Cash Flow Analysis of Microsoft - Essay Example

Cash flow analysis Introduction Microsoft is an American international company that was founded in 1975 by Bill Gates and Paul Allen. Its objectives are to be renowned globally as an advanced company that improves the way people connect, work and play. They are also involved in software and hardware development to make peoples life better. Microsoft serves over 100 countries globally. Its main purpose is developing and selling their variety of products to consumers. Their products are always up to date; it’s involved in making products such as computer PC, operating systems and office business productivity application suite which are softwares that have to be installed in appliances. The company sells its products online and also through merchants. Other products and services the company provides are; server and storage software, Microsoft Dynamics and video game consoles. It’s also involved in mobile software production; recently they purchased Nokia Handset Business. Without doubt the Microsoft company is one among the leading companies in its industry. Common Size Analysis A common size financial statement shows all items as percentages; this enables easy analysis over a given time. A common analysis from 2011 to 2014 was made. This analysis illustrated a decrease in the profits made over those three years. On the other hand an increase in the cost of sales over this period was observed. The operating cost remained the same over this period of time. The provision of 7% total sales was constant. The net income as in june 2014 was 25.42% which was a decrease, in 2013 net income was 28%, 2012 was 23%, while 2011 was 33%. A statement for the those three years tells us that cash and cash equivalents ant the current assets have increased slowly over time. On a different observation for the same period, there was a decline in terms of the long term assets of the company related to the decline in goodwill. In 2011 to 2014 the current and long term liabilities have held constant. There has been a decline from 47 to 44% in the total liabilities of the company while the stockholders’s equity has increased over that period from 52 to 55%. statements for the last three years 2012, 2013and 2014 The financial statement provides information regarding the prospect earnings capacity of a corpoartion’s assets over and above an indication of cash flows which might come from inventories and receivables . the figures in the table is in USD $ in millions and was adopted from Microsoft Corporation, the annual reports   Jun 30, 2014 Jun 30, 2013 Jun 30, 2012 Cash and cash equivalents 8,669  3,804  6,938  Short-term investments, counting securities loaned 77,040  73,218  56,102  Cash, cash equivalents, and short-term investments 85,709  77,022  63,040  Accounts receivable, net of allowance for doubtful accounts 19,544  17,486  15,780  Inventories 2,660  1,938  1,137  Deferred income taxes 1,941  1,632  2,035  Other 4,392  3,388  3,092  Current assets 114,246  101,466  85,084  Property and equipment, net of accumulated depreciation 13,011  9,991  8,269  Equity and other investments 14,597  10,844  9,776  Goodwill 20,127  14,655  13,452  Intangible assets, net 6,981  3,083  3,170  Other long-term assets 3,422  2,392  1,520  Noncurrent assets 58,138  40,965  36,187  Total assets 172,384  142,431  121,271  Ratio Analysis Ratio analysis for this period was done to get an indication of the company’s financial performance in specific areas such as profitability, liquidity and leverage ratios. This analysis can be used to determine if there has been an increase or a decrease in the company’s financial standings. Earnings per share Earnings per share(EPS) show profitability in the company. It can be calculated as: EPS= Net Income- Dividents on Preferred Stock/ Average Outstanding Shares. Relying on this formula we may say that EPS for this period has been constantly compared to its average thus, making the company a good place to invest in. Gross profit margin Gross profit margin (GPM) is used to evaluate a company’s financial health by gauging the amount of money left over from the revenue accounting for the cost of goods sold. This can be calculated as: GPM= (Revenue- Cost of Goods Sold) / Revenue For this period Microsoft GPM was constant and is doing fine beyond the companies average. Net Profit Margin Net Profit Margin (NPM) focuses on the profitability as it calculated the amount of remnant revenue after all expenses, interests, taxes and preferred stock dividends have been deducted from the company’s total revenue. It is calculated as: NPM= Earnings after Taxes/ sales For this period, the NMP shows positive and consistent results from high profit margin thus, attracting higher investments. Return on Assets Return on Assets (ROA) shows a