Wall Mart Ratio Analysis

Problem Set #1: CASE STUDY: Ratio Analysis.

Introduction

The case method simulates a real business situation, putting you in a senior management position with a given business scenario. You must identify the major issues or problems, analyze and evaluate the situation, presents alternatives, and make recommendations and develop implementation plans. The internal situation analysis normally requires financial analysis. Based on available financial information, you assess the firm’s financial performance, assess its strengths and weaknesses, and provide suggestions for future planning. A common approach is to calculate various ratios using major items from the firm’s balance sheet, income statement, and stock market data. Ratio analysis is a powerful means to evaluate the firm’s financial position and help understand the overall picture of the firm. This analysis can be more effectively performed with the use of Microsoft Excel, spreadsheet software including many useful features to facilitate and simplify the work.

The financial analysis can be made on a historical basis and also by comparing similar firms in the industries. The former method is based on a trend analysis to evaluate the firm’s present ratios in comparison with those of previous years to find the direction that the firm is moving toward and evaluate the effectiveness of its past strategy. The latter method is based on cross-sectional analysis to determine the firm’s performance relative to its major competitors and the industry average. Since trend analysis has been discussed in other section (see problem sets for Economics 2020 and Mathematics 3010), the focus of this section is the cross-sectional analysis and the evaluation of the firm based on its relative position in the industry.

Mathematics

Ratio Analysis

In general ratio analysis is based on the evaluation of four types of ratios:: (1) current ratios, which measure the firm’s ability to fulfill its short-term debt obligations, (2) leverage ratios, which measure the level of the firm’s borrowing and its debt-serving ability based on its earnings prospect, (3) activity ratios, which measure the efficiency level of the firm in utilizing the assets for business operations, (4) profitability ratios, which measure the firm’s earnings capacity.

The major ratios in these categories are as follows.

I. Liquidity Ratios

1. Current ratio

Measures the extent to which the firm’s short-term debts are covered by its cash and the assets that can be converted to cash in the near future.

2. Quick ratio

A measure of a firm’s ability to pay its short-term debt without relying on the sales of its inventory

II. Leverage Ratios

3. Debt to assets ratio

An indication of the extent to which the business is financed by the borrowed funds.

4. Debt to equity ratio

An alternative measure of the firm’s debt using, comparing the fund financed by debts and that provided by the owner.

5. Time interest earned

Case Study: Ratio Analysis by Scott Liu version 04/21/23 2

A multiple of earnings available to pay interest costs and the interest cost, which measures the level of comfort for the firm to serve its interest obligations based on its earnings prospect.

6. Fixed charge coverage

An alternative measure with the purpose similar to Time Interest Earned, showing the firm’s capacity to serve its debt obligations plus fixed obligation charges.

III. Activity Ratios

7. Inventory turnover

Based on a comparison with the industry average, it shows whether the firm has excess inventory stock or inadequate inventory.

8. Total asset turnover

It shows the relation between sales and the assets employed to generate the sales, which measures the efficiency of business operations.

9. Account receivable turnover

Based on a comparison of sales with the credit granted to generate the sales, it shows the average length of time to collect the credit.

IV. Profitability Ratios

10. Gross profit margin

A measure of the margin to cover operation costs and yield profits.

11. Net profit margin

Reflecting the profit per dollar of sales.

12. Return on total assets


A measure of the profit generated from each dollar of fund employed for business operations.

13. Return on equity

A measure of the profit earned by the owner for each of his/her dollar invested in the business.

V. Du Pont Analysis

Du Pont Analysis provides another perspective on how combined activities and financial leverage determined the profitability of the firm.

× = .

Consequently,

Net profit margin × Total asset turnover = Return on assets.

Furthermore,

× ( 1 + ) = .

In other words,

Return on Assets × ( 1 + Debt-Equity Ratio) = Return on Equity.


Excel

Next, we will construct a spreadsheet to analyze Wal-Mart Stores, Inc. as an example of ratio analysis. The firm’s 1997 and 1996 income statements and balance sheet are presented in Table 1 and Table 2, respectively.

