Investor Ratio Analysis of Wal-Mart Stores - Essay Example

RUNNINGHEAD: Investor Ratio Analysis of Wal-Mart Stores, Inc Investor Ratio Analysis of Wal-Mart Stores, Inc and Critique of ABC Costing of Student Name of Professor Name of Subject Date Contents Contents 1 Part 1 - Investor Ratio Analysis of Walmart 2 Executive Summary 2 1. Introduction 4 1.1 Brief Company Background 4 1.2 Analysis And History of The Development Of The Company 5 2. Financial Ratio Analysis 7 2.1 Profitability and Efficiency 7 2.2 Liquidity 11 2.3 Solvency 12 3.4 Investment or valuation ratios 12 4. Conclusion 14 References: 15 APPENDICES 16 Part 2 - Critique of the rise of ABC 23 1. Introduction 23 2.1 The similarities and differences of ABC Costing and Traditional absorption costing are as follows 23 2.2 Advantages and arguments for its use 24 2.3 Is there evidence of its use by the industry? 26 3.2 What are the arguments of the detractors of ABC. 28 4. Conclusion 29 References: 30 Part 1 - Investor Ratio Analysis of Walmart Executive Summary This paper has found less liquidity and more risky position of Walmart compared to the rest of average competitors in the retail industry. However, in terms of measuring profitability from the point of stockholders and management of assets, the company was found better than average competitors. In terms of wealth maximization strategies, what is employed by Walmart appears to be still high although lower than industry average. To have more than ten times price-earnings ratio is still indicative of very good prospects of how the company is valued by investors. The financial ratios as extracted and analyzed proved that the company may be less profitable in relation to revenues but more profitable in relation to total assets and equity, liquid and less solvent yet it is still good for investment and could still survive in the future based on investors’ perception (Johnson, et al, 2003). Compared however with rest of competitors in the industry WMT is not better when it comes to all the ratios even under price-earnings ratios. The lower ratios of the industry point to the non-maximized wealth-generation potential of the WMT but it is still pursuing its philosophy of helping people to save to live a better life. This is the reason for its lower prices as against competitors as confirmed by lower net profit margin, net operating margin and gross margin. 1. Introduction This paper seeks to prepare investor ratios analysis of Wal-Mart Stores, Inc. (WMT) for the years 2012 to 2013. In conducting the same, the following ratios will be discussed: profitability, liquidity, solvency in investment ratios as a way of evaluating the advantage or disadvantage of investing with WMT. 1.1 Brief Company Background Wal-Mart Stores, Inc. operates at present more than ten thousand many retail stores using several formats in many parts of the world with two segments for operation including Walmart U.S., Walmart International, and Sams Club (Yahoo Finance, 2014). Like others, it belongs to an industry that is subject to challenges in the US economy and the world, given its wide coverage of operations. The companys business model is helping customers save in an industry so they they live better and it much appropriate where there is very strong competition. Thus it faces several dangers like any other firms including, changes monetary in the monetary policies of Federal Reserve, economic instability and political developments other governments where it has its operations, , employment conditions, the continuing government budget deficit and economic disruptions brought by the sovereign debt crisis and other volatilities in the economy (Wal-Mart Store, Inc. 2014b). 1.2 Analysis And History of The Development Of The Company With the opening of first store in 1962 at Rogers, Arkansas, the rest of 1960s saw the opening of other new stores and incorporating the family business as Wal-Mart Stores, Inc. The 1970s include the recorded incredible grow, when its founder Mr Sam proved his vision of making the company to go national. In 1970, it became a public trade company with its stock sold at $16.50 per share. The secret of expansion the company is telling it customer that is sells at lowest price any time anywhere. The same philosophy is actually still adopted by the company where it wants its customer to save more and live a better life. Its concept is integrated into its business systems (Wal-Mart Store, Inc. 2014a). In 1971, the first distribution center and home office opened in Bentonville, Ark. and in 1972, it has its stocks listed on the New York Stock Exchange, with more than 50 stores and recorded sales of $78 million. In 1975, it got inspired by a visit to Korean manufacturing facility, causing the introduction of Walmart cheer. In 1979, Walmart Foundation was established (Wal-Mart Store, Inc. 2014a). The 1980s saw the decade of the first, including first Sam Warehouse Clubs, serving small businesses and individuals and first supermarket, combining supermarket and general merchandise. At this point the Walmart has reached $1 billion in revenues per year, making record compared with other companies at the time, employing about 300 stores and more than 20,000 associates. During this decade, cash registers were replaced with computerized point-of-sale systems, evidencing faster checkout that is accurate at the same time. Installation of largest private satellite was done in 1987, opening of Walmart Supercenter was made in 1988, providing one-stop shopping convenience. David Glass as CEO was