company’s profitability relative to its total assets. It depicts how management uses assets efficiently to generate earnings. This can be calculated as: Return on Assets = Net Income / Total Assets ROA was consistent for this period, thus, showing the company’s efficiency in converting its resources to net income. Furthermore this was above the company’s standard ROA. Return on Equity Return on Equity (ROE) also analyses, profit; it measures how much profit is generated by the company with the money invested by shareholders. It is calculated as a percentage using the formula below: Return on Equity = Net Income / Stockholders Equity Microsoft Corporation’s ROE for this period was positive, it illustrated higher earnings that were above average; this means that the use of investments by shareholders is efficient. Current Ratio Current ratio shows a liquidity ratio; it measures the company’s ability to pay short-term borrowings. The Current Ratio formula is: Current Ratio = Current Assets / Current Liabilities This formula demonstrates positive current ratio, where the company is managing its working capital efficiently and there is no sign of short-term borrowings made. Quick Ratio It shows a company’s liquidity; it accounts for most of the liquid assets relative to measurement of meeting a company’s short-term duty. For this reason, inventories are excluded from the computation of current assets. It is calculated as follows: Quick Ratio = (Current Assets - Inventory) / Current Liabilities The quick ratio of Microsoft Corporation is steady and there are not much current payables to handle. Moreover, it stays well above the industry standards. Average Collection Period Average Collection Period is the estimated amount of time the company takes for its business to receive payments owed by its customers and clients in terms of receivables. It is calculated as: Average Collection Period = Days x AR / Credit Sales According to the size of transaction and the operating scope of the business; some allow their customers to purchase products on credit. In order to control this circumstances, the company has come up with credit policies that vary according to the kind of business. A lower average collecting period favors the company because it does not take a long time to change receivables into cash. Microsoft cooperation standard collection period was on the higher side; this was in relation to the lenient credit policy adopted by the company. Inventory Turnover Ratio Inventory turnover ratio shows the number of times a company’s inventory is sold and replaced over a period of time. A low turnover illustrates poor sales while an excessive inventory and high turnover show strong sales or ineffective buying. Most companies adapt just-in-time inventory procedures to prevent long periods of inventory stocks. It is calculated as: Inventory Turnover = Sales / Inventory However, it may be calculated as: Inventory Turnover = Cost of Goods Sold /Average Inventory For the latest three years, Microsoft Corporation has a very favorable inventory turnover ratio and is well above the industry standards. Debt Ratio Debt Ratio is the measure of the company’s or customers leverage. The higher the ratio the more the leveraged the company is and the greater the financial risk. It is calculated as: Debt ratio = Total debt / Total assets Debt ratios differ across industries; it depends on the industry in which a company operates. In companies with volatile cash flow and little debt; a higher debt ratio can be a problem while for companies where cash flows are stable and have a higher debt ratio is not a problem. Debt ratio more than 1 indicates a company having more debts than assets. While the debt ratio less than 1 means more assets than debt. Microsoft company has maintained acceptable levels on its debt. Equity Ratio Equity ratio can be said to be the soundness of the capital structure. A higher equity ratio point out a company’s best long-term solvency position. It is calculated as: Equity Ratio = Total Equity / Total assets Microsoft Corporation, has sustained an equity ratio at 50%. This is good for the company because its total assets are well-financed by the investors or stockholders. Times Interest Earned Ratio Also known as the interest coverage ratio; it is used in assessing the company’s capability in meeting its duties in the times interest is earned. It is typically calculated as a ratio and shows the number of times a company can cover its interest charges on a pretax basis. It is calculated as: Times Interest Earned = *EBIT / Total Interest Payments Microsoft Corporation shows a different amount in this evaluation from 96% in 2011 which dropped to 59% in 2012 and then increased to 64% in 2013. This illustrates that a company is very secure and ensures security of receivable