Table 1. Wal-Mart Store, Inc.: Income Statement for years ending January 31 (millions of dollars)

For years ending January 31, 1998 1997

Revenues 119,299 106,178

Costs and Expenses: Cost of sales 93,438 83,510 Operating, selling and admin expenses 9,358 16,946 Interest Costs: Debt 555 629 Capital leases 229 216 Total Costs and Expenses 113,580 101,301

Income Before Income Taxes 5,719 4,877 Provision for Income Taxes 2,115 1,794

Net Income $ 3,582 $ 3,110______________________________________________________________________________


Table 2. Wal-Mart Store, Inc.: Balance Sheets (millions of dollars)

For years ending January 31, 1998 1997

AssetsCurrent Assets: Cash and cash equivalents $ 1,447 $ 883 Receivables 976 845 Inventories 16,497 15,897 Prepaid expenses and other 432 368 Total Current Assets 19,352 17,993

Property, Plant and Equipment, net 21,469 18,333Property under Capital Lease, net 2,137 1,991Other Assets and Deferred Charges 2,426 1,287 Total Assets $45,384 $39,604

Liabilities and Shareholders' EquityCurrent Liabilities: Total Current Liabilities 14,460 10,957

Long-Term Debt 7,191 7,709Long-Term Obligations Under Capital Leases 2,483 2,307Deferred Income Taxes and Other 809 463Minority Interest 1,938 1,025 Total Long-term Liabilities 12,421 11,504

Shareholders' Equity Common stock ($.10 par value; 2,241 and 2,285 issued and outstanding in 1998 and 1997) 224 228 Capital in excess of par value 585 547 Retained earnings 18,167 16,768 Foreign currency translation adjustment (473) (400) Total Shareholders' Equity 18,503 17,143

Total Liabilities and Shareholders' Equity $45,384 $39,604_____________________________________________________________________________

Spreadsheet Construction

These financial data are used to construct financial statements in the Excel worksheet. The example income statement and balance sheet have been created and shown in the next figure. Create the same Excel spreadsheet using your computer.


A B C D E F

1 Wal-Mart Stores, Inc.2 CONSOLIDATED INCOME STATEMENTS3 (Amounts in millions except per share data)

4 Fiscal years ended January 31, 1998 1997

5 Revenues 119,299 106,1786 Costs and Expenses:7 Cost of sales 93,438 83,5108 Operating, selling and admin expenses 9,358 16,9469 Interest Costs:10 Debt 555 62911 Capital leases 229 21612 Total Costs and Expenses 113,580 101,30113 Income Before Income Taxes 5,719 4,87714 Provision for Income Taxes 2,115 1,79415 Net Income $3,582 $3,110

1617 Wal-Mart Stores, Inc.18 CONSOLIDATED BALANCE SHEETS19 (Amounts in millions)

20 January 31, 1998 1997

21 Assets22 Current Assets:23 Cash and cash equivalents $1,447 $883 24 Receivables 976 84525 Inventories 16,497 15,89726 Prepaid expenses and other 432 36827 Total Current Assets 19,352 17,99328 Property, Plant and Equipment, net 21,469 18,33329 Property under Capital Lease, net 2,137 1,99130 Other Assets and Deferred Charges 2,426 1,28731 Total Assets $45,384 $39,604 3233 Liabilities and Shareholders' Equity34 Total Current Liabilities 14,460 10,95735 Long-term Debt 7,191 7,70936 Long-term Obligations Under Capital Leases 2,483 2,30737 Deferred Income Taxes and Other 809 46338 Minority Interest 1,938 1,02539 Total Long-term Liabilities 12,421 11,50440 Shareholders' Equity:41 Common Stocks 224 22842 Capital in excess of par value 585 54743 Retained earnings 18,167 16,76844 Foreign currency translation adjustment -473 -40045 Total Shareholders' Equity 18,503 17,14346 Total Liabilities and Shareholders' Equity $45,384 $39,604


Next, we can get Excel to calculate ratios for us by inputting formulas into relevant cells. The following table shows the results with ratios between cells I4 and J22 calculated by the computer automatically. You may type exactly the same information into these cells of the Excel spreadsheet except cells between I4 and J22.

D E F G HI I

1

2 Major Ratios3 Liquidity Ratios 1998 19974 Current Ratio 1.34 1.645 Quick Ratio 0.20 0.1967 Leverage Ratios8 Debts-Asset Ratio 0.59 0.579 Debts-Equity Ratio 1.45 1.3110 Time Interest Covered 11.30 8.7511 Fixed Charge Covered 8.29 6.771213 Activity Ratios14 Inventory Turnover 7.23 6.6815 Assets Turnover 2.63 2.6816 A/R Turnover 122.23 125.6517

18 Profitability Ratios19 Gross Profit Margin 21.68% 21.35%20 Net Profit Margin 3.00% 2.93%21 Return on Assets 7.89% 7.85%22 Return on Equity 19.36% 18.14%23

24

Then in cell F4, type: “=B27/B34”, and then the Enter key;in cell F5, type: “(B27-B25)/B34”, and the Enter key;in cell F8, type “(B46-B45)/B46”, and then the Enter key;in cell F9, type “(B46-B45)/B45”, and then the Enter key;in cell F10, type “(B13+B10+B11)/B10”, and then the Enter key;in cell F11, type “(B13+B10+B11)/(B10+B11)”, and then the Enter key;in cell F14, type “B5/B25”, and then the Enter key;in cell F15, type “B5/B31”, and then the Enter key;in cell F16, type “B5/B24”, and then the Enter key;in cell F19, type “(B5-B7)/B5”, and then the Enter key;in cell F20, type “B15/B5”, and then the Enter key;in cell F21, type “B15/B31”, and then the Enter key;in cell F22, type “B15/B45”, and then the Enter key.


