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Rod Monger May 18, 2011 The US Software Industry: A Ratio Analysis of HP, IBM, and Microsoft Introduction In this paper, we study the financial performance of three major software companies: Hewlett-Packard (HP) Company, International Business Machines (IBM), and Microsoft Corporation. Using their financial statements, we analyze the companies¶ levels of profitability and liquidity, assets and debt utilization, and dividend policy. Our analysis is comparative in that it compares the performance of three companies with each other and with the industry over three consecutive years of 2008, 2009, and 2010. We only attempt to identify where financial problems are. It should be noted that the interpretation of financial problems is beyond the scope of the current study. The first section of the paper is devoted to the ratio analysis of each company per se. We have three case studies in which profitability ratios, liquidity ratios, efficiency ratios, shareholder ratios, and capital structure ratios are calculated and briefly explained. Following the case studies, we have calculated ³industry norms´ for all categories of ratios. This is where we provide a comparative ratio analysis of the US software industry and its three major players.

2 Case Study 1: Hewlett-Packard (HP) Company I. The History of the Company In 1939, Hewlett-Packard Company, hereafter referred to as HP, was founded by two graduates of Stanford University: Bill Hewlett and Dave Packard. A decade after becoming a true corporation in 1947, HP went public and had its initial public offering of ordinary shares. It was not until the 1980s that HP took an active role in the mass production of personal computers and printers, which ³set the direction in which printers would evolve in the future´ (Dodge). Another crucial milestone in HP¶s history is the 2002 merger with Compaq Computer, which turned HP into one of the largest software companies in the world, operating in 160 countries and having around 150,000 employees. HP¶s corporate strategy is concentrated on ³market share growth and company profitability throughout the future of the business´ (Dodge). The executive management of the company attempts to operationalize the corporate strategy through employee empowerment and integration into the global market. The success with which the executive management could implement its corporate strategy has turned HP into a relatively safe investment. Standard and Poor¶s has given HP an A credit rating and an A-1 commercial paper rating (Dodge). Yet, from the perspective of the firm¶s executive managers, it is crucial to consistently watch the performance of the company as if they were potential investors. In this sense, the fundamental analysis of financial statements must be conducted. It must be noted that all financial data used in our calculations are taken from the annual reports available in HP¶s website. For further information, please visit http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-reportsAnnual.

Ratio Analysis Profitability Ratios: Before delving into the profitability analysis of HP. The general formula is the following: Return = X 100 i. Return on Capital Employed (ROCE) a. Shareholder Funds means the book value of all things in the balance sheet that describe the owner¶s capital and reserves. It should be noted that we use the ³average of two consecutive years¶ common stock. and retained earnings´ to calculate the return on shareholders¶ funds. long-term debts. Return on Shareholders¶ Funds (ROSF) a. paid-in capital. and other long-term liabilities´ to calculate the return on capital employed. In this case.´ ROSF = X 100 ii.3 II. it is important to shed light on the method with which Return on Shareholders¶ Funds (ROSF) and Return on Capital Employed (ROCE) are calculated. Capital means common stock + reserves including retained earnings + preference shares + loan notes and long-term loans. Return is the net profit for the period b. we also use the ³average of two consecutive years¶ total stockholder equity. Return means net profit for the period + any preference share dividends + loan notes and long-term loan interest b. .

