Public companies have a variety of stakeholders, such as shareholders, bondholders, bankers, suppliers, employees, and management. All these stakeholders need to monitor the firm and ensure that their interests are being served. They rely on the company’s financial statements to provide the necessary information. Detailed analysis of the financial performance of any organization depends a lot on analytical tools used by financial analysts. Ratio analysis is such a frequently used yardstick that provides a better understanding of the financial condition and performance of a company than obtained from analysis of the financial data alone.
The financial ratio analysis used in this study involves two types of comparisons. In the first part of the study, an analysis of financial performance is made for McDonald’s, U.S., and Wendy’s International Inc. In this analysis present performances of McDonald’s and Wendy’s have been compared with their past performances since 2002. The second part of this study involves analysis comparing performances of McDonald’s with performances of ‘Wendy’s International Inc.’ that is also a company in the same industry. Such a comparison will provide insight into the relative financial conditions and performances of both companies.
Intra company analysis
Measuring McDonald’s Financial Condition
Financial statements of McDonald typically contain a large amount of data. To analyze such data it is better to focus on certain key financial ratios. Accordingly, the financial data of McDonald’s has been summarized in key financial ratios as shown in table No. 1 below. This will shed light on certain important issues described hereunder relating to five years’ performance of McDonald’s:
When McDonald’s borrows, it promises to make a series of fixed payments. Because its shareholders get only what is left over after the debt holders have been paid, the debt is said to create financial leverage. In extreme cases, if hard times come, a company may be unable to pay its debts. ‘Debt Ratio’ of long-term debt to long-term capital measures financial leverage. McDonald’s Debt Ratio for 2006 is 0.35. This has reasonably come down since 2002 when the debt ratio was 0.49. The debt equity ratio has also improved a lot since 2002. In 2006 debts are only 54% of equity as compared to 94% of the equity in the year 2002. There was a continuous reduction in debts as compared to equity over a period of five years. With such reduction of the debt ratio, the confidences of equity holders get strengthen as with the reduction of debt servicing cost-profit margins are bound to get enhanced.
Bankers and suppliers have to be extra careful so far as liquidity is concerned. They know that illiquid firms are more likely to fail and default on their debts. Another reason that analysts focus on liquid assets is that figures are often more reliable. McDonald’s Current Ratio has improved tremendously from 0.71 in 2002 to 1.21 in 2006, though 2005 showed a very bright patch with the ratio at 1.45. Though there is no fixed norm, the current ratio of 1.25 to1.33 is considered healthy by most bankers. That means from 2002 to 2004 McDonald’s was not in a very healthy liquidity state. The liquidity position in 2005 and 2006 certainly signifies the stature of a healthy company. ‘Quick ratio’ describes cash more closely than others do. When trouble comes, inventories may not sell at anything above fire-sales prices. As in the Current ratio, McDonald’s Quick Ratio has made tremendous strides from 2002 to 2006 and it was exceptionally well in 2005. With regard to ‘Cash Ratio’ McDonald’s is performing as good as reflected by other liquid ratios. Clearly, McDonald’s has reached a stage where it can easily put off any temporary crises coming its way as every financial institution will readily out to lend temporary assistance to McDonald’s. The company is strong liquidity wise.
This test analyses effectiveness of the use of investments in fixed and current assets. The sales- to- assets ratio shows how hard the firm’s assets being put to use. Notice that each dollar of investment in McDonald’s generates $0.74 of sales. This ratio is 2002 was 0.64. McDonald has made progress over the period but its assets remains underutilized. The correct picture can arrive only when these ratios are compared with the standard of the industry. However, it appears that McDonald’s assets remain underutilized. The company may be using assets very efficiently but its capacity is not being fully utilized.
The speed with which a company turns over its inventory is measured by the number of days that it takes for the goods to be produced and sold. Days in inventory ratio express inventories as a multiple of the daily cost of goods sold. It appears McDonald’s is maintaining its own standard of 3.7 days over the years and effectively using inventories.
