dell Ltd. (Dell), the current ratio of HP is slightly lower.
The quick ratio is a refined liquidity ratio that relies on the most liquid of current assets for comparison with current liabilities. Thus, when computing this ratio, inventory is not considered. As observed from the appendix, the economic credit crunch affected the performance of both organizations in 2008.
Asset Management Ratios
These are measures of the efficiency of use and management of assets owned by the organization as postulated by Brigham & Houston (2007). Huge levels of investment in assets compromise the availability of cash flow to service those assets. As a result, reduction in profits will result due to reduced sales volume.
The inventory turnover ratio is a measure of the relationship between sales and inventory held by the organization. By comparing the sales and the inventory levels, an organization is able to asset the speed with which inventory is moving. High inventory turnover is a desirable factor. As observed from the schedule, HP has dropped from a high in 2005 with 2008 representing the slowest movement in inventory. Similarly, Dell has experienced reduction in inventory turnover over the years, which could be attributed to increased competition at the height of an economic crisis.
As outlined by Fabozzi et al (2007), the daily sales outstanding ratio, also termed as the average collection period (ACP) displays the number of days it takes for debtors to be converted into cash. By maintaining a short ACP, an organization reduces bad debts and debt collection costs. From the schedule, HP’s ACP has increased over the five years analyzed. Increased competition and magnified customer base could be the reason for the increase in the ACP.Get your
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The fixed asset turnover ratio measures how efficient the company is at utilizing the fixed assets to generate sales revenues. A high fixed asset turnover ratio is a sign that the organization is utilizing its fixed assets optimally. However, comparison with newer firms could present a challenge due to inflationary effect of time as outlined by Brigham & Houston (2007). HP, unlike Dell, has experienced a reduction in the efficiency of fixed assets. The fixed asset turnover ratio has experienced a steady drop over the years due to sustained increase in the fixed assets.
Total asset turnover, closely related to the fixed asset turnover ratio, is a measure of the efficiency of use of total assets in generation of sales. It measures the level of sales achieved from each dollar invested in assets. Over the years, both organizations have experienced a drop in total asset turnover, attributable to increase in assets at the backdrop of struggling sales volumes (Fabozzi et al, 2007).
Debt management ratios
These are a tool used to determine the appropriateness of the financing structure. The capital base of any organization comprises equity and, or debt. The presence of debt in the capital structure is necessary and advantageous up to certain limits. Thus, the organization has to maintain the proportion of debt to equity at optimal levels to achieve reduced costs and safety of investment.
The total debt to asset ratio also referred to as the debt ratio measures the percentage of finances originating from debt sources (Brigham & Houston, 2007). Potential investors prefer a low ratio. HP experienced an increase in its debt ratio over the past two years, a situation which is duplicated in Dell. Substantial increase in liabilities and interest expense over the same period is a sign that both companies have delved into debt financing in order to achieve growth plans.
Every company is concerned about increasing its revenues at the minimal expense in order to increase the returns to investors in the form of profits. Thus, profitability ratios form a significant role in accentuating the performance of an organization. The profitability ratios are a display of the expectations from all other financial ratios of a company.
Profit margin on sales is calculated through dividing the net profit by the revenues from sales (Besley & Brigham, 2008). This ratio measures the efficiency of the selling process. A high margin is desirable since it shows that the income formed a large part of the sales revenues.
From the appendices, HP has maintained a steady level of profitability over the years, unlike Dell, whose profits have been on a decline. Increased competition has compromised the growth in sales over the three past years at the backdrop of increased selling costs and expenses.We will write a custom
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By comparing the returns attributable to the shareholders with total assets, a firm is able to decipher the effectiveness of the use of assets in generating returns to the owners of the company. A high ratio is desirable since it shows that shareholders are getting money worth for their investment. HP has sustained acceptable levels of returns to assets over the years in comparison. However, under the influence of increasing debt capital and diminishing revenues, the return to asset for Dell has been on a decline.
Basic earning power is a ratio related to the returns on total assets. However, it is estimate through use of earnings before interest and tax. It enables the organization measure the earning capacity before influence of tax and interest, which could vary over time and distance as posted by Brigham & Ehrhardt (2007). Over the analyzed year, HP and Dell have experienced steady basic-earning-power levels.