interests to the lenders. Dividend Payout ratio: It is used to calculate the percentage of earnings paid to shareholders in dividends. It is calculated as: Dividend Payout Ratio = Dividends / Net Income The dividend payout ratio of Microsoft Corporation has been reliable over the period. There is a steady dividend ratio, which illustrates a solid dividend policy by the company’s board of directors. EBITDA Margin This measures the company’s profitability; it shows the earnings of a company before interest, tax, depreciation and amortization. Owing to the omission of depreciation and paying off, EBITDA can give the investor a clear image of a company’s core profitability. It is calculated as: EBITDA margin = Earnings before interest, tax, depreciation and amortization / Revenue In relation to prevailing industry average, Microsoft Corporation benefit from very positive and higher EBITDA margin. Financial performance comparison with S & P 500 In this industry, we shall analyze and compare Microsoft company with its rival CA Technologies in relation to the financial aspect for the latest five years. This comparison will give investors a solid outlook on the financial situation of these companies in relation to their profitability, growth and performance. For more reliability in this industry; comparison of S & P500 is enough as it gives market capitalization, price earnings ratio, net profit margin, price to free cash flow and return on equity, debt to equity and dividend yield. According to these analyses; Microsoft Corporation maintains a higher net profit margin and return on equity; this means that the company is able to generate high profits and uses its resources efficiently. According to the dividend yield ratio CA Technologies shows a higher ratio than Microsoft Corporation though both these companies performed well above the industries average. In terms of market capitalization, the total market share of Microsoft Corporation enjoys almost 15% of it. Additionally, when we compare CA Technologies to Microsoft, Microsoft has higher cash flows in relation to free cash flow measurement which means the company can get involved in more capital extensive projects without having debt financing. Free cash is a financial performance measurement that is calculated as an operating cash flow less capital expenditures. It signifies the cash that a company is able to generate after its expenditure; it can be termed as the money required in maintaining or expanding its asset base. Microsoft Beta Analysis Beta Analysis measures the risk of stock when it is incorporated into a well diversified portfolio; it is taken as one of the most important equity volatile measures. The Capital Asset Pricing Model (CAPM) demonstrates two mechanisms by which to expect stock returns. The first depends on the covariance with the movement of the market and the second is not explained by the market; where there is an increase in the price of the stock. Beta Analysis is best demonstrated by the first part of the theory which talks about covariance with the market. The stock price has a tendency to move in the same direction as the market when Beta Analytic is positive, and it shows how much using the magnitude of Beta. The stock of Beta goes up by 1% when the Beta is more than 1 simultaneously the stock is expected to go up by more than 1%. On the other hand, if the is the market detoriats by 1%, more than 1% will be dropped by the stock. It is rare for a company to have negative Beta, which actually demonstrates a negative correlation. When the market escalates, it is expected that there is a decline in the stock prices. Microsoft Beta = Covariance = 0.73 Microsoft Corporation has a Beta of 0.73 in agreement with recently published financial statements. It is considerably higher than that of Beta industry and much higher than that of the sector. Also, the beta for all stocks is over 1000% lower than the firm. SWOT Analysis Strengths Comprehensive Product Portfolio - Across the diverse customer classes, Microsoft presents a wider-range of software,hardware solutions and services which puts them a head in the market. Focused Research and Development Activities -The company has a strong competitive advantage and builds brand equity by prioritizing innovation and optimization through strong research and development activity. Strong Intellectual Property – the company has different ways of protecting its intellectual property investments. The company works in the U.S. and globally to ensure the enforcement of copyright, trademark, and other protections that apply to its software and hardware products, services, labeling and business plans. The company maintains a diverse U.S. and international portfolio of intellectual property which help it in protecting its technologies. International patents