McDonald’s does not sell its products on credit to actual consumers, but there is every possibility that franchisees, distributors, or other chain members might be taking a bit too long to pay back bills. The inventory turnover ratio is a good indicator in this regard. McDonald has improved a lot from 20.58 days in 2002 to 14.37 days in 2006. The company is definitely following a stringent credit policy as is clear from its much-improved performance over a period of five years.
If an assessment about the proportion of sales finding its way into profits is to be made, ‘Net profit margin’ is the best indicator. McDonald’s has really made strides from 0.6% of sales in 2002 to 13% of sales in 2005 and 2006. Various tax implications are dependant on this profit margin. Other stakeholders must also be satisfied over such increasing performance, but there is always room to improve. Bankers and other investors are keen to know about return on investments (ROI) or return on assets (ROA), which in fact is a logical measure of the performance of assets. McDonald’s is earning 10% in 2006 on its average total assets investment. This certainly is the superior return (after taxes of course) on investment in any field. Such performance was bound to happen because of a great improvement in net profit margins.
Another measure that concerns the common stockholders is ‘Return on Equity’ McDonald’s shareholders is lucky for their investment is yielding a huge return of 23% in 2006. This has increased from just a 9% return on equity in 2002.
Shareholders are mainly concerned with the dividend they receive. McDonald’s payout ratio suggests that shareholders have received 35% of their earnings in 2006 back as a dividend. This is almost a static strategy of McDonald’s since 2003. McDonald’s is certainly caring for its shareholders.
Measuring Wendy’s International Inc.’s Financial Condition
Wendy’s performances and financial condition for five years have been analyzed on similar criteria as were used for McDonald’s. Data from published financial statements for five years have been converted into suitable financial ratios as depicted in Table II below so that analysis is made through the universally accepted tool of financial ratios.
Debt ratios for Wendy’s range from 34% of the equity in 2002 to 38% of the equity in 2006. In between the debt ratio also dipped to 25% in 2005. As per normal financial parlance, a company is not considered overburdened even when its debts are double the amount of capital employed provided the company is servicing its debts comfortably. Wendy’s is hardly doing well after servicing of debts, as its Net Profit margins are only 2% of its sales in 2006. In fact, the profit margin has declined from 8% in 2002 to its lowest 2% in 2006. Any debts more than the position of 38% of the equity in 2006 may put Wendy’s into financial crises unless the company devises other ways to improve profit margins.
Though networking capital was negative as compared to total assets from 2002 to 2004, Wendy’s kept its liquidity positive as is reflected from its current ratios from 2002 to 2006. In fact, Wendy’s has improved all its Current, Quick and Cash ratios over a period. This reflects that Wendy’s is managing its liquid resources quite effectively and provide the creditors with an impression that their obligations would be met whatever may be the position of its profit margins. This creditability is certainly helping Wendy’s in view of stiff competition in the industry. Trade creditors are more than willing to go along with Wendy’s.
Productivity of assets
The sales to assets ratio have maintained normalcy since 2002. The assets are helping to produce sales equivalent to 1.02 times their value in 2002 to 1.18 times their value in 2006. There was a bad patch in 2005 when assets could only be exploited to the extent of 71% of their total value. However, an average of 1.01 times has been maintained over five years. Two types of reference can be drawn here. Either asset are not qualitatively strong, or those are not being effectively exploited in production. Assets must produce a turnover manifold of their value in order to put the company in a profitably strong position.
Wendy’s is just keeping its ship afloat. Net margins are meagre 2% of sales in 2006. In fact, net margins dropped from 8% of sales in 2002. Similarly return on assets has also shown a downward trend from 9% in 2002 to just 1% in 2006. The situation is quite dismal. On equity investments, the company is doing just about reasonable. Despite all these, shareholders must be feeling satisfied as 71% of earnings on equity has been given to them as dividends in 2006 despite a very low ROE in 2006 as compared to earlier years.
