Financial Statement Analysis Fall 2011 Section 2 October 17, 2011

Draft 2: Financial Statement Analysis

Group 7 NETGEAR Kyle Marshall Quan Dang Minh Hoang Shane Estes

Dai Thai

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These ratios make evaluating a company a much simpler task by being able to see a scalar for items of interest instead of large and variable dollar amounts. Juniper. The three categories are to be explored for the company NETGEAR and three of its competitors: CISCO.Financial Statement Analysis Crucial financial data from the four financial statements. Page 1 of 19 . which measures how well a company can cover its current liabilities that are due within the next year. Current ratio = current assets/current liabilities The current ratio is one of the short-term liquidity analysis ratios. Liquidity Liquidity refers to both how much cash and cash equivalents a company holds as well as how quickly a company can generate cash. particularly the balance sheet and the income statement. It also makes evaluating a company in terms of its industry much easier by factoring out economies of scale that may not be shared by all members of a particular industry. We look at 5 years of previous data to determine any company specific trends as well as industry-wide trends. This is a near term measurement as current liabilities are regarded as coming due within one year and current assets are projected to become cash within the next year. can be processed into ratios. Of great concern to the analyst wishing to make an informed decision about the financial condition of a company are the liquidity. Liquidity ratios are important for determining how capable a company is in paying off its short term liabilities. & Seagate. and capital structure ratios. profitability.

50 2.50 1.00 1. Just by looking at the current ratio. A value of two indicates that every dollar of liability has two dollars of assets to cover it. we can tell that Cisco is doing better than its competitors since their current ratio has been increasing rapidly in recent years while Juniper and NETGEAR’s current ratios are declining. Other companies in the industry such as Cisco and Juniper also have high current ratios ranging from 2.50 3. Tech companies such as NETGEAR use quite a bit of cash for R&D and mergers and acquisitions.00 0.00 2. it is still quite high. The reason for this high current ratio is likely due to the fact that tech companies usually have a large amount of cash on their balance sheet.1 to 3. The value of cash on hand can outweigh the opportunity cost of storage by being a buffer to revenue variability and macroeconomic uncertainty.6 to 2.50 0. A minimum of 1 would indicate that a company has enough assets to cover its liabilities. ranging from 2.0 in the last 5 years. This is a good sign. Quick asset ratio = (cash + marketable securities + accounts receivable)/ current liabilities Page 2 of 19 .9.Current Ratio 3.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry Even though NETGEAR’s current ratio has been declining from 2005 to 2010.

we see Cisco having the highest recent quick ratio of 2.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry NETGEAR has a quick ratio.50 2. The ratios give a good indication of a company’s ability generate cash in the near term to cover its financial obligations. Again.00 0. This is done because liquidating inventory may not be a smooth process.50 1. Juniper and Seagate.55 as a result of having high cash and investment. Quick Assets Ratio 3. This indicates that these tech companies do indeed hold a large amount of cash or cash equivalents.3. which ranges from 1.9 to 2.00 2. It may not happen quickly.00 1. Accounts Receivable Turnover = Sales/AR Page 3 of 19 . hence it is not considered in the quick test.50 0. A very similar pattern is found with Cisco.The quick asset or acid-test ratio is very similar to the current ratio except that it excludes inventories. Operating efficiency Many liquidity ratios can be classified into a subcategory called operational efficiency.

Page 4 of 19 .AR turnover shows how many times receivables are collected or turned over during the year. Because Cost of goods sold and inventory are recorded at historical prices. Accounts Receivable Turnover 10. even if it is processed first into a receivable.00 9.00 4. It gives an indication of how efficiently a company is collecting. Inventory Turnover = COGS/ Inventory Inventory turnover shows how many times an amount of inventory would be sold or turned over in a given period of time.98 which is the lowest among its competitors.00 1. this ratio is a good indicator of how quickly inventory can be processed back into cash.00 8.00 6.00 7.00 0.00 3.00 5. This could indicate that NETGEAR’s collection process is inefficient compared to others in the industry. notably one year.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry NETGEAR’s account receivable turnover for 2010 is 3.00 2.