issued and with a portfolio of over 55,000 U.S. and over 40,000 pending, it is just reasonable to make Microsoft one of the leading technology companies today. Robust Distribution, Sales and Marketing Network –the company upholds a strong distribution and marketing network to leverage operational performance.OEMs (Original Equipment Manufacturers); distributors and resellers; and online are the three chief channels in which Microsoft markets and distributes its products. Weaknesses Pending Legal Proceedings – Microsoft Corporation is a defendant in countless unsettled cases against it. Product design, manufacture and performance liability and other litigations such as contracts, employment issues or intellectual property rights are what the company is occupied in its legal dealings. Such litigations bring upon extra costs to the company, and if confirmed guilty this will incur huge penalties that will negatively influence its profitability. Example case is against Motorola which it filed several patent infringement actions in Germany against the company and several of its subsidiaries. Rising Debt Burden –One of the key consequences on the operational performance of the company is the increasing debt burden. This crisis will have an immense effect on investors as well as to the company as a whole because it will make it hard to raise resources at favorable terms from the market. Since June the 30, 2014, Microsoft’s total debt component had been US$22.645 million, which compared to previous year had increased by 45.2%. Business Limitations: Browsers –It is well recognized that Microsoft is one of the leading technology providers globally. Microsoft Company has dominated web browsing for with over 90% of the market share just before Google and Netscape overthrew it in the market. Opportunities Growing cloud computing markets –Microsoft could take advantage of on the mounting markets for cloud computing. It is estimated that the global market for cloud computing will reach approximately at US$210 billion by 2014. What is more, is that that the global cloud services market would reach over US$555 billion by 2020, growing at a CAGR of 17.6% from 2014 until 2020. Strategic Partnerships –Microsoft center of attention has now been on entering into new joint ventures for the development of innovative and technologically advanced products. Such partnerships offer the company a competitive edge and allow it to garner a high market share. Inorganic Growth Initiatives - Strategic acquisitions offer a strong growth opportunity for the company. It becomes very important for a player to have a diversified operational portfolio with the rising competition in the industry. Generally, setting up new units or businesses costs heavily to the company and it takes some time to realize the gains from the same. Instead, in acquiring outstanding brands and expand their business operations globally, companies prefer the inorganic growth strategy. Demand for Smartphones –There is an increase in demand for smartphones today and with this Microsoft could capitalize on this emerging opportunity for mobile device manufacturers. The global smartphone sales in 2012 according to in-house research reached 718.95 million, and by 2018 it is presumed to reach 1.9 billion. Threats Intense Competition – What impacts the company’s performance is the highly competitive environment for software development. In all its segments, the company faces stiff competition. In Windows Live software and services, its key competitors include Apple, Google and Yahoo!.As well as its Internet Explorer product which also faces stiff competition from the browsers developed by Apple(Safari), Google (Chrome), Mozilla, and Opera Software Company. Foreign Currency Exchange Rate Risk - Exchange rate volatility could have an adverse effect on the companys financial results. The company is geographically diversified and has operations globally. Influenced by a range of currenciesare the valuation of assets, cash flows and earnings. Rapid Technological Changes –To compete effectively in a rapidly changing technology market, Microsoft continually introduces new products that achieve market acceptance. These are characterized by fast technological changes, emerging industry standards, varying market conditions and recurrent new product and service introductions and enhancements in the IT enabled communication equipment industry. Availability of Pirated Versions of its Product - Microsoft is exposed to a major threat related to piracy of its software products. Yearly, the company loses billions of dollars to piracy worldwide. The piracy rate is at 30% or more in several countries. Investor’s required rate of return for Microsoft Both corporate finance and equity valuation uses the necessary rate of return (RRR), a determinant that investors look for when investing their money. Based on RRR, investors can compare the profitability and riskiness, liquidity and inflation before making an investment. In discounted cash flow examination, RRR is used to calculate the net present value.  