Question
Prepare an eight- to ten-page fundamental financial analysis (excluding appendices, title page, abstract, and references page) that will cover each of the following broad areas based on the financial statements of your chosen company:a.Provide a background of the firm, industry, economy, and outlook for the future.b.Analyze the short term liquidity of the firm.c.Analyze the operating efficiency of the firm.d.Analyze the capital structure of the firm.e.Analyze the profitability of the firm.f.Conclude with recommendations for the future analysis of the company (trend analysis).
Answer
Google Inc Financial Analysis
Abstract
Google Inc. is one of the largest technology companies in the world. The company provides various products and services to customers. Originally providing internet search services to computer users, the company has diversified to include software and hardware products in the recent period. The overall purpose of this study is to evaluate the financial health of the company and evaluate its future prospects. Through a detailed examination of its financial statements, it will be possible to describe the company’s financial health as well as its future prospects. The study takes into consideration various ratios relating to liquidity, operating efficiency, capital structure, and profitability ratios. The major findings of the study indicate that Google is currently in good financial health. This is after a thorough examination of the various financial ratios. This is explained in more details in the report below. Further, the study indicates that Google needs to diversify its revenue base to overcome stiff competition from a variety of sources.
Google Inc. Financial Analysis
Google Inc. is an American multinational company that specializes in technology and internet-related products and services. The company has its headquarters in Mountain View, California. Its core operations include managing online search requests, cloud computing, online advertising, building software and hardware, and other activities. The company commenced operations in 1998. The pioneering developers are Larry Page and Sergey Brin, who established the company together while they were students at Stanford University. Since its inception, Google Inc. has continued to experience growth and exert dominance in the market especially as the world’s most popular search engine. The company went public in 2004 through an IPO offer to the public. In 2006, Google acquired YouTube through purchase of its stock. Nonetheless, YouTube continued to operate as a separate entity from Google. In 2015, Google became part of Alphabet Inc., a holding company, in an effort to restructure Google.
Background
Google Inc. is in the technology industry. The company began operations as an online search firm. Currently, the company offers over 50 technology-related products and services to consumers worldwide. The most notable technology products and services are in the line of e-mail, online search, software, mobile phones, tablet computers, and cloud services (Alphabet Inc., 2016). Specifically, these include YouTube/video, Gmail, Google Books, Google Earth, Google Chrome, Android operating system, and Google Apps. Each of these products is in use by more than one billion users each month. The company primarily earns revenue from various sources including AdSense Google Network, Google Website, cloud service, hardware, digital content, and advertising (Alphabet Inc., 2016). Advertising involves performance and brand advertising.
Google faces competition from various sources in the technology industry. Search engines and information service providers search as Yahoo, Bing, Baidu, Yandex, Seznam, and Naver are competing with Google for customers (Alphabet Inc., 2016). Google is also facing competition from e-commerce websites, job query websites, travel query websites, and health query websites. The most popular e-commerce websites are Amazon and eBay. Social networks also compete with Google in terms of advertising. The traditional advertising media such as radio, television, billboards, and others also offer stiff competition for advertisements (Alphabet Inc., 2016). Companies that provide enterprise cloud services such as Microsoft and Amazon also offer competition to the technology giant. Projections into the future indicate that Google could be headed for tough times as revenue sources may decline. This is due to increasing competition, availability of multiple online advertising platforms, and declining rate of user adoption of the company’s products.
Short Term Liquidity of the Firm
The short-term liquidity of the company concerns the ability of the company to service its short-term obligations, including the current portion of the long-term liabilities. Short-term liquidity is critical in evaluating whether the company holds the ability to service debts, including the long-term liabilities. The evaluation of the short-term liquidity risk involves the analysis of the operating cycle of the company. If a firm has high cash inflows compared to the cash outflows, it stands a higher change of being able to clear short-term liquidities. It is possible to evaluate the short-term liquidity of the firm using three key ratios: current ratio, quick ratio, and cash ratio.
The current ratio indicates the firm’s ability to settle current liabilities using current assets. A higher current ratio indicates that the firm is in a better position to settle current liabilities using current assets. Generally, the current ratio value falls at 2 or more than two. A current ratio figure of below 1 indicates the firm is not able to settle current liabilities using current assets. The current ratio is given by: Current ratio = current assets/current liabilities. From the annual report, Google had total current assets worth $105,408, 000 and total current liabilities worth $16,756,000 (Alphabet Inc., 2016). Current ratio = 105,408,000/16,756,000 = 6.29. The current ratio of 6 indicates that Google has six times current assets compared to the current liabilities. As such, the company can be able to settle its current liabilities using current assets.