name during this period (Wal-Mart Store, Inc. 2014a). In the 1990s , WMT became America’s Top Retailer. Its international business started via a joint venture with Cirfra, a Mexican retail company, with opening of Sam’s Club in Mexico. During this period its founder Sam Walton passed away at the age of 74 and he was replaced by Rob Walton as chairman of the board, In 1993, it was celebrating $1 billion sales per week. During this period it expanded to Canada by purchasing Woolco stores. In 1996, it opened its first stores in China and making it celebrate $100 billion sales per year. It entered the UK by acquiring ASDA in 1999 (Wal-Mart Store, Inc. 2014a). The 2000s or New Millennium, came with still more favorable development for the company. WMT’s changing with the times is one of its clear strengths. With the new millennium the company had offered its customers seamless shopping experience whether these customers are online or on their mobile devices. It was in 2000, when H. Lee Scott succeeded David Glass as CEO. The online shopping resulted to employing more associated in its stores worldwide. For it to top that Fortune 500 ranking America’s largest companies in 2002, was proof of its huge revenuesin the industry. It is during this period that WMT entered the Japanese market by investing in Seiyu. By 2010, it has entered India after Mike Duke become CEO in 2009. From its creation in 1962, the company has been in almost more than fifty years as it help people from its more than 200 million customers each week save money so that they can live better , while employing more than 2 million associates in more than 11,000 stores in more than 25 countries (Wal-Mart Store, Inc. 2014a) 2. Financial Ratio Analysis To arrive at investor ratio analysis, this sections is divided into profitability and efficiency, liquidity, solvency and investors ratios analysis 2.1 Profitability and Efficiency Using the profitability ratios of return on equity this paper can measure how profitable the company is in relation to the competitors in the industry. Table A. Financial Ratios (Walmart Stores, Inc. 2014b, Reuters, 2014 b). See Appendices A-1, A-2, A-3, B and C) WMT’s average return on equity (ROE) of 22.0% for the past two years from 2012 to 2013, shows better past performance in relation to the industry average of 14.65% for the past five years. An average of about 22% return on equity definitely attracts investors, as it would mean that for every £100 the investors expect returns of about £22. It may be noted that return on equity uses the formula of having net profit divided by the total stockholders‘ equity. When compared to an average rate of 0.25%, if money was invested in risk free investments at the United Kingdom (Housepricecrash 2014), the said 22% ROE is still higher. The company’s return on assets also averaged 8% for the past two years , which is also still higher than the industry average of 6.9%. Return on asset is more of measure of efficiency rather profitability as this time the divisor of the formula is average total assets instead of total equity. Such higher ratio than industry average therefore implies that managers of Walmart are doing well compared with managers of competitors in the industry. Such better performance is an evidence of motivated managers in producing value for its customers and shareholders. Profitability as measures in higher ROE and efficiency as measure in terms of ROA provides evidence of alligned performance measures of the company. See Table A above. Even if viewed from a creditors point of view, WMT as borrower, would have the capacity to pays its obligations as its stockholders are more than compensated in using WMT’s borrowings to produce wealth.. By investigating the gross margin of WMT for the past two years , the company reflected a consistent of 25% for the past two years while the industry average was 40.64% . This is indicative of higher profitability for Walmart at this level. However, this is not validated when it comes to its having lower operating margin of 6% for the years 2012 and 2013 as against industry average of 14.45% for the past five years. Unfortunately, even if profitability is brought to the level of the net profit margin, the compant still reflected an average of 4% for the past two years as against industry average of 10.57% for the past five years. Please refer to See Table A above together with Appendices A-1, A-2 , B and C for the formula and summary of extracted data from the financial statements of the two companies. The performance ratios of business entities like WMT wouuld tell how they delivered well to their stakeholders in the same way that a doctor’s checkup results would tell health of a person at a certain point time. Gross profit margin which relate to gross income to sales indicates how much can the retail companies can get from selling the products and services by comparing the selling price and the cost of the product. It may be pointed out that the companys having lower gross margin, net operating margin and net profit margin than the rest of competitors could indicate further potential for more profitability. It is interesting however to find what could explain the lower gross margin, net operating margin and net profit margin of Walmart compared with industry averages, considering that the company was found to have higher ROE and ROA. The possible explanation is the company was willing to offer customers lower price in relation to the cost of providing the goods and service to clients. Low gross margin