Assumptions Rate of return on LT Treasury Composite 3.33% Expected rate of return on market portfolio 12.92% Systematic risk (β) of Microsofts common stock 1.00 Solution: rMSFT = RF + βMSFT [E(RM) – RF] = 3.33% + 1.00 [12.92% – 3.33%] = 12.95% Required rate of return on Microsofts common stock 12.95% The Company’s valuation The growth rate of Microsoft corporation can be calculated in three steps using the current year figures. Primary the computation of ROE which has earlier been calculated in ratio analysis, discussion; this ratio turns out to be at 30.09% and the subsequently the computation is the calculation of the growth rate which is the dividend payout which is 34.5% for the year 2013. After determining the ROE and the dividend payout ratio, the next is the computation of the growth rate by its formula which is: Growth rate= ROE x (1 - dividend-payout ratio) Sustainable growth rate of a company is calculated using the Growth Rate Formula. In the case of Microsoft Corporation, the growth rate was 19.71% as determined by this formula. In regard to analysts; stakeholders or individuals who have interests in the company anticipate that the company will grow its earnings at an average annual rate of 8.54% over the subsequent five years. Analysts have foretold an earning increase of 2.15% this year as compared to the past year. Analysts will assume earnings growth of 8.24% next year compared to this years forecasted earnings. The company’s stock market value is $ 39.87 which was brought about by calculating the intrinsic stock value of Microsoft Inc. and by discounting the dividends per share at 12.95%.   2014 2015 2016 2017 Growth forecast 2.15% 8.24% 9.36% 10.69% P/E growth 2.15% 8.24% 15.25% 14.09% Conclusion on Valuation of Microsoft Corporation Relying on the calculations and analysis of the financial performance of Microsoft Corporation using financial ratios, enterprise value to free cash flows and historical enterprise value, overall it can be supposed that the company is greater than before from the year 2011 to 2013. One may suggest that the company has performed better in all the relevant areas and recently its stock is valued fairly in the open market. The company’s Weighted Average Cost of Capital (WACC) is 12.47% and the free cash flow growth rate is 22.91%, which is impartially higher than other players in the same industry. We may conclude by suggesting that the company is carrying out well its operations as well as its policies, thus, those who have invested in this company are enjoying profits. The company is being taxed highly by regulatory bodies such as the Internal Revenue Bureau due to the high profits it collects. Employees are safe because the company is sustainable, its stakeholders are happy because of the continuous production and services given by the company. At present the stock assessment on the stock market basis is justified and there is a likelihood that the company’s net worth will keep on growing as it is finding new gaps to attract a stronger customer base and innovative product structure. Recommendations As revealed in the figures, computations and analysis, Microsofts earnings and revenues are growing and the company is continuing to have tactical plans to strengthen, innovate and satisfy the needs of every individual, thus making a plausible performance year after year. It has been given an A+ standing in its financial statement. Furthermore, it has nearly 30% of its $229 billion market capitalization. It has a trailing P/E of 15 and a forward P/E of 8.7. One of the most amazing things is that Microsoft Corporation can able to come up with dividends yearly. The companys shares at present generates 3.4% with a 23 cent quarterly dividend. Based on these indicators it is strongly recommended that one buys stocks in the Microsoft Corporation campany. REFERENCES Anon., 2013. Company Information. Retrieved fromhttp://www.microsoft.com/about/companyinformation/en/us/default.aspx?navindex=0[Accessed 10 April 2013]. Anon., 2013. Microsoft Corporation. Retrieved fromhttp://www.gurufocus.com/financials/MSFT&affid=45223 [Accessed 10 April 2014]. Anon., 2013. Profitability Analysis.Retrieved fromhttp://www.stock-analysis-on.net/NASDAQ/Company/Microsoft-Corp/Ratios/Profitability[Accessed 10 April 2014] Anon., 2014. Microsoft Corporation (MSFT). Retrieved fromhttp://finance.yahoo.com/q?s=MSFT[Accessed 10 April 2014]. Anon., 2014. Microsoft Corporation Revenue & Earnings Per Share (EPS). Retrieved fromhttp://www.nasdaq.com/symbol/msft/revenue-eps [Accessed 10 April 2014]. Read More