Ratio Analysis And Statement Of Cash Flows
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Ratio Analysis and Statement of Cash Flows
Financial ratios are “just a convenient way to summarize large quantities of financial data and to compare firms performance” (Brealey & Myer & Marcus, 2003, p. 450). Financial ratios are very useful tools in order to determine the health of a company, help managers to make decision, and help to compare companies that belong to the same industry in order to know about their performance.
Home Depot and Lowes are two home improvement chains in the United States. Home Depot is the leading company in this industry followed by Lowes as the second largest. This paper uses financial ratios to compare these companies regarding operating profitability, asset utilization, and risk management in the years 2005 and 2006. The evaluation compares the performances of these stores against the industry.
Operating Profitability
Home Depot closed the fiscal year of 2006 reporting that its sales were $90.8 billion, which was a 10% increase from fiscal year 2005. The Home Depots operating profit was $27,427 million for 2005 and $29,907 million for 2006 (MarketWatch, 2007). Lowes closed the fiscal year of 2006 reporting sales of $46.9 billion, an 8.5% increase compared to fiscal year 2005. Lowes gross operating profit was $16,273.00 million for 2005 and $12,307.00 million for 2006 (MarketWatch, 2007). Both companies increase sales from the previous year. Home Depot had greater sales and higher operating profit than Lowes.
Profitability Ratios
Profitability ratios determine the companies earnings. The Net Profit Margin is calculated by dividing net income by sales. Home Depots portion of revenue from profits equaled 7.2% in 2005 and 6.3% in 2006. Lowes portion of revenue from profits equaled 6.4% in 2005 and 6.6% in 2006. Home Depot had a decreased in profit margin while Lowes increased its profit margin in 2006.
Home Depots Net Profit Margin for 2005 =
Home Depots Net Profit Margin for 2006 =
Lowes Net Profit Margin for 2005 =
Lowes Net Profit Margin for 2006 =
Another measure of profitability is the return on equity which is calculated by net income/average equity. This measure shows that Home Depot had a better return on equity in 2005 while Lowes had a better return on equity in 2006. Nevertheless, Home Depot reinvested earnings to generate additional earnings in a better way than Lowes in 2006.
Home Depots Return on Equity 2005 =
Home Depots Return on Equity 2006 =
Lowes Return on Equity 2005 =
Lowe s Return on Equity 2006 =
Asset Utilization
Efficiency ratios determine how efficiently companies are using assets. A high efficiency score shows a company is working close to capacity and is useful for comparing to companies in the same industry (Brealey & Myer& Marcus, 2003).
Efficiency Ratios
The asset turnover ratio shows how well companies are using assets. The ratio is calculated by dividing sales by average total assets. This ratio shows that both companies were using their assets more efficiently in 2005 than in 2006. Home Depots turnover ratio is higher than Lowes in 2006 so Home Depot uses assets better.
Home Depots Turnover Ratio 2005 =
Home Depots Turnover Ratio 2006 =
Lowes Turnover Ratio 2005 =
Lowes Turnover Ratio 2006 =
The inventory turnover ratio helps managers to monitor “the rate at which the company is turning over its inventories” (Brealey & Myer & Marcus, 2003, p. 457). Inventory turnover = cost of goods sold / average inventory.
Home Depots 2005 = 54191 / ((9076 + 10076) /2) = 3.84
Home Depots 2006 = 61054 / ((11401 + 12822)/2) = 5.04
Lowes 2005 = 24165 / ((4584 + 5982) /2) = 3.19
Lowes 2006 = 30729 / ((6635 + 7244) /2) = 4.43
Risk Management
The risk of investing in a company can be determined by some leverage ratios. Leverage ratios measures how much financial leverage the companies have take on (Brealey & Myer & Marcus, 2003). Home Depots and Lowes risk management can be analyzed by calculating their leverage ratios.
The long-term debt ratio measures the long-term debt to total long-term capital. Home Depot long-term debt ratio in 2005 was 0.9 and 0.32 in 2006. Lowes long-term debt ratio was 0.20 in 2005 and 0.22 in 2006. It can be concluded that in Home Depot, 32 cents of every dollar of long-term capital is in the form of long- term debt in 2006 and in Lowes, 22 cents of every dollar of long-term capital is in the form of long-term