indicates that its direct cost may be as high as competitors but it is willing to have low mark-up because its philosophy is to maintain the loyalty of its customers by offering low price at anywhere and at anytime. It is helping it customers to save more by offering better priced products than competitors. This is therefore a proof the company was fulfilling its mission in serving its customers. The lower net profit margin indicates that it has sacrificed much for customer’s benefits, so as to increase sales over period of time, while maintaining and acceptable level of profitability enough to compensate its shareholders who are actually receiving more than shareholders of competitors. Lower net profit yet higher return on assets is proof of economies of scale. Because it has wider base customers, its revenues kept on increasing while producing acceptable level of profit. 2.2 Liquidity Profitability is the sole performance measure of a company’s financial health. With is the need to maintain its capacity to survive in the short-term by being able to pay its current obligations as they mature within a short period of time. Thus, it needs to have good short-term liquidity ratios. They are the current ratio and quick ratios, which are determined from the financial statements. Since liquidity indicates capability to pay a company‘s currently maturing obligations, there is need to extract the same from the financial statements (Brigham and Houston 2002). To get the current ratio uses current assets to be divided to current liabilities, while quick assets ratio is almost the same except that the inventory and prepaid expenses are being deducted from the current assets to have a new numerator but the denominator is the same. Quick ratio then is just a stricter way to find whether company is indeed capable of meeting current obligations on time. As applied now to WMT, the computed average current ratio and average quick ratio for the years 2012 and 2013 indicate lower liquidity than competitors. While both average ratios of the company and are below 1.0 , the same is still acceptable because the company is in the retail industry, which can easily generate funds. See Table A. 2.3 Solvency Financial leverage indicates long-term capacity of a company to keep up it stability over the long term. It is referred to as solvency and determined by the debt to equity ratio, with the formula of having the total debt of the company divided by its total equity (Helfert, E. 2001) Having good solvency should comfort investors including creditors that the company will not just survive the short term but it must also have a long life to recover its long term investments. WMT’s average debt to equity ratio for the past two years 1.69 as against 0.89 industry average indicates more than two times advantage against its competitors in terms of risk. See Table A above. 3.4 Investment or valuation ratios As stated earlier companies aim not only for profitability, they also aim for wealth maximization (Brigham and Houston, 2011). Generally, companies which generate more profits should generate more wealth. The factor that would explain the exception is due to assessment of long-term risk from the investor. It is basic in finance that the higher the return, the higher would be risk and vice versa. As to how these happen, a comparison of the profitability and investment ratios must be done. It is in the investment ratios that investors’ response to how the companies performed are measured. Some of these investment ratios include price-earnings ratio, price to sales, price to book ratio, price to tangible book and even price to cash flow. Please refer to Table B below. It was found earlier that Walmart was less profitable and lower liquidity than industry average yet it has still higher financial leverage than industry competitors. As to whether investors trust WMT company over the other competitors is measured in terms of valuation ratios. In terms of price-earnings (P/E ratio ) for the last twelve months Walmart reflected lower ratio. This means that is lower profitability, liquidity and solvency, investor could assume a higher risk with Walmart over other competitors. Table B- Comparative Investment Ratios (Reuters, 2014b) 4. Conclusion This paper has found less profitability, less liquidity and more risky position of Walmart compared to the rest of average competitors in the retail industry. However, in terms of wealth maximization strategies, what is employed by Walmart appears to be still high although lower than industry average. To have more than ten times price-earnings ratio is still indicative of very good prospects of how the company is valued by investors. The financial ratios as extracted and analyzed proved that the company may be less profitable, liquid and less solvent yet it is still good for investment and could still survive in the future based on investors’ perception. Compared however with rest of competitors in the industry WMT is not better when it comes to all the ratios even under price-earnings ratios. The lower ratios of the industry point to the non-maximized wealth-generation potential of the WMT. References: Brigham, E. and Houston, J. (2002), Fundamentals of Financial Management, London: Thomson South-Western Helfert, E. (2001). Financial Analysis: Tools and techniques: a guide for managers. Housepricecrash (2014), UK Base Rate, Retrieved 12 March 2014 from < http://www.housepricecrash.co.uk/base-rates.php > Johnson, et al (2003). Financial Accounting. Tata McGraw-Hill Reuters (2000a). Company