financial comparison of Pepsi and Coke. The comparison of the two companies is facilitated by the use of GAAP, which means that the financial statements of the two companies are constructed, broadly, according to consistent methodologies and criteria. As a result, there should be direct comparability between the statements of these two companies.
Two main techniques will be used for this comparison. The first is horizontal analysis, where the results of the company are compared against past results from the same company. The second is vertical analysis, where the results of each company are compared on a year-over-year basis according to how the different line items are weighted. The two companies can also be compared on this basis. Horizontal analysis allows the two companies to be compared on the basis of which company is growing faster or controlling costs better. The vertical analysis allows the two companies to be compared with each other on the basis of how their line items stack up (for example, which firm has lower fixed costs or which firm has a higher gross margin).
This report will consist of five parts. The first two sections will consist of a horizontal and vertical analysis of Coca-Cola. The second two sections will consist of a horizontal and vertical analysis of PepsiCo. The fifth and final section of the paper will consist of a comparison between the two firms on the basis of the previous analysis. Conclusions will also be drawn from this thorough analysis of the financial condition of both firms. The objective of this task is to make a determination as to which of these companies is the best one to invest in.
Coca-Cola Horizontal Analysis
Coca-Cola's total revenue has increased 32.5% in fiscal year 2011. This compares to an increase of 13.3% in fiscal year 2010. The increase is attributed to increases in Asia in particular, but also improvements in the economic environment in the United States, where the economy stabilized after a long stretch of either recession or sluggish growth. The company's cost of revenue increased 43.5%, compared with an increase of 14.4% in FY 2010. These figures show that Coca-Cola's costs have increased faster than the company's revenues. This is a cause for concern for the company's management, because it means that the company is seeing its pricing power erode -- normally the company would want to either drive costs down from their suppliers or increase prices to consumers in order to maintain their margins. The selling, general and administration expense increased 68.2% in FY2011 and 27.2%, again a sign that the company's cost controls are relatively poor. These sorts of costs should not increase that much faster than sales.
On the balance sheet, Coca-Cola has seen its current assets increase 18%, where its current liabilities have increased 31.2%. Again, this highlights that the past year was challenging for the company. The long-term debt decreased in FY 2011 by 2.7%, but this came after an increase in FY2010 of 177.5%, so again there is evidence that Coca-Cola's financial position in weakening over the past couple of years. The growth in the total equity is 1.1%, much lower than the growth in either revenues or profits; and the growth in FY 2010 was 25%, a healthy increase but lower than the company's increase in expenses.
Most companies do not perform a horizontal analysis on the statement of cash flows, but a horizontal analysis can be conducted. There are times when the statement of cash flows sheds light on the company's performance that the analysis of the income statement cannot shed. While Coca-Cola saw its revenue increase in FY2011, the rate of increase in cost of revenue was higher and this is reflected in the cash flow from operations, which decreased 1% in FY2011. While this comes on the heels of an increase of 16.4% the year before, having any decrease in the cash flows from operations is disheartening. As a result of this decrease, Coca-Cola was forced to curtail its investing activities and because the stock price was relatively low due to poor performance, the company retired significantly more stock in FY2011 than the year previous, in order to prop up the stock price.
Coca-Cola Vertical Analysis
The cost of revenue in FY2011 was 39.1% of revenue, whereas in FY2010 cost of revenue was 36.1% of revenue. This indicates that the company's cost of goods sold is increasing at a faster rate than the revenue, and this is a negative sign that if it occurs over the long run will have strong negative consequences for the company's financial health. In addition, the operating margin has declined to 23% in FY2011 from 39.1% in FY2010. This is a significant decline in the operating margin, and highlights the fact that Coca-Cola has struggled to control its costs even as the company's revenues expand.
On the balance sheet, Coca-Cola has current assets that are 31.88% of total assets in FY2011, compared with 29.5% in FY2010. This is probably not a significant change, but it is worth noting that inventory is now 3.86% of total assets, compared with 3.6% a year ago. It is important that the company manage its inventory levels in order to have a healthy cash conversion cycle.
Also on the balance sheet, short-term debt has increased to 16% of the firm's capital structure, compared with 11.1% in FY2010. This indicates that perhaps the company has a major bond due, but the long-term debt is significantly higher than it was two years ago. This calls into question the firm's debt management, since short-term obligations have spiked so high in a single year. The equity at Coca-Cola is currently 39.2% of the capital structure, compared with 42.5% last year. This indicates that the company has taken on more debt, and not retained enough earnings. In general the horizontal and vertical analysis reveals that Coca-Cola is not in the best financial health. The company's trends are generally negative.
PepsiCo Horizontal Analysis
In FY2011, Pepsi increased its revenue by 15%, compared with an increase of 33.7% in FY 2010. This represents a downturn in revenue growth at the precise time when the global economy began to recover in earnest from the economic crisis. The cost of revenue increased 18.8% in FY2011, compared with an increase of 32.2% the previous year. The company's costs are increasing at an uneven pace, which implies that a longer-term analysis is necessary to determine a trend. The sales, general and administrative expense should perhaps also be considered. This increased 12.2% in FY2011, slower than the sales increase, but 48.9% in FY2010, which is a rate much higher than the rate of increase in revenues. The net income only increased 1.9%, which compared with the increase in revenue is paltry. The net income increase in FY2010 was 6.3%, again much lower than the increase in revenue. This indicates that PepsiCo is having trouble controlling its costs, because healthy revenue improvements are only turning into mediocre profit improvements.
The balance sheet also shows some issues. The most important balance sheet item in the horizontal analysis is the long-term debt, which increased 2.8% in FY2011. This is a relatively minor increase, but considering that equity decreased 5.2% over the same time period, this is a little bit of a negative trend.
PepsiCo Vertical Analysis
With the vertical analysis, we can see that at PepsiCo the cost of revenue in FY2011 was 47.5% of the revenue, whereas in FY2010 it was 45.9%. This indicates that the cost of revenue has grown faster than the revenue itself, which is a sign that the firm's pricing power over either buyers or suppliers (or both) is deteriorating. The selling, general and administrative expense is 36.7% as of FY2011, compared with 37.6% of revenues in FY2010. This indicates that with respect to this overhead expense, Pepsi has contained its growth to a level lower than that of sales. This compares with Coca-Cola, where the same situation does not hold.
The balance sheet at PepsiCo is also worth considering. Current assets are 23.9% of the asset base in FY2011, compared with 25.7% in FY2010. This lack of increase in current assets is more striking when compared against the increase in current assets. These were 24.9% of the total capital structure of the firm in FY2011, but only 23.3% in FY2010. This indicates that while the current liabilities were growing, the current assets were not. This is a deterioration in the company's liquidity. Beyond this, the long-term debt was at 28.2% of the total assets in FY2011, compared with 29.3% in FY2010. This is not a major change, but it does represent that the company's debt is growing at a faster rate than its equity. The shareholder's equity was 28.2% in FY2011, compared with 31% in FY2010. This again illustrates that the company's financial condition is deteriorating somewhat, given that the equity is decreasing and the debt-load is increasing.
In total, we can see that Pepsi's financial condition has deteriorated…