The other measure of short-term liquidity is the quick ratio, also known as acid test. The quick ratio is a better measure of short-term liquidity because it evaluates the firm’s ability to settle short-term liabilities without having to sell its inventories. In other words, the quick ratio evaluates the firm’s ability to settle short-term liability using the most liquid assets. The calculation of quick ratio follows the following formula: Quick ratio = (current assets – inventories)/current liabilities. Thus quick ratio = (105,408 – 268)/16,756 = 6.27. This ratio means that Google has $6.27 of liquid assets for every $1 of the current liabilities. This means it is easy for the company to settle its current liabilities without having to sell inventory.
The other measure of short-term liquidity is cash ratio. The cash ratio is a comparison of the company’s cash and cash equivalents and its current liabilities. The cash ratio utilizes the most liquid current assets while ignoring others including the cash receivables. It shows the company’s ability to pay current liabilities at the particular period without having to liquidate other assets. The formula for cash ratio is: Cash ratio = (cash equivalents + marketable securities)/current liabilities. The cash ratio for Google is: cash ratio = 86,333/16756 = 5.15. The results indicate that Google can be able to settle its current liabilities using cash equivalents and marketable securities only. Google has $5.15 of cash equivalents and marketable securities for every $1 of its current liabilities.
Operating Efficiency of the Firm
The operating efficiency of the firm involves measures to determine its utilization of assets as well as management efficiency. Operating efficiency helps in evaluating the utilization of assets by the firm (Rich, Jones, Mowen, & Hansen, 2013). It helps in informing the management the efficiency of asset utilization by looking at how fast the firm converts the assets into sales. As such, efficiency ratios help in examining the relationship between the firm’s assets and sales or the cost of goods sold. There are three main efficiency ratios. These are total asset turnover, receivables or debtors turnover, and inventory or stock turnover. By calculating efficiency ratios, it will be possible to tell how well Google is managing various resources in the course of generating revenues.
Total asset turnover is an efficiency ratio that measures the company’s ability to generate sales with regard to the total investment made in the total assets (Rich, Jones, Mowen, & Hansen, 2013). The calculation of total asset turnover involves making comparisons of the total assets and the net sales of the company. The ratio shows the company’s efficiency in using its assets to generate sales. The formula for total asset turnover is as follows: total asset turnover = net sales/average total assets (Rich, Jones, Mowen, & Hansen, 2013). Total asset turnover = 90,272/167497 = 0.54. This means that for every 1 dollar the company invests as assets, the company obtains $0.54 as revenues. However, it is worth noting that the asset turnover ratio may differ according to the industry. For instance, asset turnover ratio tends to be higher in the retail industry.
The inventory or stock turnover ratio indicates how many times stock is replaced within a year. It helps in telling how quickly goods are sold (Rich, Jones, Mowen, & Hansen, 2013). A low inventory turnover indicates the company is having weak sales, hence excess inventory. On the other hand, a high ratio indicates that the company is having high sales. The formula for calculating inventory turnover is as follows: Inventory turnover = sales/average inventory. The average inventory is calculated as follows: average inventory = (opening inventory + closing inventory)/2. Google’s average inventory is (491 + 268)/2 = 379.5. Inventory turnover = 35,138/379.5 = 92.6. This indicates that Google moved inventory over 92 times a year. By dividing 365 by the inventory turnover, it is possible to see that the inventory is on hand approximately for 3.9 days.
Receivables or debtors turnover ratio highlights the firm’s effectiveness in advancing credit and collecting the accumulated credit as debt (Rich, Jones, Mowen, & Hansen, 2013). It helps in assessing the effectiveness of the firm in utilizing its assets. The receivables or debt turnover ratio is calculated as follows: Debt turnover ratio = net credit sales/average accounts receivable. Debt turnover ratio = 26,064/14,137 = 6.39. The average duration for the accounts receivable is (365/6.39) = 57 days. This means it takes an average 57 days to clear the accounts receivable. The company should reevaluate its credit policy and aim at reducing the average duration to 30 days.
Capital Structure of the Firm
The capital structure of a firm concerns how the firm finances operations and drive growth. A firm may use various sources of fund to finance operations or growth such as issuing of bonds, common stock, retained profits, and among others (Palepu, 2007). Firms may apply a combination of capital structures to finance operations and growth. For instance, the firm may apply short-term and long-term debt, preferred equity, common equity, and including others. The capital structure of the firm comprises of debt and equity. When the amount of debt is significantly high, the firm may present a risk to investors due to the higher possibility of the firm being unable to cater for the current portion of debts. The firm may prefer debt to equity because debt provides tax advantages to the firm (Palepu, 2007). In addition, debt allows the firm to retain total ownership. Financing through equity requires that the firm give up a share of the ownership as determined by the amount of equity. The major benefit of equity is that the firm does not have to pay interest when it makes losses.
