Google vs. Microsoft Financial Ratio Analysis (2009–2012)

Introduction to Ratio Analysis

Ratio analysis is a tool by which companies in the same industry can be compared. Its use helps offset the differences in size between companies — for example, one company may have a larger absolute profit figure but a smaller profit margin than a competitor. The ratio — profit margin — may be a better indicator of which company is actually more profitable. In this analysis, Microsoft and Google are compared. Microsoft operates a variety of multi-billion dollar businesses, including servers, Office, and Windows, while Google generates most of its revenue from advertising sales. Yet both companies are remarkably profitable, and both face similar situations with respect to excess cash flow. They are also two of the major driving forces in the Internet industry, competing directly in browsers and mobile operating systems.

Key Ratio Definitions

The current ratio is a liquidity ratio that indicates a firm's ability to meet its financial obligations over the coming year.

The quick ratio is another liquidity ratio, similar to the current ratio, but it removes inventories from the numerator. The rationale is that inventories cannot be assumed to be liquidated at book value.

Accounts receivable turnover indicates how quickly a company collects on its invoices. This ratio illuminates the company's cash conversion cycle. It is significant because older, uncollected accounts are at greater risk of non-payment.

Days receivable expresses the same concept as accounts receivable turnover, stated in terms of days rather than times.

Inventory turnover reflects how rapidly inventory moves. Because older inventory is harder to sell — or harder to sell at full value — a higher rate of inventory turnover is generally desirable.

Days' inventory is an alternative expression of inventory turnover using the same underlying figures.

Asset turnover is an efficiency ratio (sales divided by assets) that reflects how well a firm's assets are being deployed to generate revenue.

Invested capital turnover complements the asset turnover ratio, telling the same story but using total assets minus one as the denominator.

Equity turnover reflects the degree to which owners' equity is converted into revenue. It is another efficiency ratio, one that removes debt from consideration.

Capital intensity measures sales relative to a specific asset class (plant, property, and equipment), again reflecting the efficiency with which capital assets are converted to revenue.

The gross margin reflects the bargaining power a firm holds over buyers and suppliers. The greater this bargaining power, the higher the gross margin will be.

The net margin incorporates all of a firm's costs, not just cost of goods sold (COGS). When used alongside the gross margin, it can help management determine whether changes in net profitability stem from shifts in gross margin or from changes in the company's internal and fixed cost structures.

Earnings per share (EPS) reflects, roughly, what shareholders receive from the company's operations. This measure is less critical from a purely operational perspective — because the number of shares outstanding is not an operating metric — but shareholders pay close attention to it, which means management must as well.

Financial Data: Microsoft and Google (2009–2012)

The table below presents four years of calculated ratios for both Microsoft (MSFT, Years 1–4) and Google (GOOG, Years 5–8). All underlying data were sourced from MSN Moneycentral and each company's annual reports. Key figures are discussed in the sections that follow.

Microsoft (MSFT)

Working Capital: $22,246M (2009) | $29,529M (2010) | $46,144M (2011) | $52,396M (2012)

Current Ratio: 1.82 | 2.13 | 2.60 | 2.60

Quick Ratio: 1.16 | 1.41 | 1.83 | 1.93

Accounts Receivable Turnover: 5.22 | 4.80 | 4.67 | 4.67 times

Days Receivable: 69.91 | 76.02 | 78.21 | 78.13 days

Inventory Turnover: 16.95 | 16.75 | 11.35 | 15.42 times

Days of Inventory: 21.53 | 21.79 | 32.15 | 23.67 days

Asset Turnover: 0.75 | 0.73 | 0.64 | 0.61 times

Invested Capital Turnover: 1.35 | 1.22 | 1.01 | 0.96 times

Equity Turnover: 1.48 | 1.35 | 1.23 | 1.11 times

Capital Intensity: 7.76 | 8.19 | 8.57 | 8.92

Gross Margin: 79.2% | 80.2% | 77.7% | 76.2%

Profit Margin: 24.9% | 30.0% | 33.1% | 23.0%

EPS (Common Stock): $0.002 | $0.002 | $0.003 | $0.002

Google (GOOG)

Working Capital: $26,420M (2009) | $31,566M (2010) | $43,845M (2011) | $46,117M (2012)

Current Ratio: 10.62 | 4.16 | 5.92 | 4.22

Quick Ratio: 8.91 | 3.50 | 5.01 | 3.35

Accounts Receivable Turnover: 7.39 | 5.86 | 6.14 | 5.84 times

Days Receivable: 49.40 | 62.27 | 59.43 | 62.45 days

Inventory Turnover: 0.00 | 0.00 | 40.86 times (first year with inventory)