Shareholders are concerned about revenue as well as capital gains as postulated by Bragg (2003). Since common shares have a residual claim among all stakeholders, returns attributable to shareholders are what remain after all obligations have been cleared. Over the years analyzed, HP has experienced steady and moderate returns to shareholders while Dell experienced a sharp drop in the year 2009. Dismal performance in 2009 led to reduction in net income for Dell, emanating from increased finance and selling costs.
Market Value Ratios
Market value ratios relate the organizations share value to the other performance measures. They are predictable from the characteristics of the other ratios. Attractive profitability, debt management, liquidity and asset management ratios are a sign that the company is performing well. Investors will be attracted to the shares of such a company, leading to increase in share price according to Brigham & Ehrhardt (2007).
As the name suggests, the price/earnings (P/E) ratio compares the price per share to the earnings per share. Besley & Brigham (2008) suggested that it displays the earnings per dollar of investment in the shares. High P/E ratio is as sign of growth prospects and minimal risk. HP experienced a high P/E ratio in 2005 with the rest of years performing poorly. This is due to increasing earnings per share coupled with reduction in the share prices. On the other hand, Dell has a stable P/E ratio because of increasing shape prices and decreasing earnings per share.
Another measure of performance is thorough comparing the price of the share to the cash flow. By so doing, one is able to relate the share prices to the cash flow levels of the organization. From the ratio analysis, HP and Dell have maintained a stable price/cash flow level over the years analyzed.
Valuation of a company though comparison of the market price to the book value of share is termed as the market /book ratio. Companies whose ratio is high are financially sound companies whose returns are high, thus, huge demand for their shares (Bragg, 2003). The markets to book ratios of both organizations have gradually decreased due to diminishing financial performance.Not sure if you can write
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HP and Dell are firms whose market factors resemble. Over the years, they have achieved matching financial performance owing to the fact that they are exposed to the same risk factors. As observed, the difference in strategy has set both companies apart in certain characteristics.
Besley, S. & Brigham, E. F (2008). Essentials of Managerial Finance. Ohio: Cengage Learning. ISBN: 978-0-324652-161
Bragg, S. M. (2003). Business Ratios and Formulas: A Comprehensive Guide. New Jersey: John Wiley and Sons. ISNB: 0-471-39643-5.
Brigham, E. F & Houston, J.F. (2007). Fundamentals Of Financial Management. Ohio: Cengage Learning. ISBN: 978-0-324319-811
Brigham, E. F & Ehrhardt, M. C. (2007). Financial Management: Theory And Practice. Ohio: Cengage Learning,.ISBN: 978-0-324422-696
Fabozzi, F. J et al (2007). The Complete CFO Handbook: From Accounting to Accountability. New Jersey: John Wiley and Sons. ISBN: 978-0-470099-261
|Days Sales Outstanding||79.730||71.506||69.277||70.539||36.051|
|Fixed Asset Turnover||10.172||10.921||13.373||13.355||13.439|
|Total Asset Turnover||1.004||1.172||1.222||1.151||2.243|
|Total Debt to Assets||13.789||15.752||9.226||6.337||6.755|
|Profit Margin on Sales||6.687||7.037||6.965||6.762||2.766|
|Return on Total Assets||6.673||7.349||8.189||7.560||3.102|
|Basic Earning Power||0.096||0.096||0.099||0.083||0.064|
|Return on Common Equity||19.280||21.503||18.949||16.458||12.901|
|Days Sales Outstanding||53.514||41.644||40.765||36.376||31.764|
|Fixed Asset Turnover||26.001||26.834||22.913||23.836||27.884|
|Total Asset Turnover||1.756||2.260||2.298||2.356||2.414|
|Total Debt to Assets||12.226||7.589||2.130||2.953||2.761|
|Profit Margin on Sales||2.819||4.056||4.821||4.498||6.389|
|Return on Total Assets||4.674||9.351||10.693||10.076||15.457|
|Basic Earning Power||0.086||0.129||0.136||0.124||0.207|
|Return on Common Equity||33.105||61.904||73.099||61.085||67.307|