00 0.00 10. NETGEAR inventory turnover is not too much below industry average.7 for year 2010. This lower in sales could due to the fact that it is a smaller company. NETGEAR inventory turnover is lower than industry average because it has a lower sales than average.00 14.00 2. Days Sales Outstanding = 365/ ARTO DSO is an attempt to quantify the average number of days a company takes to collect on its receivables. it has a smaller number of sales and has to compete with its larger competitors.00 4. NETGEAR has an average collection period of 91.00 6. therefore.00 2005 NETGEAR 2006 Juniper 2007 Cisco 2008 2009 Seagate 2010 Industry In the table above. This number is also a bad sign compared to Cisco’s much lower average collection period of 50 in the same year.00 8.00 12. However. Page 5 of 19 . The average of this industry is around 40 to 50 days.Inventory Turnover Ratios 16.

00 0.00 40. We see NETGEAR consistently taking longer to roll over its inventory than its competitors. Days Sales Inventory= 365/Inv. Days Supply Inventory 90.00 40.00 50.00 80.00 0.00 30.TO DSI is a measurement of how many days it takes for inventory to be turned over.Days Sales Outstanding 100.00 70. This means that it is taking too long to collects accounts receivable.00 60.00 50.00 20.00 60.00 10.00 20.00 90.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry NETGEAR almost doubles that of industry average in 2010.00 10.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry Page 6 of 19 .00 80.00 30.00 70.

00 160.00 0. which is the numeric difference between the current assets and the current liabilities.00 100.00 20. Cash to Cash Cycle 180.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry We see that NETGEAR is a little slower on the loop than its main competitors. is divided into sales for the working capital turnover. In this case the inventory is too high for NETGEAR.00 40.00 80. Page 7 of 19 . Cash to Cash Cycle = DSO + DSI By combining the days sales outstanding and the days standing inventories into the cash to cash cycle.00 60.NETGEAR has been underperformed because a higher ratio would represent a less effective inventory management.00 140. we get a good idea of how many days it typically takes a dollar invested into inventory to be converted back to into cash as an asset. Working Capital Turnover = Sales/Working capital Working capital. NETGEAR lags its industry. all else being equal. This ratio shows how every dollar above that needed for the short term obligation can generate a dollar amount of sales.00 120.

It has a poor showing in efficiency within its industry.00 4. Page 8 of 19 . for example. pay for its operations.00 12. The low account receivable turnover and high days sales outstanding number shows.00 8. pay its creditors. Profitability Beyond knowing the liquidity of a company. while NETGEAR’s current and quick-asset ratios show it has an acceptable amount of liquidity.Working Capital Turnover 14. that NETGEAR’s customers don’t pay as quick as other’s in the same industry. Its inability to collect cash timely could be a reason to worry since they won’t get access to much of their assets (specifically account receivables) in order to reinvest in R&D or pay their debts.00 0.00 2.00 2005 2006 2007 2008 2009 2010 NETGEAR Juniper Cisco Seagate Industry In conclusion.00 6. it is equally important to an investor to know if a company can not only pay its short term liabilities.00 10. And can a company profit enough that it can grow as a business or increase its cash or liquid asset holdings as insurance against macroeconomic swings. but also if can pay its expenses. pay its taxes and ultimately pay back an equity stakeholder with profit.

The result is a percentage of by how much revenues exceed the costs of goods sold. NETGEAR is underperforms based on the industry average. Page 9 of 19 . The higher the number the better as all subsequent expenses for operations. the less costly it is to produce the products. than it would for Juniper or Cisco. Bigger companies have the economy of scale effect. it costs more to make products for NETGEAR and Seagate. Both Seagate and NETGEAR are smaller in size compared to Juniper and Cisco. Gross Profit Margin 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2005 NETGEAR 2006 Cisco 2007 Juniper 2008 2009 Seagate 2010 Industry NETGEAR's gross profit is lower than two of its competitors most likely because of its size. and taxes come from gross profit. This remainder is then divided by sales. The more they produce. The impact of gross profit margin being smaller is also caused by the lower sales revenues in smaller companies as well as the higher costs of goods sold.Gross profit margin = Gross Profit/ sales Gross profit is the remainder after the costs of goods sold has been subtracted from the sales. A bigger company could produce products for less cost than that of a smaller company. Therefore. interest.