However.75% 6. the return on capital employed (ROCE) has progressively grown since 2007.09% 2008 21. Category/Year Return on shareholders¶ funds Return on capital employed Gross profit* as percentage of sales Net profit as percentage of sales 2007 19. and went up to 19.03% 54.35% yet its gross profit margin came slightly down.96% 7. it maintained a relatively stable gross . In contrast to ROSF.22% 58. This is true in HP¶s case. ROSF once peaked at 21.95% * Gross profit = Total net revenue ± Cost of Sales Cost of Sales = Cost of products + Cost of services + Financing interest HP seems to have a rather random return on shareholders¶ funds (ROSF).50% 2010 19. and the other two cases are analyzed from 2008 to 2010. In order to see how HP manages its cost of goods sold (or cost of sales) over four years. HP reached a peak of 24. then fell to 18.03% 6.03% 23.35% 24. The reason is that the fluctuation in certain ratios could be better seen if the 2007 analysis is included. In 2007.68% 6. In the time period from 2007 to 2010.64% in 2008.14% 24.4 ROCE = X 100 It must be mentioned that the ratio analysis of 2007 is also included in order to show a rather big picture of HP¶s performance.91% 64.90% in 2010. Such returns suggest that the company could effectively utilize its equity and obtain the possible maximum return on it.90% 38.59% 23.64% 2009 18.50% in 2009. it is important to look at the company¶s gross profit margin.

82 -0. which is a sign of increasing profitability.09 0. A higher current ratio makes the company capable of paying its short-term debt as they come due.20 1.09 8142 2008 0. i. that is.5 profit thereafter. HP seemed to have problem paying its short-term obligations in 2008 and 2010 due to the raise in current liabilities and fall in current assets. Regarding its current ratio.e. Here.97 in 2008 and 1.03 4781 Liquidity ratios suggest how efficiently a company functions in short-term. This might also be due to that year¶s financial crisis. Liquidity Ratios Category/Year Current ratio Acid-test ratio Net working capital to total asset ratio Working capital 2007 1. in line with a notable drop of current ratio and acid-test ratio in 2008. Considering the context in which the company performed. HP experienced drops of 0.22 1. To highlight the overall performance of HP.02 0.97 0.03% (2008¶s net profit margin). which might be an indication that the company¶s strategy to keep the cost low works well.08 9536 2010 1. In regard with the acid-test ratio. Particularly.. net working capital also fell to a negative amount. Though the company¶s net profit margin came back to 6. .09 in 2010 yet could be able to bid up the ratio to its normal level in 2009 and 2010.01 -1211 2009 1. we also have to look at the figures of net profit margin. the 2008 financial crisis. we notice a big jump from 6.95% in 2010. to see how easy it was for HP to pay its interest and taxes.07 0. it still increased to 6.96 0.68% in 2009.96% (2007¶s net profit margin) to 7. HP could manage to maintain notable increases in the figures of net profit margin.

1 days) 0. as a result of HP¶s attempts to keep inventory as low as practical and enhance sales. As HP moved from 2007 towards 2010. The accounts payable-to-purchase ratio measures how much time it takes HP to pay its creditors.29 days) 0. On the other hand. which is a drastic drop compared with the 62 days in 2009.5 days) 0.148 (54.144 (52. in 2008. The greater this ratio becomes. In 2007.49 times 0.8 days) 0. the analysis shows that the accounts receivable-to-sales ratio has taken an increasing pace from 2007 to 2010.05 days) 2010 15.6 Efficiency Ratios Category/Year Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase* ratio 2007 9. which might have contributed to the dramatic drop in the current ratio and the negative amount of net working capital of 2008.12 (43. the time that it took HP to pay off its creditors dropped to 54 days. . it delayed the payment of its payables. the more time it takes HP to collect its debt.143 (52. It is suggestive of how successful the company¶s executive management is implementing its sales or inventory strategies.99 times 0. the time span increased to about 52 days. however.15 (54. it took HP about 43 days to collect debts.02 days) * Purchase = (Cost of sales + Closing inventory) ± Beginning inventory Perhaps.25 times 0.146 (53.1 days) 2008 11.30 times 0.14 (51. we notice that inventory turnover obtains a faster pace year by year. In 2010.75 days) 2009 12.17 (62.