Days of Inventory: 0.00 | 0.00 | 0.97 | 8.93 days

Asset Turnover: 0.58 | 0.51 | 0.52 | 0.53 times

Invested Capital Turnover: 0.66 | 0.63 | 0.62 | 0.67 times

Equity Turnover: 0.66 | 0.63 | 0.65 | 0.70 times

Capital Intensity: 4.88 | 3.78 | 3.95 | 4.23

Gross Margin: 62.6% | 64.5% | 65.2% | 58.9%

Profit Margin: 27.6% | 29.0% | 25.7% | 21.4%

EPS (Common Stock): $16.641 | $21.691 | $24.833 | $27.362

Microsoft Ratio Analysis

Both companies have recorded exceptional financial performance over the period examined. Microsoft has increased its working capital significantly, rising from roughly $22 billion in 2009 to $52 billion in 2012. A healthy current ratio is approximately 1.0 in most industries, and Microsoft comfortably surpasses that benchmark — its quick ratio had climbed to 1.93 by 2012. With $52 billion in working capital and healthy liquidity ratios, liquidity is not a concern for Microsoft.

Microsoft does exhibit a somewhat sluggish accounts receivable turnover, and there are two related concerns. First, the receivables trend is moving in the wrong direction: days receivable increased from roughly 70 days in 2009 to 78 days in 2012, meaning the company is taking longer to collect from its customers — particularly the enterprise clients that make up the majority of its base. The fact that the company holds $63 billion in cash and equivalents should not encourage it to be cavalier about collections, especially in segments where competition is minimal, such as Windows and Office.

Inventory turnover is more rapid. Although Microsoft has experienced a generally negative trend toward slower inventory turnover, inventory (at $1.137 billion in 2012) represents a minimal share of the company's current assets. Whether inventory turns quickly or slowly is unlikely to affect the company's financial outcomes in any material way.

Asset turnover has also trended downward over the four years, indicating that the company has added assets faster than it has added sales. Invested capital turnover and equity turnover have similarly slowed, highlighting that whatever Microsoft has been deploying capital into recently is not generating the same returns as its prior activities. A key explanation is the rapid accumulation of working capital: if Microsoft is holding large amounts of cash on the sidelines — which it is — that cash will not earn as much as its core operating businesses. The more cash piles up, the less efficient the company appears across all three turnover metrics, which explains the consistent decline.

A declining gross margin may also be contributing to lower returns. Microsoft's gross margin fell in each of the four years examined, suggesting either that its pricing power in existing businesses is eroding or that it is entering new, less profitable lines of business. The net margin has not tracked the gross margin in a straight line, which indicates that Microsoft has taken steps to cut costs elsewhere in order to partially offset the gross margin decline. As a result, the net margin has exhibited greater volatility than the gross margin.

Microsoft's earnings per share did not rise in a linear fashion — a fact that likely discouraged shareholders. EPS increased for three consecutive years but fell in 2012 when Microsoft's net income dropped. This decline was not the product of operating deterioration; rather, it resulted from a $6.2 billion writedown related to the online advertising company aQuantive (Goldman, 2012).

Conclusion

Overall, both Google and Microsoft are financially healthy companies. If there is a question mark for both, it lies in accounts receivable: both firms show collection periods that seem high and have been trending upward. However, on the measures of liquidity and investor returns, Microsoft and Google have both performed very well — with the single exception of Microsoft's 2012 writedown related to aQuantive.

References

Goldman, D. (2012). Microsoft's $6 billion whoopsie. CNN Money. Retrieved November 18, 2014, from http://money.cnn.com/2012/07/02/technology/microsoft-aquantive/index.htm

Google 2012 Annual Report. Retrieved November 18, 2014, from http://www.sec.gov/Archives/edgar/data/1288776/000119312513028362/d452134d10k.htm

Microsoft 2012 Annual Report. Retrieved November 18, 2014, from http://www.microsoft.com/investor/reports/ar12/download-center/index.html

MSN Moneycentral. (2014). Microsoft. Retrieved November 18, 2014, from http://www.msn.com/en-us/money/stockdetails/financials/fi-MSFT?ocid=qbeb

MSN Moneycentral. (2014). Google. Retrieved November 18, 2014, from http://www.msn.com/en-us/money/stockdetails/financials/fi-GOOG?ocid=qbeb