from the gross profit. Operating Profit Margin 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% 2005 NETGEAR 2006 Cisco 2007 Seagate 2008 2009 Juniper 2010 Industry While NETGEAR is operating profit margin is positive. the higher the better. it still below the industry average.Operating Profit Margin = Operating profit/ sales The operating profit margin is found by first calculating the operating profit. fuel. which is the profit remaining after subtracting all operational expenses such as labor. rent. The operating profit is what the company is able to produce above its costs to operate. is the ratio between net income and sales for a given period. of how Page 10 of 19 . in percent form. Net Profit Margin = net income/ sales The net profit margin ratio. This measure gives a concise measurement. or simply profitability. The operating profit is then divided by sales to give a percentage of every sales dollar that will become an operating profit. Like all of the profit margin numbers. etc.

Asset Turnover = sales/ total assets Asset turnover. A high productivity ratio is desirable for a Page 11 of 19 . Net Profit Margin 30% 20% 10% 0% -10% -20% -30% -40% -50% 2005 NETGEAR 2006 Cisco 2007 Juniper 2008 2009 Seagate 2010 Industry The profit margin of the industry has averaged around a respectable 10%. However. A high profit margin is desirable because it means that the company is keeping more of the profits from each sale has income. which is slightly concerning in itself. NETGEAR’s profit margin has averaged around 6%. also known as productivity. is the ratio between sales for a period and the total assets from the previous period. The asset turnover ratio gives insight into how productive a company is being with its total assets relative to sales. although a few dips in profitability for individual companies have occurred.much of each sales dollar actually translated into net income. NETGEAR performed better than the industry in asset turnover. and it is the combined effects of both which demonstrate NETGEAR’s respectable ROA.

This measurement is very important to potential investors because it helps to Page 12 of 19 . there is also a moderate amount of variance between companies in the industry. NETGEAR sales more than its competitors.60 0.00 2005 2006 2007 2008 2009 2010 NETGEAR Cisco Seagate Juniper Industry The productivity for NETGEAR and its competitors is seemingly low. A large part of this is due to the differing product lines and services of each company. Asset Turnover 1. Although.00 0.60 1. Return on Assets (ROA) = NI/ Total Assets = profitability x productivity Return on Assets is the ratio relating net income in a given period to the total assets in a previous period. This productivity is a positive sign in a high technology field which requires taking advantage of all assets. but rather they make their money through other methods such as high sales margins.40 1.40 0. Although the asset turnover of each company is because it signifies that they are making more revenue from a given amount of total assets. This implies that they do not have a large amount of sales. This is likely since NETGEAR products are available at places like Wal Mart and Best Buy and generally are cheaper to purchase than Cisco or Juniper products.20 1. NETGEAR has historically maintained an asset turnover ratio above 1.80 0.20 0.

Return on Equity (ROE) = Net income / owner’s equity Return on Equity is computed as the ratio of net income for a given year to total owner’s equity of the previous year.3 0.1 0 -0.2 0. A large number can mean that a company is not only generating a reasonable income.1 -0. saw NETGEAR’s ROA rise to around 9% to rebound from a three year slide. The current ROA is an acceptable level for the industry and should provide potential investors with confidence in the continued success of the company. meaning that they are neither excelling nor lagging in their asset utilization. with individual companies having large variations. but is also being very efficient with their resources. 2010.4 2005 NETGEAR 2006 Cisco 2007 Seagate 2008 2009 Juniper 2010 Industry The return on assets for NETGEAR’s industry has varied slightly over the past five years.3 -0. Return on Assets 0. This ratio can be further disaggregated into two ratios which provide further information into a company’s business activities: asset turnover and profit margin. NETGEAR’s ROA is seemingly identical to the industry average.2 -0. The most recent reported year.demonstrate how well a company is utilizing its assets to generate income. This positive news is likely contributable to the end of the recession and resulting increases in net income. This ratio gives a more clear idea of how a company performed Page 13 of 19 .