68% 2010 43.stock-analysis-on.58 2008 $3. HP¶s earnings per share (EPS) have increased with slight proportions.07 $0.7 Shareholder Ratios Category/Year Earnings per share Price to earnings (P/E) ratio* Market price Dividends per share Dividends yield Dividends cover 2007 $2. with the exception of 2009. HP had the P/E ratio of 18.08 $49.60 $50.46% X 100 2008 35.60 in the next year. Once again. EPS is an important determinant of the ordinary shares¶ market price and P/E ratio.97 $0.35 10.21 15. not receiving a constant income.90 $0. it becomes clear that one should purchase HP¶s common stock only if her investment objective is capital gain.76 18.31 $38.32 0.64% 8.78 10. Gearing Ratio Category/Year Gearing* * 2007 28.37 $0.net/NYSE/Company/Hewlett-Packard-Co/Valuation/Ratios#PE From 2007 to 2010.63% 10 2010 $3.08. This abnormal instability of the price-earnings ratio might be due to the tremulous era following the 2008 financial crisis.79 * http://www. In 2007. By looking at the low level of HP¶s dividend yield.31 in 2010.82% 11.47% 2009 41.26 in 2008 but became 15. it fell to 10. however.32 0. it dropped to 10.93% 10.66% .32 0.46 2009 $3.32 0.26 $34. The dividend yield is defined as ³part of the total return that an investor receives along with capital gains and losses´ (Dodge).

and capital structure ratios.wss. II. Computing Scale Corporation. from the standpoint of potential investors. They changed their name to IBM after deciding to enter the Canadian market in 1914. The History of the Company Hermand Hollerith founded Tabulating Machine Company in 1896. Later on. shareholder ratios. IBM became the chief contractor of the defense industry. however.8 In 2007. Case Study 2: International Business Machines (IBM) I.. Developing computer machines for the United State Air Force. Time Recording Company. which could mean a higher rate of risk for potential investors. For further information. please visit http://www. IBM played an important role in introducing new hardware systems and thus attracted the attention of potential investors. Of the above-mentioned ratio categories. It could be divided into two parts: return on shareholders¶ funds (ROSF) and return on capital employed (ROCE). Ratio Analysis Profitability Ratios: As is mentioned in the introduction. The world witnessed the first IBM PC in 1981. From 2007 onwards. and Tabulating Machine Company were merged together to form CTR. Since then. efficiency ratios.com/investor/financials/financial-reporting. It must be noted that all financial data used in our calculations are taken from the annual reports available in IBM¶s website.ibm. It signals that HP has been willing to accept a higher rate of debt. the most important one. We calculate ROSF based on the following formula: . HP was considered to be a relatively low-geared company. liquidity ratios. is the profitability ratios. HP¶s gearing ratio has steadily increased. there are five main categories of ratios with which one analyzes how healthy a company is: profitability ratios.

The performance of the return on capital employed is rather random. IBM had the highest percentage of return on capital employed in 2009.85% The percentage of return on shareholders¶ funds (ROSF) decreased from 2008 to 2010. and 45. IBM had a progressing net profit margin from 2008 onwards.13% 45. Liquidity Ratios Category/Year Current Ratio Acid Test Ratio 2008 1.06%.29% 45. 2009.02% 2010 11.07% 14. The gross profit margin for 2008.38% 84.35 1.29 2010 1. we use the average capital of two consecutive years.15 1.72% 14. we use the following formula: ROCE = X 100 It should also be noted that in the denominator of both formulas.06% 11.07% respectively.12 .72%.38% 44. As the table shows.29%.09 2009 1. 90.02% 83. 45. It is clear that IBM had the highest gross profit as the percentage of sales in 2009.18 1.9 ROSF = X 100 To arrive at ROCE. and 2010 was 44.56% 90. Category/Year Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales 2008 12.90% 2009 11.

