## Introduction

Gap Inc is an international business entity that has outlets in various parts of the world. The outlets of Gap Inc deal in personal care products, clothes and other accessories for women, men and even children. The major brands of Gap Inc in the business include Old Navy, banana republic, and piperlime among other top brands in the world. In the United States of America, the retail industry is one of the largest industries in the economy, recording an average of US $ 3.8 trillion annually. Almost 12.4 % of all business establishments in US are involved in the retail industry and the gross margin of the industry is between 31% and 33%.

There is stiff competition in the retail industry and this has seen the sales of Gap Inc drop significantly. Apart from the drop in sales, the company has also been experiencing a decrease in the number of customers. This prompted the company to explore strategies of improving on their sales. The company adopted some measures such as markdowns, aggressive promotion and product campaigns among others. This has caused a recent improvement in the sales of the company though slight. A financial analysis of Gap Inc is critical at this time to determine the financial soundness of the company.

Financial analysis is the process of selecting, evaluating and interpreting information from the financial statements of a company in order to obtain information for decision-making. Financial statements have to be interpreted in order to make sense to decision makers in the firm. Financial analysis makes sense out of the financial statements and this enables decision-making.

Financial statement analysis is therefore a very important tool for the success and growth of an organization. It provides information for decision making either outside or inside the organization. The main tool used to carry out financial analysis is the ratio analysis. The various ratios of the organization will be compared against subsequent years and against the industry in order to determine the growth of the firm in relation to the industry and competitors in the industry.

The data used to carry out financial analysis comes from the financial statements of Gap Inc. Other sources of data include the press releases about the economy or industry performance and economic data such as the gross domestic product (Block & Geoffrey, 2009). It is important for the financial analyst to make a careful selection of relevant data for analysis. All data must be obtained before beginning the process. There are numerous financial ratios. A ratio is an expression of quantitative relationship between elements (Helfert, 2001).

Financial ratios are classified into various categories such as liquidity ratios, profitability ratios and activity ratios among others. These ratios are classified based on the information they provide for decision makers of the company. The ratios are analyzed in the next section.

## Ratios of Gap Inc

### Ratios measuring the Liquidity of Gap Inc.

The ratios are vital for the operations of the firm since they help in determination of the ability of the corporation from meeting its daily operations. Gap Inc. is expected to have high liquidity in order to assure its stakeholders of continued operations. Therefore, high liquidity ratios are favorable for the corporation. These assets are also known as liquid assets and they include cash, bank deposits, stock, and notes receivable among others (Vance, 2002).

#### Current ratio

Current ratio is the ratio of current assets to current liabilities and it is an indicator of the ability of a company to meet current liabilities using current assets.

Current ratio = current assets / current liabilities

The current ratios for Gap Inc for the years 2011, 2010 and 2009 are 1.87, 2.19, and 1.86 respectively (Appendix 4). The ratio fluctuated for the three-year period as indicated. However, the high ratios indicated the ability of the corporation for meeting its liabilities in the short period from the company’s easily convertible assets.

#### Quick/acid test ratio

The ability of an organization to operate depends on the ability of the firm to finance the daily activities. The activities can be funded from the assets of the firm that can be converted to cash fast. This ratios measures the speed at which the Gap Inc. is able to converts its assets to liquid cash for effectiveness in daily operations. Inventory is factored out of the liquid assets because it takes time to convert to cash.

Quick ratio = (Current assets – Inventory) / Current liabilities

The quick ratios for Gap Inc for the years 2011, 2010 and 2009 are 1.1, 1.5, and 1.16 respectively (Appendix 4). The ratio provides a similar indication as the current ratio, the ability to meet short-term obligations. In addition, the ratio fluctuated over the three years.

#### Net Working capital to sales ratio

It is the ratio between working capital (Current assets less current liabilities) in relation to sales. It is an indicator of the ability of a company to meet liquidity needs (sales) using the amount of current assets which remain after taking care of current liabilities.

Net working capital = (Current assets – current liabilities) / sales

The net working capital to assets ratios for Gap Inc for the years 2011,2010 and 2009 are0.13, 0.18 , and 0.13 respectively (Appendix 4). The ratio was low and remained constant over the three years.

### Ratios of Profitability

These ratios give an understanding of the components of the income of a company in relation to unit sales (Block & Geoffrey, 2009).

#### Gross profit margin

The ratio is utilized in the determination of the income earned on unit sales of the inventory of the firm without inclusion of the earnings of the company forms other sources.

Gross profit margin = Gross income / sales

The Gross profit margins for Gap Inc for the years 2011, 2010 and 2009 are 40%, 40%, and 38% respectively (Appendix 4). The gross profit was constant for the two years before dropping to 38% in 2011.

#### Operating profit margin

It is the ratio of net income to sales and it show the remains in dollar terms of sales after taking care of cost of sales.

Operating Profit margin = operating income / sales

The operating profit margins for Gap Inc for the years 2011, 2010 and 2009 are 13%, 13%, and 11% respectively (Appendix 4). The ratios indicate that the operating profit of the firm indicated a declining trend.

