Sun Microsystems: Financial Analysis

Executive Summary

After carrying out an audit of ratio analysis of Sun Microsystems, a number of inferences can be drawn. The firm is operating at losses as the profitability ratios does surpass the industrial average and the trend is declining. The company however is financially stable owing to its high current, quick and debt ratios. On the other hand, it is effectively utilizing its assets to generate sales revenue. It has high inventory and accounts receivable turnovers, which may be high than the trend looks up toward a dangerous point.

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The management ought to improve the profitability, performance, activity, debt paying ability and liquidity through a cost reduction mechanism, adoption of a favourable credit policy and a sound financing policy. They also need to invest in projects that generate positive net present values for the benefit of the shareholders

TREND ANALYSIS.

2007 2006 2005
Profitability
a) Gross profit
= Gross profit
Sales
6265000
13873000
45.2%
5629000
13068000
= 43.1%
4589000
11070000
= 41.5%
b) Net Profit
= Net Profit
Sales
309000
13873000
2.2%
(870000)
13068000
= -6.7%
(323000)
11070000
= -2.9%
c) Return on Owner’s Equity(ROE)
= Net Profit after tax
Equity
7% (13.27%) (1.63%)
d) Return on Total Assets
= Net Profit after Tax
Total Assets
3.06% (5.9%) (0.75%)
DuPont analysis
Sales x Assets x N. Profit
Sales x Assets x Equity
7% (13.27%) (1.63%)

On profitability/ performance, it can be noted that the profitability of the company is fluctuating from time over time. This is shown by the Gross profit margin, Return on Assets (ROA), Return on Equity (ROE) and the operating profit margin. In 2006, the ROE increased to -13.7% from -1.63% in 2005 then it increased to 7% in 2007. The net profit margin took the same dimension of fluctuating in year 2006 it decreased to-6.7% from -2.9% in 2005 before increasing to 2.2% in 2007.. In 2005, the ROA was -0.75% before declining to -5.9% in 2006 further up to 3.06% in 2007

The Gross profit margin also increased to 43.1% in 2006 from 41.5% in 2005. In 2007, it increased to 45.2%.The profitability of the company has been fluctuating and it seems the effect lies on operating , gross profit is positive but if the management does not take care, the operating costs will affect the company’s profitability in the long-run. This is because although there are fluctuations they are associated with operating costs, as the gross profit seems to be stable.

Cash flow analysis and financial position

Using free cash flow to net sales and net profit cash flows are also in fluctuating trend. Cash position is in a manner that cannot meet obligations. This can be seen from the figures of years although look fluctuating quick ratios and acid test ratio are health.There the same conclusion about financial position can be made using both the acid test and cash ratios. From the acid test ratios, the firm’s ability to meet its financial obligations from the most liquid assets is not questionable. The exception was between 2000 and 2005 where the ratios were less than 1.Although the required rated is 2:1 no year this has reached this level. Liquidity and debt paying ability, the current ratio indicates that the firm is financially stable and liquid with a ratio of 1.34:1, 1.409:1,1.462:1 and 1.705:1 for years 2007backward to 2004.from the trend it shows that the stability was coming down. This means that for every $1 of current liability there are more $1. of current Assets. The recommended ratio is 0.5:1 i.e. current assets should be twice as much as current liabilities.

The quick Asset Acid test ratio also declines from 1.107:1 in 2004 to 0.994:1 in 2005, to 0.923:1 in 2006 and 0.808:1in 2007 The ratio indicates how able the firm is in meeting its financial obligations from the most liquid assets. From quick and acid test ratio one is able to know that mostly stock was held in large quantities. The ability of the firm pay liabilities was coming down as it is shown by times interest earned and the amounts of cash flows that were being held. The times interest earned fluctuated as 5.251, 6.511, 5.52 and 3.521for years 2004, 2005, 2006 and 2007 respectively.

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The working capital of the company contains an insignificant proportion of cash through as we can deduce from the financial health ratios. The firm cannot therefore meet its obligations comforting.