67% . Under liquidity ratios. IBM operated unsatisfactory in 2009 in terms of inventory turnover and accounts receivable to sales ratio.02 9. IBM had a higher ratio of current ratio and acid test ratio in 2009.0170 4.77% 2009 $10.1165 (42. In the span of time under our consideration.1198 (43.89) We calculate efficiency ratios in order to realize whether the collection and payment of debts are efficiently managed. It is not so useful to compare the liquidity ratio of one company over different years.69 12.12 12.0164 4.52) 0.79 times 0.33 0.1449 (52.01 times 0.0226 4. The account receivable period means how many days it takes IBM to collect its receivables.30) 0.13 days) 2009 20.93 0.41 days) 2010 21. The inventory period means how many days it takes IBM to sell its inventory.10 Liquidity ratios indicate that whether the company has the capability to meet its current obligations.61 times 0.1209 (44. Shareholder Ratios: Category/Year Earnings Per Share Price/ Earnings Ratios Dividend Yield Dividend Cover 2008 $9.69% 2010 $11. the account payable period indicates that how many days it will take the company to pay its payable accounts. We need to compare the liquidity ratios with those of the industry in order to realize whether they are high or low. Efficiency Ratios: Category/Year Inventory Turnover Account Receivable/Sales Account Payable/ Purchase 2008 21.55 0. we calculate current ratio and acid test ratio.727) 0.1436 (52.1241 (45.

The dividend yield measures the exact rate of return to shareholders based on their investment. As the table shows.11 Based on the table. The P/E ratio measures the value that investors are assuming for every dollar of current earning. Therefore. which implies that the company had 4.69 more times available capital to pay its dividend obligations.69. Dividend cover signals the available amount to pay shareholders declared dividends. Thus.38% 2010 39. the dividend cover is 4. IBM had a progressing earning per share in the three consecutive years of 2008. the higher IBM¶s P/E ratio is. 2009. the more attractive the company will be for the potential investors.84% .2% 2009 42. the greater the dividend yield. the more demand will be for its common stock. Gearing: Category/Year Gearing 2008 44. in 2009. and 2010.

26 2010 %30. . History of the Company Microsoft is a multinational corporation headquartered in Washington. Microsoft¶s management attempts to enhance profitability as much as practical to encourage further investment.12 Case Study 3: Microsoft Corporation I. we can notice that it fell dramatically in 2009 perhaps due to the fact that operating expenses went up.12 %55.93 %79. please visit http://www.80 %60.17 %23.26 %80.41 %28. We compare the profitability ratios of Microsoft Corporation over three consecutive years. By looking at Microsoft¶s net profit margin. USA. Ratio Analysis Profitability Ratios: Category/Year Return on shareholders¶ funds Return on capital employed Gross profit* as percentage of sales Net profit as percentage of sales 2008 %29.45 %29.aspx. monitors the performance of executive management.95 Profitability ratios provide the analyst with the net results of financing policies and decisions.com/investor/AnnualReports/default.microsoft. While a high return on sales is good. made up of mostly outsiders. Microsoft lunched its Initial Public Offering (IPO) in 1986 with the opening stock price of USD 21.65 2009 %24. It must be noted that all financial data used in our calculations are taken from the annual reports available in Microsoft¶s website. The board of directors. Microsoft started offering dividends in 2003.02 %80. For further information. II.16 %58.

95 times 0.41 2009 1.13 everything else equal. it might delay the payment of debts. Efficiency Ratios: Category/Year Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase* ratio 2008 11. .44 1. this ratio increases in a decreasing rate.06676 (24.12 2.1915 (70 days) 0. In the case of Microsoft. Inventories are typically the least liquid asset of the company. and this is a negative sign. which is calculated by deducting inventories from current assets and then dividing the remainder by current liabilities.75 times 0. If a firm sets a very high price on its products. we should also be concerned with turnover. Liquidity Ratios: Category/Year Current ratio Acid-test ratio 2008 1.82 1. The current ratio of Microsoft Corporation has been increasing year by year. Acid-test ratio is the most used liquidity ratio. Acid-test ratio measures a firm¶s ability to pay off short-term obligations without relying on the immediate sales of inventories.77 times 0.79 2010 2.2082 (76 days) 0.7 days) 2010 16. the current ratio will fall. It means that the company is able to pay its short-term debts with enough ease.05688 (20.5 days) Accounts receivable to sales ratio is also called ³average collection period´. it may get a high return on each sale but not make many sales.2249 (82 days) 0.3 days) 2009 16. This ratio represents the average length of time that the firm must wait after making a sale to receive cash. If current liabilities are rising faster than current assets.10 If a company is faced with financial difficulties.06441 (23.