#### Net profit margin

Net profit margin is the ratio of net income to sales and it point towards the amount of sales in dollar value that remain after taking care of expenses and cost of sales.

Net profit margin = Net income / sales

The net profit margins for Gap Inc for the years 2011, 2010 and 2009 are 8%, 8%, and 7% respectively (Appendix 4). This indicates a declining trend for the net profit hence measures should be taken to change to trend to an upward trend.

### Activity ratios

The ratios point to the ability of an organization to handle its assets efficiently. They show the benefits that a company derives from various types of assets. They are also used to measure the profitability of a company against all the assets involved (Helfert, 2001).

#### Turnover of Inventory

The ratio points to the ability of the stock of the corporation to create income for the company.

Inventory turnover = cost of goods sold / inventory

The inventory turnover ratios for Gap Inc for the years 2011, 2010 and 2009 are 5.42, 5.74, and 6.03 respectively (Appendix 4). The figures fluctuated, increased first before decreasing.

#### Turnover on Total asset

Total asset turnover ratio = sales / total assets

The total assets turnover ratios for Gap Inc for the years 2011, 2010 and 2009 are 2.08, 1.78, and 1.92 respectively (Appendix 4). The figures begun on a high of 2.08, dropped to 1.78 before showing an upsurge of 1.92.

### Financial leverage ratios

These show the company’s long-term financial obligations and its ability to meet the obligations as they fall due. Financial leverage indicates the structure of the sources of finance to Gap Inc. Companies use a mixture of equity and debt to finance their investments. More use of debt leads to high profitability but high financial risk hence it is important for a firm to analyze financial leverage carefully. Financial leverage ratios of gap Inc. indicate the financial risk taken by the company through use of debt (Vance, 2002). The ratios are of two types, which are component percentages and coverage ratios. Component percentages show the comparison of debt with either total capital or equity capital. Coverage ratios show the ability of the company to meet obligations arising out of debt such as interest.

#### Total debt to assets ratio

It is an indicator of the proportion of assets, which are financed using either long term or short-term debt.

Total debt assets ratio = total debt / total assets

The total debt to assets ratios for Gap Inc for the years 2011, 2010 and 2009 are 0.42, 0.63, and 0.42 respectively (Appendix 4). The ratio increased to 0.63 before dropping to 0.42.

#### Long term debt to assets ratio

This ratio shows the percentage of assets financed using long-term debt only.

Long term debt to assets ratio = Long term debt /total assets

The long-term debt to assets ratio for Gap Inc in 2009 was 1.45. There was no long-term debt in the company in 2010 and 2011 (Appendix 4).

#### Debt to equity ratio

It is an indicator of relative use of debt and equity as sources of capital for the company.

Debt-equity ratio = total debt / total shareholders’ equity

The debt to equity ratios for Gap Inc for the years 2011, 2010 and 2009 are 0.73, 0.63, and 0.72 respectively (Appendix 4). Given that a high debt to equity ratio is not encouraging, the ratios are not high hence acceptable (Yahoo Finance, 2011).

#### Times interest coverage ratio

This is a comparison of the earnings available and the interest expense.

Times interest coverage ratio = Earnings before interest and taxes / interest

The times interest coverage ratios for Gap Inc for the years 2010 and 2009 are 0.3 and 1.59 respectively (Appendix 4). There was no interest expense in 2011.

### Shareholder ratios

These are relevant to shareholders and they indicate the profitability of the company in terms of the shareholder investments (Vance, 2002).

#### Earnings per share

This is the amount of net operating income per share held in the company.

Earnings per share = Net income available to shareholders / Number of shares outstanding

The earnings per share for Gap Inc for the years 2011, 2010 and 2009 are 2.07, 1.89, and 1.66 respectively (Appendix 4).

#### Price earnings ratio

This is the ratio of market price per share to the earnings per share of common shares.

Price-earnings ratio = Market price per share / Earnings per share

### Return on investment ratios

These ratios show the profitability of a company in relation to the amount of assets invested. This is the ratio of the net operating income to total assets of a company (Helfert, 2001).

Return on investment = Net operating income / Total assets

The return on investments for Gap Inc for the years 2011, 2010 and 2009 are 0.17, 0.14, and 0.13 respectively (Appendix 4).

In conclusion, Gap Inc is doing well financially since it is able to meet its obligations as they fall due. The assets of the company are also managed effectively and the company does not have high financial risk. There is improvement in the financial position over the three years. However, the firm needs to improve on its financial performance to avoid fluctuations.

## References

Block, S. & Geoffrey, H. (2009). Foundations of Financial Management. New York: McGraw-Hill Irwin.

Helfert, E.A. (2001). *Financial analysis: tools and techniques: a guide for managers*. New York: McGraw-Hill Professional.

Vance, D.E. (2002). *Financial analysis and decision-making: tools and techniques to solve financial problems and make effective business decisions*. New York: McGraw-Hill Professional.

Yahoo Finance, (2011). Gap Inc. Web.