Financial Analysis of Estee Lauder

Financial Analysis of Estee Lauder Company Financial ratios are important in determining the relationships between different values in the most important financial accounts used by a company. In many ways, they constitute the easiest way to evaluate a company from a financial and profitability point-of-view. Each financial ratio targets a particular area of expertise. This report will deal with liquidity ratios, profitability ratios, asset efficiency ratios, solvency ratios and market tests in order to build an image of where the company is currently standing.

Liquidity Ratios The current ratio shows the rate at which current liabilities are increasing, as compared to the company's current assets. If the company is beginning to pay its debts later than usual, accumulating short-term liabilities and, at the same time, the current assets value remain at the same value (or are decreasing), then one may conclude that the company is encountering a short-term insolvability experience.

In the case of Estee Lauder, current ratio followed an ascending trend during the period from 2000 to 2002, only to fall back in 2004 to similar values as in 2000. The current ratio is thus oscillating around value segments of 1.7-2.0, with a mean of 1.8. This values show a consolidated short-term financial solvability for the company. During a five-year period, oscillations have been minor in a value set around 1.8, pointing out towards the fact that Estee Lauder is not likely to have difficulties in honouring short-term debts.

The quick ratio or acid test is calculated similar to the current ratio, only that the inventory value is subtracted from the current asset value. It is often the case that the stock and inventories are the company's least liquid current assets, so the quick ratio is a way to find out further information on the company's solvability without considering stock values. In this case, Variations are similar to those of current assets, with a mean value of 1.2 over the analyzed five-year period.

With inventory values ranging from $545 million to $654 million, the quick ratio refers around the same value in this period. The inventory turnover is a financial ratio that shows the efficiency with which the company is using its stock. As seen, it is linked with the quick ratio previously discussed. The inventory turnover ranged from 1.9 to 2.3 during the analyzed period, with a peak of 2.3 in 2000 and 2004.

In general, the inventory turnover is influenced by numerous factors, including the accounting methodology used in evaluating stock (FIFO - first in, first out or LIFO - last in, first out) or in the market price for the respective stock. The very small variation from year to year in the case of Estee Lauder point out towards a stable policy in terms of inventory. Profitability Ratios The profitability ratios show, in the last instance, the actual result of all operational actions that a company is involved in.

In fact, profitability ratios combine the determinants that have led to calculating asset efficiency, liquidity or debt management ratios. Further more, as they are reported to the net sales value, the profitability ratios give an objective view on how much the company is spending on selling its goods and on what the final profit is as compared to the initial net sales value. The gross margin ratio shows how much is invested into the actual sale of the company's products.

In other words, what is the cost of the goods sold, as a proportion of the total net sale values? Here, the gross margin ratio has followed an ascending trend, growing, from 2000 to 2004, with 2.4%. The cost of goods sold during this period has increased, but only to support sales that grew by more than 30% during this time. The net profit ratio, calculated as a percentage value of the net income compared to net sales, gives perhaps the best financial perspective on the profitability of the company.

In the case of Estee Lauder, the net profit ratio has undergone a significant decrease in 2002, only to grow again in 2003 and 2004, without reaching the 7.1% value from the beginning of the analyzed period. Explanations for this sharp decrease can be found when observing the evaluation of two important elements from the company's financial statement: the operating income and the income before tax. Both these elements have undergone decreases of around - 45% in 2002, due, perhaps, to an increase in financial and operational costs.

Solvency Ratios Mainly, solvency ratios are aimed to point out towards two important issues. First of all, the company's capacity to pay its debts during a certain period of time. Second of all, the rate at which the company is using the financial leverage or the proportion of debt as a source of finance for the company's actions. The times interest earned ratio is determined by dividing the earnings before tax and interest (EBIT) to the overall value of interest related costs.

The TIE ratio is important because it shows by what values the company's earnings can vary without affecting the capacity of paying interest rates and covering lending costs. A low TIE may be a signal that the company is about to have financial difficulties and encounter problems with the creditors. In Estee Lauder's case, the TIE was the same during the analyzed period, remaining at 1.0 from 2000 to 2004.

Of course, the TIE depends on the company's preference of using a higher or lower financial leverage, but in this case, the financial leverage is extended at maximum. Practically, the company is running as risky as it can and any decreasing variations of profits can bring prejudices to the company's solvability. Interest rate spending is equal to the company's EBIT and in no case should the margin decrease any more.

Asset Efficiency Ratios The asset efficiency ratios show the rate of efficiency with which the company is using the assets it currently holds. In general, these ratios are calculated by comparing the company's net sales to different components of the company's total assets. The total asset turnover and the fixed asset turnover are the best financial ratios in this case, as they show the degree of efficiency with which the company is using its fixed assets and its total assets.

The fixed-assets turnover shows the efficiency with which the company is using its machines and equipment. Analyzing the trend during the period 2000-2004, the -8.6% decrease in 2002 can perhaps indicate a certain loss in efficiency during that year. However, a simpler explanation can be found when analyzing the trend of total assets and current assets during this period of time.