32% 2009 $1. it takes less time (70 days) for Microsoft Corporation in 2009 to collect accounts receivable from debtors.44 1. Apparently. P/E ratio shows how much the investor is willing to pay per dollar of reported profits.14 As the above table indicates. if it is lower.79 0.52 2. two numbers for earnings per share are disclosed: basic and diluted EPS. we consider the basic earnings per share.68 0. When comparing this ratio with that of the industry.397971 3.18 0. Shareholder Ratios: Category/Year Earnings per share Price to earnings (P/E) ratio* Market price Dividends per share Dividends yield (%) Dividends cover 2008 $1.052 0.15% 2010 $2.93 $32. on the other hand. it suggests that the company is regarded as being somewhat riskier. and it varies in different years. In this report. it took Microsoft 82 days to receive from debtors. Dividend yield ratio shows how much the investor will be paid per dollar of reported profit. In order for us to understand the standard amount of dividend yield.63 13. These numbers differ with respect to the definition of available net income and the number of shares outstanding. This ratio is higher for firms with strong growth prospects and relatively little risk. this company does not hold a constant growth rate of EPS. In 2008.13 12.57 $26.12% In the financial statements of Microsoft Corporation.367096 4.194102 4.90 16. it should be compared .30 $21.

16 30. it is evident that Microsoft raced ahead of HP and IBM from 2008 to 2010.15 with other companies in the industry.530733 X 100 2009 15.45 80.90 2008 % 12. While HP and Microsoft experienced a slight decline in ROSF over the span of three years.85 60.65 Microsoft 2009 % 23.75 6. This ratio is also higher for firms with strong growth prospects and relatively little risk.93 58.26 55.95 36.56 2010 % 11.89 45.22 24.8 29.90 33.14 23.41 80.68 64. Similarly.50 2010 % 19.02 In regard to the return on shareholders¶ fund (ROSF).03 58.1 24.38 2008 % 28.74713 The Industry Analysis: A Comparative Study Profitability Ratios: a) Companies Category/Company Years Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales HP 2008 % 21.06 11.03 7. Microsoft could manage to have a considerable increase in the rate of return on shareholders¶ funds.17 79.02 IBM 2009 % 11.07 14.72 14.02 30.33158 2010 17.26 2010 % 29. Gearing Ratio Category/Year Gearing* * 2008 9.64 2009 % 18.95 54.68 44. Microsoft could obtain the highest return on .91 23.59 6.60 45.

41 51.16 capital employed (ROCE).22 1.44 27. the net profit margin of Microsoft is greater than that of IBM HP whose net profit margin is surprisingly low. In 2009. the lowest return belonged to IBM. b) Industry Norms Years Return on shareholders¶ funds Return on capital employed Gross profit as percentage of sales Net profit as percentage of sales 2008 % 20.82 2009 1.79 2010 2. The company that has one or more ratios below the industry norm indicates the existence of a problem in its operation that must be identified and cured.97 0.16 26.41 2009 1.16 9.29 2010 1. Microsoft could also be in a superior position regarding the gross profit margin.35 1.23 26.96 2008 1.10 .15 1. Liquidity Ratios: a) Companies Category/Company Years Current Ratio Acid Test Ratio HP 2008 0.08 The industry norm is calculated by the sum of companies¶ profitability ratios divided over the number of companies.95 10.07 2010 1.82 1.77 50.09 IBM 2009 1.18 1. Microsoft¶s gross profit margin fell in 2010. Reflecting a similar pattern.6 8.77 49.09 0.4 2010 % 20.12 Microsoft 2008 1. The lowest gross profit margin belong to HP.44 1. all three companies experienced a drop in ROSF and ROCE. yet it is by far above that of IBM and HP.81 2009 % 17. Over the three years.12 2.