Inter company analysis
McDonald’s is far ahead of Wendy’s as far as the magnitude of volumes is concerned. Despite such a paradox, a comparative financial analysis is possible using ratios as an analytical tool. Such a comparison provides insight into the relative financial conditions and performances of each of the firms. Under this study financial analysis and comparisons of McDonald’s and Wendy’s have again been confined to the issues of Financial Leverages, Liquidity, Assets’ Productivity, and Profitability.
The profitability of a company can be evaluated in two ways: profitability in relation to sales and profitability in relation to investment. McDonald’s average net profit margin over five years since 2002 is 10.6% as compared to Wendy’s 4.2%. Similarly, the average return on assets (ROA) for McDonald’s over five years is 7.6% and for Wendy’s, it is 4.6%. These ratios give the impression that McDonald’s is the leader of the industry not only earning a good margin on sales but on effective utilization of assets. Profit margin can be enhanced in a competitive market only when purchases and direct expenses are cost-effective. McDonald may be using the old maxim of bulk purchasing to economize the rates.
The performance of Wendy’s is not satisfactory when compared to McDonald’s. Either Wendy’s is keeping margins low in the face of stiff competition or it is not economizing on purchases and other expenses. Wendy’s return on assets is also far from satisfactory.
Wendy’s has generated sales 18% over the investments in average total assets in 2006. During 2006 McDonald’s has not even generated sales equivalent to the average cost of its assets. The generation of sales is only 74% of average total assets costs. This is a very typical situation. By generating low sales McDonald’s net margins are 13% and that of Wendy’s are only 2% on the much higher generation of sales by its assets. That shows McDonald’s sales policies are different from normal sales policies. McDonald’s is generating qualitative sales to earn more and its assets are not overworked. Wendy’s is working overtime with assets to produce more sales, and this can have some negative effects on the productive life of assets. Else, Wendy’s will have to increase maintenance costs to keep assets productive all the time. Such policies may prove counterproductive for Wendy’s. From the point of McDonald’s their assets are underutilized. Underutilization assets also add to the overall cost as finance cost is bound to occur whatever may be the utilized capacity of assets.
A firm’s ability to meet short-term obligations is judged through its liquidity position. Liquidity ratios provide insight into the present solvency of a company and its ability to remain solvent in the event of adversities. The idea here is to compare short-term obligations with the short-term resources available to meet these obligations. Comparative Current Ratios of McDonald’s and Wendy’s for 2006 are 1.21:1 and 1.6:1 respectively. The higher the current ratio, supposedly, the greater the ability of the firm to pay its bills. That means Wendy’s is better placed in 2006 as compared to McDonald’s. Similar is the reflection of Quick ratios and Cash Ratios. However, a preview of Wendy’s ratios for the year 2005 shows that the company facing some liquid difficulties airing this year. It pulled itself out with Current, Quick, and Cash ratios of 1.3, 0.5, and 0.4 respectively. Despite having a healthy current ratio, Wendy’s would have faced difficulties in meeting liabilities at very short notice. The liquid assets like Cash were meagre as compared to other Current assets. Cash generation would have taken some time to meet instant obligations.
Debt ratios are considered to analyze the long-term liquidity of the firm. The debt to equity ratio reflects the company’s ability to meet long-term obligations. McDonald’s in the year 2006 carried a debt ratio of 0.35 as compared to 0.38 of Wendy’s. The ratio of debt to equity varies according to the nature of the business and volatility. McDonald’s and Wendy’s are in the same industry and carry a very low debt ratio and debt-equity ratio when averaged over a period of five years. Both the companies are not overburdened with long-term debts. There is another way to analyze this feature of the industry. The industry’s business runs with the franchisee network. Accordingly, most of the assets required to carry on franchisee outlets are financed or arranged by franchisees themselves. In view of such allocation of sources for capital investments, the companies do not feel the need for the arrangement of outside funds other than those of franchisees. Accordingly, tone major feature of this industry is being less burdened with long-term debt obligations.