Profile. Retrieved 12 March 2014 from < http://www.reuters.com/finance/stocks/overview?symbol=WMT.N> Reuters (2014b). Industry Ratios. Retrieved 20 January 2014 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=WMT.N> Wal-Mart Store, Inc. (2014a). Company History. Retrieved 12 March 2014 from < http://corporate.walmart.com/our-story/history/ > Wal-Mart Store, Inc. (2014b). Annual Report for 2013, Retrieved 12 March 2014 from http://c46b2bcc0db5865f5a76-91c2ff8eba65983a1c33d367b8503d02.r78.cf2.rackcdn.com/88/2d/4fdf67184a359fdef07b1c3f4732/2013-annual-report-for-walmart-stores-inc_130221024708579502.pdf> Yahoo Finance (2014), Company Profile, Retrieved 12 March 2014 from < http://finance.yahoo.com/q/pr?s=WMT+Profile> APPENDICES Appendix A-1. Consolidated Statement of Income, 2013 (Wal-Mart Stores, Inc. 2014b) Appendix A-2. Consolidated Balance Sheet, 2013 (Wal-Mart Stores, Inc. 2014b) Appendix A-3. Consolidated Statement of Cash Flows, 2013 (Wal-Mart Stores, Inc. 2014b) Part 2 - Critique of the rise of ABC 1. Introduction This first section of this part of the paper will compare and contrast ABC costing and traditional absorption costing, identifying the arguments used by its supporters and determining to what extent ABC costing is taken up by the industry. The second section will analyse the impact of ABC, whether it had the desired affects and knowing the arguments against held by detractors. 2.1 The similarities and differences of ABC Costing and Traditional absorption costing are as follows Both are costing method used by companies. As costing methods, both could be used for pricing products of companies and both still include cost of materials, direct labour cost and overhead. It is however their differences that matter most for decision makers (Bernstein, 1993; Edwards, Miles, and Winterfeldt, 2007). To appreciate their differences, knowing which comes first may put the proper context. At this point, it may be said that ABC costing comes after absorption costing. From the same evolution of the costing methods, spotting now difference between absorption and ABC become easier. In terms of number of cost pools, ABC has more than absorption costing. Necessarily ABC have more number of the applied rate since there would be more bases using activities that are more or less controllable on the part of management. In terms of, suitability on to the industry, ABC costing is more applicable to capital-intensive while those of traditional costing, labour intensive are its match. Lastly in terms cost and benefits, the same must be computed and considered, but since ABC is more complex than traditional costing, it is cost more but the benefits could be more in properly made applicable to user. . 2.2 Advantages and arguments for its use The benefits of each method of each method can be demonstrated. As ABC evolved from absorption costing, this should interest the reader to know good reason or benefits offered by ABC. The claimed benefits include improve product cost or service data. Necessarily, this would bring improved decisions about pricing, service mixes and product strategies. These would be the effect of course of more accurate information since there would be cost reduction by eliminating non-value added activities. It would also afford greater control of costs because of its focus on behaviour of costs at their origination (Atkinson, Anthony, et al. 2005) The innovation of ABC costing came as a matter to need to find an alternative to absorption costing. As business decision need to know whether it goes to making or doing products or service that would generate profit, the cost of the same becomes important. Errors or mistakes in costing necessarily lead to wrong decision in pricing. Thus, initially business entities moved from get puzzled or problematic with the limitation of traditional absorption since they could miss important control that is available to them. Thus they found costing using ABC in their desire to have more accurate cost information for their products. While looking searching for some good or useful than originally intended, the managers in some of these companies surprised by the information revealed by the use of ABC. The new costing system provided these entities a new perspective of the built-up of costs, which eventually led them to improve pricing policies and to develop different products strategies. High volume production due capital intensive investments necessitated the search for alternative costing method of costing. It was discovered in the course of search that long production run products produced the effect of low cost than actual cost. It was also found that low volume, short production run products lower units cost than actual. The results of these are attraction to the use of ABC cost. In the desire of research to establish an ABC products cost, it was found the current organisation of activities leads to repetition of activities and processes, which means waste. It was therefore theorized that the organisation and flow of processes can be changed to eradicate repetition and attain cost savings (Jo Avis, et al, 2008). 