19 2010 16.14 0.10 2009 1. Microsoft¶s accounts payable to purchase ratio is low relative to that of HP and IBM. IBM could also collect its debts much sooner than HP and Microsoft. relative to IBM and Microsoft. HP seems to push back the payment to its creditors as much as practical.3 0.45 1.46 1.95 0.05 0.11 2008 11.20 0.15 0.146 2008 21.77 0.25 0.75 0. b) Industry Norms Years Current Ratio Acid Test Ratio 2008 1.144 2010 15. On the other hand.19 1.11 IBM 2009 20.61 0. Microsoft¶s ability to pay off its short-term debts has increased.38 2010 1.06 IBM maintained a high level of inventory turnover.79 0. Although being capable of paying its obligations.22 Microsoft 2009 16.06 0. The immediate liquidity of the firm as measured by acid-test ratio has gone up in proportionate with the current ratio. .39 Efficiency Ratios: a) Companies Category/Company Years Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase ratio HP 2008 11. HP has the weakest position regarding.17 Moving from 2008 to 2010.14 0.12 0. Having a lower accounts receivable to sales ratio.49 0.143 2009 12.14 0.12 2010 21.01 0. Microsoft and HP moved shoulder to shoulder with each other in this regard. implying that Microsoft does not delay its creditor¶s payments.17 0.

15 0. Microsoft is also the most attractive option for potential investors.052 0.18 b) Industry Norms Years Inventory turnover Accounts receivable to sales ratio Accounts payable to purchase ratio Shareholder Ratios: a) Companies Category/Company Years Earnings per share ($) Price to earnings (P/E) ratio* Market price ($) Dividends per share Dividends yield Dividends cover HP 2008 2009 2010 2008 IBM 2009 2010 2008 Microsoft 2009 2010 2008 14. .18 21.02 9.93 138.9 0.69 11.0093 10.15 1.58 146.119 3.78 10.156 0. Regarding the dividend policy.07 0.55 1.69 12.26 34.94 1.18.017 4.90 16.19 0. but IBM¶s EPS continued to grow.44 1.3 2. HP¶s P/E ratio exceeded the industry P/E ratio in 2009.35 10.31 38.6 50. In 2008.38 3.46 3.32 0.93 0. Microsoft¶s P/E ratio stood above the industry¶s average in that year.0164 4.37 4.32 0.16 0.13 It is evident that investors value each dollar of IBM¶s earnings much higher than the earnings of HP and Microsoft.0063 10 3.63 13.97 0.11 2009 16.15 0.93 0.33 84. HP¶s and Microsoft¶s EPS slightly dropped.33 0.19 4.12 2010 17.13 12.0226 4.0082 11.79 1.71 32.42 2.12 12.77 0.37 0.79 9.85 2.68 26.32 0.48 0. In 2009.21 15.67 0.77 10. the average P/E ratio was 12.

64 12. as it moved towards 2010.75 IBM is a highly geared company in the beginning of 2008.33 2010 17.8 5.97 0.18 50.38 2010 39.89 0.86 Gearing: a) Companies Category/Company Years Gearing (%) HP 2008 35.07 6.44 2009 5.2 0.94 70.84 2008 9.2 .19 b) Industry Norms Years Earnings per share Price to earnings (P/E) ratio Market price ($) Dividends per share Dividends yield Dividends cover 2008 3.82 0.81 70. its gearing ratio increased.47 2009 41.66 2008 44.53 Microsoft 2009 15.52 2009 3.20 IBM 2009 42.68 2010 43.95 2010 4.92 13.39 2010 6. Though its gearing ratio increased. yet its gearing ratio decreased as it moved towards 2010.71 0. Microsoft kept its financial leverage low compare to HP and IBM.47 6.61 11. b) Industry Norms Years Gearing (%) 2008 3. HP experienced an inverse course of action. In other words.23 0.

14 Apr.scribd. 2008. Hewlett-Packard. .20 Work Cited: I. Web." Scribd. and Joe Barnes. <http://www. "Hewlett-Packard. Chad. Dodge. 18 May 2011.com/doc/54882240/HP-Paper>.

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