The debt-to-equity ratio is key in evaluating the capital structure of the firm. This ratio compares the firm’s total liabilities against the shareholder equity (Palepu, 2007). In other words, the debt-to-equity ratio provides an analysis of the percentage of capital structure financed through debt and that financed though equity. Debt-to-equity ratio is calculated as follows: Debt-to-equity ratio = (Current debt + non-current debt)/shareholders’ equity. Debt-to-equity ratio = 28,461/139,036 = 0.20. The debt-to-equity ratio is below 1, meaning that the company mainly relies on equity to finance operations. Google may consider increasing the portion of debt since it is cheaper to finance operations using debt rather than equity.
Another important ratio is the debt-to-capital ratio. This ratio measures a firm’s application of financial leverage by making comparisons with the total capital and the obligations it is facing (Palepu, 2007). The debt-to-capital ratio shows how the firm applies debt in financing operations with regard to its total capital. Debt-to-equity ratio is calculated follows: Debt-to-capital ratio = total debt/(total debt + shareholder equity) = 28,461/(28,461 + 139,036) = 0.17 or 17 percent. As such, it would be safer to invest in this company since it has a lower debt-to-capital ratio. A company having a high debt-to-capital ratio may face problems with repaying the debt since this could be an indication that the debt exceeds total capital in the company.
Profitability of the Firm
Profitability ratios enable the management to analyze the firm’s earnings and expenses (Gibson, 2012). The firm’s profitability determines its ability to meet operational costs and reward the investors who include the owners and the shareholders. Profitability is one of the critical measures of business success. Profitability is the reward that business owners expect at the end of the financial year (Gibson, 2012). The management is constantly looking for ways to improve profitability. Various profitability ratios can assist managers in evaluating the returns made by the business. Profitability ratios can help in determining the attractiveness of the business to investors. The most popular profitability ratios include return on equity (ROE), gross profit margin, and return on assets.
ROE measures the total returns made by the firm as a percentage or fraction of the shareholder equity. In other words, ROE measures the total returns in terms of profits associated with every dollar committed by the shareholders in form of equity (Gibson, 2012). The formula for ROE is as follows: ROE = Net income/shareholder equity. ROE = 19,478/139036 = 0.14 or 14 percent. This indicates that each dollar of stockholder equity (common stockholders) generates $0.14 worth of net income. A return on equity of 14 percent indicates that the company does not generate high returns for the common stockholders. This is a cause for concern among the management.
Gross profit margin enables the management to evaluate the percentage of income available to cater for operating expenditures. Gross profit margin reveals the amount of money left after the company settles operating costs and expenditures (Gibson, 2012). The formula for calculating gross profit margin is as follows: Gross profit margin = gross profit/revenues x 100 = 55,134/90,272 x 100 = 61%. This figure indicates that 61 percent of the income is available for operations, debt repayment, expansion, payment to shareholders, and for other expenditures. Return on assets (ROA) is a measure of the firm’s profitability in relation to its assets. It measures the efficiency of the management in utilizing assets to yield profits (Gibson, 2012). The formula is as follows: ROA = net income/total assets = 19,478/167,497 = 11.63%. This indicates that the yield on the assets is 11.63 percent of their total value.
Conclusion
Google Inc. is one of the most profitable technology companies in the world. The company is primarily involved in managing online search requests, cloud computing, online advertising, building software and hardware, and other activities. The financial analysis indicates that Google has a strong financial health in various sectors. In particular, the company shows strength in its profitability, capital structure, liquidity levels, and performance. There is need to conduct valuation in order to determine what the firm is worth. Valuation can enable investors know the relative worth of making an investment in the firm. The trend analysis indicates that an increasing number of users are individuals are turning to online world for advertising. Google can take advantage of this to earn higher advertising revenues. Another trend is the use of multiple devices to access the internet and including Google company products. Lastly, Google is set to reap big from non-advertising activities in the future such as Google Play, Google Cloud, and hardware products.
References
Alphabet Inc. (2016). Alphabet Inc.: Form 10-K. United States Securities and Exchange Commission. Retrieved from
Gibson, C. H. (2012). Financial reporting and analysis. Boston, MA: Cengage Learning.
https://abc.xyz/investor/pdf/20161231_alphabet_10K.pdf
Palepu, K. G. (2007). Business analysis and valuation: IFRS edition, text only. London: Thomson Learning.
Rich, J., Jones, J., Mowen, M., & Hansen, D. (2013). Cornerstones of Financial Accounting. Boston, MA: Cengage Learning.
Appendices
- Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts
- Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions)
Retrieved from https://abc.xyz/investor/pdf/20160331_alphabet_10Q.pdf
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