Financial Comparison Financial Analysis Is a Tool Essay
- Length: 6 pages
- Sources: 4
- Subject: Business
- Type: Essay
- Paper: #41879325
Excerpt from Essay :
Financial analysis is a tool that allows third parties to analyze corporate financial statements. One of the main reasons that the Securities and Exchange Commission requires that statements are compiled and presented in a consistent manner is to ensure that third parties will be able to use the statements to compare different companies. These comparisons can, among other things, help with investment decisions. This paper will compare PepsiCo and Coca-Cola Company, the two leading soft drink marketers in the world. PepsiCo is actually the larger of the two companies, because it is more diversified, with its snack food properties. These properties also alter the company's finances, creating certain points of difference between the two companies. This report will cover a number of different forms of financial analysis, arriving at a conclusion about which company has the stronger financial position.
The first set of ratios to be studied are the liquidity ratios. Two of the major liquidity ratios are the current ratio and the cash ratio. Pepsi's liquidity, solvency and profitability ratios for the past three years are as follows:
LT Debt to Equity
The current ratio for Pepsi has been declining steadily for the past three years, as has the cash ratio. This indicates a deterioration in the company's liquidity position. The decline in the cash ratio is particular means that the decline in liquidity is not strictly attributable to changes in accounts receivable or inventory.
Pepsi's debt ratio has increased substantially, in 2010 in particular. The long-term debt to equity also increased over that year. This, combined with the reduction in liquidity in 2010, points to an event that changed the company's financial health. During the 2010-year, Pepsi acquired Russian food company Wimm-Bill-Dann for $3.8 billion (PR Newswire, 2010), and Pepsi Bottlers for $7.8 billion (FTC, 2010). These transactions reshaped the company's finances. However, it is worth noting that both the solvency and liquidity ratios weakened in FY2011, indicating that the company was having some trouble with either ongoing business conditions or with integrating the new acquisitions.
Pepsi's margins have also weakened. The company's margins are healthy in general, at 52.5% for the gross margin and 9.7% for the net margin. However, these are not as strong as they used to be. At least some of the margin reductions must have come from the newly acquired properties, and the objective of Pepsi management should be to bring those assets into a level of performance that is in line with PepsiCo's historical norms.
The ratios for Coca-Cola are as follows:
Coca-Cola's financial performance over the past three years is better than Pepsi's in terms of raw numbers, but has a similar trend. The company's current ratio dropped, along with its cash ratio. The debt ratio and long-term debt to equity increased significantly, and its margins have declined. Again, looking at the size of the balance sheet tells the story, as Coca-Cola went through a major acquisition in 2010. Similar to Pepsi, Coca-Cola Company bought its major North American bottler Coca-Cola Enterprises for $12.3 billion, which included taking on $8.8 billion in CCE's debt (Leckey, 2010).
The key to Coca-Cola's performance is that it made only the one acquisition, whereas Pepsi made three. This allowed Coke to bring the acquired enterprise into its company more easily. The company therefore has been able to make some headway in paying down the debt it acquired, as evidenced by the reduction in its long-term debt to equity ratio, even as the total liabilities to assets increased. The company has still seen its margins suffer, however, and that it worth taking into consideration.
A vertical analysis can help to make sense of the ratio analysis. For example, both companies saw their current ratios decline, as well as their cash ratios. It is important to understand what caused these declines. For Coca-Cola, there has been an increase in the short-term debt that the company holds, from 13.9% of assets in FY2009 to 16.1% of assets in FY2011. The vertical values of current assets have declined in that time, from 36% in FY2009 to 31.9% in FY2011. This means that the company purchased more fixed assets than it purchased current assets, and that has resulted in an erosion of the company's liquidity position. The long-term debt in FY2009 was 21.1% of the total value of the firm. This decreased to 19.2% in FY2010 and 17.1% in FY2011, highlighting the fact that Coca-Cola has paid down some of the debt it inherited from Coca-Cola Enterprises.
The vertical analysis of Coca-Cola's income statement should reveal the causes of the decline in the company margins beyond the increase in the cost of goods sold. The selling, general and administrative expenses in 2009 were 18.2% of revenue. In 2010, these had increased to 20.4% of revenue and in 2011 they were 26% of revenue. This dramatic increase in key overhead expenses is the primary cause of the company's eroding margins. Normally, a company would want to see its administrative expenses decline post-merger and the company enjoys operating synergies and increased efficiency. That is not what has occurred at Coca-Cola in the short-run.
At Pepsi, the balance sheet vertical analysis reveals how much debt the company acquired with its purchases. In FY2009, long-term debt was 18.5% of the balance sheet. This increased to 29.3% in FY2010, and then declined slightly to 28.2% in FY2011 despite growing in total. The company has therefore taken some steps to reducing its debt, but saw its equity grow at a slow rate as well. Meanwhile, current liabilities have grown substantially as a percentage of the total balance sheet. They were 21.9% in FY2009, 23.3% in FY2010 and 24.9% in FY2011. This explains the company's declining liquidity ratios in part, along with a decline in the among of cash that the company has on its balance sheet. All told, Pepsi has not done much to improve its balance sheet, and the vertical analysis confirms this weakness.
With respect to the income statement, Pepsi has seen its margins reduced. Some of this represents an increase in the cost of goods sold as a percentage of revenues, given the decline in the gross margin. As with Coca-Cola, Pepsi saw an increase in its selling, general and administrative expenses with the new acquisitions. These were 33.7% of revenues in FY2009, 37.6% in FY2010 and 36.7% in FY2011. These expenses further eroded the company's margins.
The two companies have experienced a very similar history over the course of the past three years. However it is reasonable to conclude that in general, Coca-Cola has the better financial health of the two firms. On an absolute basis, Coca-Cola's figures are generally better. Whereas three years ago, it was less liquid than Pepsi, today it is more liquid. It also has lower debt and better margins. The numbers of each of these companies, it should be noted are within the range of healthy companies. They are both flirting with poor liquidity (around 1.0 on the current ratio) and high debt, but for now both firms are sufficiently healthy. That said, Coke is healthier. Consider the selling, general and administrative expense. This is only 18.2% for Coke, versus 36.7% for Pepsi, over double the percentage. This percentage might reflect that Pepsi has multiple businesses, whereas Coke does not, implying that there is a need for more administration at Pepsi.
In addition to having better absolute numbers, Coca-Cola's trends are better. For example, in terms of liquidity both firms have seen a decline in liquidity over the course of the past three years, but the rate of decline has been much sharper at Pepsi than at Coke. This trend has occurred with the other measures as well. Coca-Cola has improved its long-term debt to equity ratio, for example, in FY2011, something that PepsiCo has yet to do. Thus, both in terms of Recommendations
Both of these firms face the same situation, and the recommendations are therefore applicable to both. They need to integrate their acquisitions into their organizations. This is the basic premise for the recommendations. The first is to improve pricing power. Right now, both of these companies have seen their margins squeezed, with the cost of goods sold growing faster than revenues. These companies need to be able to raise prices to match the growth in their cost structures. By doing that, they can restore their margins, starting with the gross margin. The rise that both firms have seen in their selling, general and administrative expenses is something that should not occur. These companies need to realize synergies from their 2010 acquisitions,…