2.3 Is there evidence of its use by the industry? The evidence of its use is clear on companies using the same. Reported of use of ABC by several Eurpean Companies, proves its use by the industry is beneficial (Major, 2012) Using a sample computation to show an advantage of ABC over absorption costing would make things clearer. To provide a concrete evidence of applicability of ABC and its advantage over absoprtion of traditional costing is to use an illlustration. This section assumed as hypothetical accounting data from a company which can use either traditional costing under absorption or ABC as introduced. It can be demonstrated in Appendix A that the company can just get its unit cost from adding the material cost per unit, direct labour per unit and factory overhead per unit. Computation of the factory overhead per unit and it uses direct labour hours as basis. It is therefore so simple to get unit cost under traditional costing since by multiplying by 300 the direct labour cost per unit then, all the cost components is clearly identified. It assumed however in Appendix A that the company has that experience of having factory overhead as three times the direct labour cost per unit. Thus the estimate could be wrong since the same can be very arbitrary. To alternatively use ABC costing, there is need to have cost pools consisting of the activities of setting up the equipments, inspecting the equipment and operating the equipments. The cost drivers need to be identified and they are number of set ups, inspection hours and machine hours. See Appendix A. It can noted that to estimate how much activity based costing (ABC) is better than traditional costing, there is need to look at the difference in costing. It may be observed that under the ABC, the unit cost is £ 18,247.00 as against absorption costing at £18,500.00 or a difference of more than £1,000 per unit. See Appendix A. Under ABC, the appropriate activities are defined after carefully analysing the same and a cost driver rate is derived for each kind of appropriate activity by dividing estimated unallocated overhead costs to cost drivers that are properly identified. ABC brought unallocated fixed cost with the activities that consume resources, thus in effect redefining the behaviour of the fixed cost into variable cost. Based on the illustration made, ABC extended in effect to have more variable cost information. This would then afford the decision maker to know what are manageable and in effect helps the company in executing responsibility accounting that could hold managers accountable for their decisions. Note the difference per unit cost may not be that material but if a company happens to manufacture a billion quantity of the product, the difference in unit cost may be material in knowing the correct information. However to use ABC given the complexity and cost issues, management must conduct a separate cost benefit analysis. Complexity should mean simpler way to prepare costing under the traditional way, and it costs fewer to do the same. Absorption costing can still be continued if the organization is not too big to engage services of certain personnel to get the ABC system operational still the advantages of simplicity and lower cost is all other things are assumed equal. It can be simple because the externally reported information on inventory cost as per the company‘s published annual report and cost of goods sold will be the same as that used for internal purpose (Weygandt, Kieso & Kimmel, 2005; Emmanuel, C., D. Otley & K. Merchant, 1990). 3.2 What are the arguments of the detractors of ABC. The detractors are course referring to the disadvantages or limitations of ABC costing. Although ABC was the result for continuous search for better costing, it does not necessarily mean that it has addressed all the problems in costing. One of its limitations is the additional cost that would be involved in adopting the use of the same. Another limitation is the change of arbitrary allocations as in absorption costing may still be possible. However, the choice of using and not using would be a question of whether a decision must have basis or not and would be best addressed by the management. 4. Conclusion ABC costing has provided a better way of helping management make decisions because it considers what are relevant cost for decision making over that of absorption cost which are basically prepared using the external standards. Given the good differences between activities based costing compared and absorption costing , infavor of the former, there is basis to use ABC in certain cases. The difference justifies the search for alternative costing system from absorption or full cost accounting. To be blind in subscribing to the use what is theoretically deficient could only result to mistaken information and eventually to wrong decision. Activity based costing are not without drawbacks and one of which is the cost of adopting and implementing the same. The choice of which method to use could still be best evaluation in terms of cost benefit analysis since they are means to an end as far as the business decision makers are concerned. References: Atkinson, Anthony, et al. 2005. Management Accounting. New Jersey: Person Custom Publishing Bernstein, J. (1993). Financial Statement Analysis, Sydney: IRWIN Edwards, Miles, and Winterfeldt. (2007). Advances in decision analysis: from foundations to applications. Cambridge University Press Emmanuel, C., D. Otley & K. Merchant (1990). Accounting for management control. Cengage Learning EMEA. From Practice to Theory. Springer Major, M. (2012). Management Accounting Change in the Portuguese Telecommunications Industry < http://garj.org/garjmbs/pdf/2012/May/Major.pdf> Weygandt, Kieso & Kimmel (2005). Managerial Accounting: Tool for Business Decision Making. John Wiley & Sons, Inc. Avis, et al (2008). CIMA Official Learning System Management Accounting Decision Management. Elsevier s References: Read More