Profitability Ratio Analysis of Gillette Company - Case Study Example

Investment analysis report: Gillette Introduction The purpose of this study is to create an investment report which will involve a thorough analysis of the financial performance of Gillette Company. The researcher will attempt to analyse the profitability, liquidity and the solvency ratio of the company for the year 2003 and compare the same with the values reported in 2002. This comparative analysis will set a foundation on the basis of which the researcher can identify the opportunities available to the company as well as their risk exposures. Following the identification of these factors strategies will be recommended to the company that are aimed towards opportunity implementation and mitigation of risk exposures. Profitability ratio analysis of Gillette Company Net profit margin: Calculated by dividing the net profit by the revenue, this ratio indicates how well a company has been able to convert each dollar of revenue earned into net income (Robinson and Henry, 2012). Figure 1 given below shows that Gillette Company’s net profit margin increased from 14.3% in 2002 to 14.9% in 2003. This highlights that the company’s managers have been successful in implementing effective business strategies that are aimed towards reducing the operating and financial expenses that has greatly contributed to the augmentation in net profit margin. Figure 1: Gillettes net profit margin (Source: Gillette, 2003) Gross profit margin: This ratio is the quantifier of a company’s financial health by denoting the amount of capital remaining after the cost of goods sold by a company is deducted from the revenue generated. As is evident from figure 2 given below, indicates that Gillette’s gross profit margin increased marginally from 0.585 in 2002 to 0.599 in 2003. The values highlight the company’s stable financial health in terms of its ability to pay off its financial and operating expenditures. According to Berk and DeMarzo (2007), it is extremely important for a company to maintain a stable gross profit margin and such has been the same in case of Gillette company which is a good indicator of the company’s financial performance as the company is in good position to accumulate sufficient saving for future investments. Figure 2: Gillettes gross profit margin (Source: Gillette, 2003) Return on Asset: This ratio is calculated by dividing net income by total assets. The ratio provides a good indication of the extent to which a company is making profit with respect to its assets (Wahlen, Stickney and Brown, 2010). As is evident from figure 3 given below Gillette’s ROA has increased steadily from 12.3% in 2012 to 13.8% in 2013. The increasing value of ROA suggests that Gillette’s management strategies were very effective which in turn allowed the company to translate every dollar of asset invested into net income. The managers efficiently utilized the assets in its business operations which in turn contributed to this gradual increase in ROA. Figure 3: Gillettes ROA (Source: Gillette, 2003) Return on capital employed: Computed by dividing the earnings before interest and taxes by the capital employed, this metric indicates how effectively a company has used its capital in order to generate value for the shareholders (Thukaram, 2007). Figure 4 given below indicates that Gillette’s ROCE has increased considerably from 28% in 2012 to 32% in 2013. This drastically increasing value of ROCE suggests that the company has used its capital very efficiently. The increasing value clearly indicates a company’s stability in relation of its ability to provide healthy returns to company associates.. Figure 4: Gillettes ROCE (Source: Gillette, 2003) Liquidity ratio analysis of Gillette Company Acid test ratio: Acid test ratio is one of the fundamental indicators of an organization’s capability to fulfil its short term obligations with adequate short term asset reserves. Ratio less than 1 indicates that the company does not have adequate short term assets that can be used to pay off short term liabilities (Ormiston and Fraser, 2009). As is evident from figure 5 given below, it can be seen that not only has the acid test ratio decreased considerably from 0.823 in 2012 to 0.699 in 2013, the values are less than 1. This suggests that the company does not have sufficient short term asset reserves and thus will have to sell its inventories in order to meet its short term obligations. In such strenuous situations the company’s financial performance has to be monitored very cautiously. Figure 5: Gillettes acid test ratio (Source: Gillette, 2003) Cash ratio: Cash ratio is a primary indicator of a company’s short term liquidity. This metric helps companies to determine the amount of most liquid assets available at their disposal in order to meet short term liabilities (Ingram and Albright, 2009). It is evident from figure 6 given below that the cash ratio of Gillette Company is significantly less than 1. In fact that the cash flow decreased from 0.230 in 2012 to 0.186 in 2013. This is not a good sign as the company’s level of liquid assets is decreasing gradually which in turn limits its scope to meet short term obligations. The company’s liquidity position is highly unstable and therefore appropriate measures needs to be taken. Figure 6: Gillettes Cash ratio (Source: Gillette, 2003) Current ratio: The ratio between