The ROE for 2010 increased for the first time in several years. the three profit margins for NETGEAR have been respectively positive which shows that the company is keeping more of the profits from each sale. ROE is considered to be one of the most important ratios for any company. NETGEAR ROA and ROE are at an acceptable level for the industry and has gradually increases since the end of the recession in 2009. and many investors require a strong ROE before potentially investing in a company. NETGEAR has high sales margins. Cisco and Juniper. which is a positive sign for the company. In conclusion. This result of increase in net income provides potential investors with confidence. it is very consistent with its profit margins throughout the years.5 0 -0. NETGEAR has maintained a positive ROE since 2006.5 1 0. Page 14 of 19 .5 -1 2005 NETGEAR 2006 Cisco 2007 Juniper 2008 2009 Seagate 2010 Industry The ROE graph of NETGEAR and several of its competitors demonstrates that the ratio has been relatively constant in the industry over the past five years.relative to owner financing. so its asset turnover is higher than industry average. Despite NETGEAR being a smaller company than its two competitors. providing another positive signal to shareholders of the company. Return on Equity 1.

how a business is financed. If a company also issues debt it must be able to repay the principle as well as it matures. This is due to the fact that it has no long term debt. A company deemed a credit risk has a significant chance of default and/ or bankruptcy. Debt to Equity Ratio = Total Liabilities/Stockholder’s equity This ratio gives the proportion of debt to equity in financing the assets. the interest expense. For the last two years all of its liabilities have been current (non-interest bearing) liabilities. While borrowing will leverage a company and ideally allow it to succeed with other peoples’ money. Page 15 of 19 . the company must generate enough profit to pay for the cost of capital. NETGEAR has a low debt to equity ratio. For these very important reasons capital structure and credit risk of companies is of serious importance to investors. Capital structure being the distinction of asset ownership between contributed capital and borrowed capital.Capital structure A final an important class of ratios are those dealing with capital structure.

taxes. no long term liability. This would represent that a company can pay its obligations and have profit to spare towards interest. it has no interest expense. Debt Service Margin Ratio = cash flow from operations/ current portion of long term debt The debt service margin allows one to see how much long term debt impacts cash flow.00 3. NETGEAR may have no long term debt because it’s too young of a company.50 2. Because NETGEAR has no debt.50 3. It may experience too much variability in its profits to take on the risk of contractual payments. However. It is Page 16 of 19 .00 2. Therefore. A higher number is better. and net income. A ratio of one would be the minimum needed without going into default.50 0.Debt to Equity 4. the TIE ratio for NETGEAR is undefined.00 2005 2006 2007 2008 2009 2010 NETGEAR Cisco Seagate Juniper Industry Times Interest Earned Ratio = Earnings before interest and taxes/ interest expense The utility of this ratio is to see how easily a company can pay its interest expense with profits.50 1.00 0. the debt service margin is undefined. Also because NETGEAR has no interest bearing debt.00 1. a ratio of greater than one would be needed to put an investor at ease.

4[Retained Earnings/Total Assets] +3.83.00 -4.00 -2. The Z-score is a sum of weighted ratios of liquidity.00 0. As credit risk analysis is concerned with expected credit loss. Altman’s Z-Score Altman’s Z-Score is a method of determining the risk of an individual company defaulting/ going bankrupt in the near future.also in a rapidly changing and growing industry. which gives them a low bankruptcy risk for the next year. A large portion of NETGEAR’s high Z score can be attributed Page 17 of 19 .00 6. NETGEAR says in its 10-K that it must constantly come up with new products just to stay competitive. Altman’s Z-Score =1.00 8.00 NETGEAR 4.99[Sales/Total Assets] Z-Scores 10.6[Market Value of Equity/Book Value of Liabilities] + 0.3[Earnings Before Interest and Taxes/Total Assets] +0. Altman’s Z-score is an approximation of the chance of default in the near term.2[Working Capital/Total Assets] +1. It has been shown to be 95% accurate predicting a default in one year out and 72% accurate two years out.00 SEAGATE 2.00 2005 2006 2007 2008 2009 2010 JUNIPER CISCO The Z score for NETGEAR during 2010 was calculated as 4. and capital structure. profitability. which is the chance of default x loss given default.

indicate that NETGEAR is currently financially sound and not facing bankruptcy risk. Page 18 of 19 . Seagate has a negative Z-score of -0. All other financial their lack of long term debt. excluding the profit margin. which lowers total liabilities in favor of higher owner’s equity.09. which is the result of having a low market value and high liabilities in addition to negative operating income.

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