Comparing this with the competitors, the company is performing above the industrial average. In order to improve on acid test ratio the company should reduce amount of stock being held. This will improve the ratios.

Looking at the ratios we can deduce that the company is performing well and management wants the world to know that company although making losses it is in a sound financial position that they can meet obligations without much problems.

The analytical audit of the company’s capital structure shows a fluctuation in gearing fluctuating from time to time although the fluctuation. the gearing seems to low to the level where they can not affect the company future continuity. They are in the levels of 0.24 and below. The company seems not to exceed this level, which was in year 2000 and 2003. for other years it is below this level. This variability indicates that the firm does not have a sufficient and steady internal financial resource to finance its assets. These get depleted compelling management to use external financial instruments. This usage of external sources to finance its assets increase chances of the company suffering financial risk that may lead to bankruptcy. In addition, one can deduce that the company does not have a define capital structure to followed as the gearing seems to fluctuating.

The audit of inventory reveals a high “buy and sell” frequency of goods. This is shown by low stock turnover ratios. They are very high all the 10years although from 20003 to 2007 they have been coming down. This further means that on average, the goods stayed for 27 days in the warehouse for the 10 years. The firm’s efficiency with which it is utilizing its resources (inventory) to generate sales is declining.Its highest efficiency on utilization of stocks was in 2003 when stock stayed in the warehouse for only 13 days on average.

A review of the financial Statements of this company indicates that the company did not manufacture its products. The company just specializes in merchandising. It is impractical for a manufacturing company not to have opening and/or closing works-in progress. Further, an analysis of the finished goods indicates zero balances although. We do not have the work in progress analysis.

However, activity with regard to debtors (accounts receivable) shows a haphazard performance with improvements being interchanged with poor performance. It was only in 2007 and 2005 when the company recorded a high accounts receivable turnover of 8.6 times and 7.7 times respectively. Even though the turnover rates in 2004 and 2006 were lower at 7.4 times and 7.1times respectively. The account receivable came down from 51.2 to a low of 42.3 in 2007.this shows that the company had improved in its collection policy.

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There is no improvement of the debt/equity ratio it keeps on fluctuating that is 6.693:1, 4.214:1, 3.064:1 and 3.753:1 in years 2004 to 2007 respectively. this ratio is an indicator of the how many times the shareholders funds can pay total liabilities. From this, I deduce that on average for every $3 of debtors they will get $1 from the shareholders funds. This trend is very dangerous as the bankruptcy risk is high. If the company commit a technical default and creditors decide to go to court then the company will go under. Debt/assets ratio has also shown a downward trend except a small improvement in year 2007.the ratio was 0.87, 0.81, 0.75 and 0.79 for years 2004 to 2007 respectively.

In order to achieve better future results, better or higher to industrial average, the firm needs to cut down its operating expenses. This would considerably improve the profitability ratios. They also have to review their policy on capital management and keep optimal levels of various items of current assets. This would improve the firm’s liquidity position. In order to improve the return on owner’s equity ratio, the management should invest in viable projects that would yield positive NPV’s.This has the effect of maximizing their wealth. To improve on the financial ratios, the firm would ensure that it has more liquid assets and resort to internal sources of finance as opposed to external ones. They should consider vertical integration as a strategy for improving their profits.

References

Carlson S; (1969) International Financial Decisions; North Holland Pub;

Choi F. S.; ( 2003) International Finance and Accounting Handbook; Wiley

Christofferson P; (2003) Elements of Financial risk Management; Elsevier.Gapenski l, Brigham E; (1994) Financial Management: Theory and Practice; Dryden Press.

Givens C., (2002); More Wealth without Risk, Mc GrawHill,

Lindsay R; (1967) Financial Management, An Analytical Approach; R.D Irwin, 1967

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Luecke R; (2002) Finance for Managers; Harvard Business School Press;

Poitras G;( 2002) Risk Management; Elsevier,

Sanzo R.,( 2005); Ratio Analysis for small Business, Yale University Publishers, USA.Seitz N; (2004) Capital Budgeting and Long-term financing Decisions; Thomson Learning,

SunMicroSystems (2007). Web.

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