a company’s current assets to its current liabilities provides an indication of a business’s competency to fulfil its short term obligations. A value less than 1 suggests that the company is unable to meet its short term liabilities (Fridson and Alvarez, 2011). Such has been the case of the company in the year 2013 where the realized current ratio value is 0.998 as opposed to a relatively stable ratio of 1.089 in 2012. Nonetheless, this drop in the current ratio points out to the fact that the company is failing to generate cash out of its products.. The decreasing current ratio also shows that Gillette Company was not in a stable financial condition during the year 2003. Figure 7: Gillettes Current ratio (Source: Gillette, 2003) Solvency ratio analysis of Gillette Company Debt-to-equity ratio: Debt to equity ratio points out to the fact that the level to which business operations are being funded using debts with respect to equity. Figure 8 given below reveals that Gillette’s debt to equity ratio increased from 1.09 in 2002 to 1.10 in 20003. This indicates that the company’s proportion of debt finance increased marginally over these two years. This suggests a marginal increase in the company’s exposure to external borrowings. From one point of view it can be said that a marginal increase in debt financing is good as it is relatively cheaper than equity but another perspective shows that the company is exposed to the risk of high interest rate (Epstein, 2009). Figure 8: Gillettes Debt to equity ratio (Source: Gillette, 2003) Current debt to inventory ratio: This ratio indicates the extent to which a company is dependent on inventories in order to meet its short term obligations (Berk and DeMarzo, 2007). Figure 9 given below shows that the ratio decreased relatively from 3.76 in 2002 to 3.34 in 2013. This suggests that Gillette’s reliance over its inventory in order to pay short term debts has decreased considerably over these two years. Nevertheless, this figure presents a contrasting scenario regarding the financial health of the company as opposed to what was revealed by Gillette’s acid test ratio and cash ratio. Figure 9: Gillettes current debt to inventory ratio (Source: Gillette, 2003) Total liabilities to net worth ratio: The ratio between total liabilities and the owner’s equity of a company, this metric indicates the extent to which business creditors are protected from the loss of income (Epstein, 2007). A higher value indicates lesser protection for the creditors. As is evident from figure 10 given below the ratio increased considerably from 4.36 in 2002 to 4.48 in 2013. This indicates that the company is not in a financially stable position to pay off its creditors. Figure 10: Gillettes total liability to net worth ratio (Source: Gillette, 2003) Additional information required to analyse Gillette’s financial statements Apart from the annual report of the company itself, the additional information required to analyse Gillette’s financial statements are the analysts’ reports published in various financial websites such as Bloomberg, financial times and Morningstar. In addition financial statements of companies are also uploaded in these websites which also makes it easy for analysts to evaluate the financial statement of companies. Alongside financial figures reported in news papers as well as in audit reports can also be a useful starting point for financial statement analysis. Concluding points Opportunities available to the company Considering the highly profitable position of the company, Gillette managers should look forward to use a proportion of its earnings for prospective investment purposes. The managers can use it to invest in positive NPV generating projects in order to diversify their source of earnings and generate a sustainable source of revenue stream. Risks exposures of the company As far as risk exposure is concerned, the company’s decreasing cash reserves and other short term assets as well as increasing debt to equity ratio sends an alarming signal. The company could easily become insolvent if does not have adequate cash reserves to meet its obligations. The same can happen if interest rate fluctuates for which the company has to pay greater interest for higher amount of debt. Reference List Berk, J. and DeMarzo, P., 2007. Corporate finance. New York: Pearson Education. Epstein, L., 2009. Reading Financial Reports For Dummies. 7th ed. Bedford, London: Thomson Learning. Fridson, M. S. and Alvarez, F., 2011. Financial Statement Analysis: A Practitioners Guide 6th ed. New York: Physica-Verlag. Gillette, 2003. Annual Report. [pdf] Gillette. Available at: [Accessed 4 February 2015]. Ingram, R. W. and Albright, T. L., 2009. Financial Accounting: Information for Decisions. 4th ed. Harlow: Prentice Hall Companion. Ormiston, A. and Fraser, L., 2009. Understanding Financial Statements. 4th ed. London, Thousand Oaks CA: Sage Publication Robinson, T. R. and Henry, E., 2012. International Financial Statement Analysis. 6th ed. Harlow: Prentice Hall Companion. Thukaram, R. M. E., 2007. Management Accounting. 6th ed. London, Thousand Oaks CA: Sage Publication Wahlen, J. M., Stickney, C. P. and Brown, P., 2010. Financial reporting, financial statement analysis. 4th ed. New York: Physica-Verlag. Appendix 1: Profitability ratio calculation Appendix 2: Liquidity ratio calculation Appendix 3: Solvency ratio calculation Read More