For the ratios in 1996 (the fiscal years ending January 31, 1997), you only need to copy the formula in cells F4:F22 to cells G4:G22. Immediately you will see the ratios are calculated for 1996 data as well.

Du Pont Analysis is further presented as follows. To get your own results, you first type he table as follows except the cells showing ratios.

D E F G H I J

26 Du Pont Analysis2728 Return on Asset = N Profit Margin X Assets Turnover29 1997 7.89% = 3.00% X 2.6330 1996 7.85% = 2.93% X 2.683132 Return on Equity = Return on Asset X (1 + Debt-Equity Ratio)33 1997 19.36% = 7.89% X 2.4534 1996 18.14% = 7.85% X 2.31

3536

Then in cell G29, type: “=F20”, and then the Enter key;in cell I29, type: “=F15”, and then the Enter key;in cell E29, type: “=G29*I29”, then the Enter key;in cell G30, type: “=G20”, and then the Enter key; in cell I30, type: “=G15”, and then the Enter key; in cell E30, type: “=G30*I30”, then the Enter key;in cell G33, type: “=E29”, and then the Enter key; in cell I33, type: “=(1+F9)”, and then the Enter key;in cell E33, type: “=G33*I33”, and then the Enter key;in cell G34, type: “=E30”, and then the Enter key; in cell I34, type: “=(1+G9)”, and then the Enter key;in cell E34, type: “=G34*I34”, and then the Enter key.


Business Application

The last two sections provide a brief introduction of major ratios and the use of Excel to calculate them. These ratios are firm specific, but also determined by the industry nature and economic environment. Therefore, a more meaningful way to undertake analysis is to compare a company’s ratios with those of its major competitor or the industrial average. To help you perform ratio analysis with focus on real application, we have put on the Application Pack web site (iris.nyit.edu/appack) an Excel template designed to simplify the ratio analysis process. To use this template, you need to have a computer with Internet access. Then what you need is only to follow the instructions and collect financial data and enter them into the computer. As a result, all the ratios will be available to you automatically. The demonstration of this ratio analysis is based on 1998 financial statements of Wal-Mart and Kmart, two major competitors in the mass retail industry.

First, go to the web site, iris.nyit.edu/~apsom, and download the Excel Tool Analysis template. Then load the Excel program and open the Excel file “Tool-Analysis.” Selecting “Source” tab at the bottom of the screen to select this worksheet if you are not yet in it. Following the steps, first click the Hyperlink to connect you to relevant web sites to get the companies’ accounting data from 1998’s10K reports filed with SEC. Based on the data retrieved from these web sites, you can prepare the simplified income statements and balance sheets of these two companies as follows.

1998 Income Statement

(Amount in million) Kmart Wal-Mart

Sales $ 33,674 $ 139,208Cost of good sold 2 6,319 108,725Gross margin 7,355 30,483Selling, general and admin expenses 6,245 22,363Other expenses 19 0Interest expense 293 529Other fixed charges 0 268Income before taxes 4798 7323Taxes 230 2740Others 50 153Net income $ 518 $ 4,430


http://iris.nyit.edu/appack

1998 Balance Sheet

(Amount in million) Kmart Wal-Mart

Cash and equivalent 710 $ 1,879Account Receivables 0 1,118Inventory 6,536 17,076Other current assets 584 0Total current assets 7,830 21,132Property and equipment, net 5914 23,674Other fixed assets 422 5,190

Total Assets $ 14,166 $ 49,996

Current liabilities $ 3691 16,762Long-term liabilities 1538 9,607Other long-term obligations 2958 2,515Shareholders’ equity 5979 21,112

Total Liabilities and Shareholders’ Equity $ 14,166 $ 49,996

Next you may click “Report” tab at the bottom of the screen to select the template for presenting the financial statements in the spreadsheet.

A macro has been written to facilitate you to enter data to present financial statements. What you need to do is to click the Another Company button to initiate the macro and follow the instruction to enter the required data. After you complete the input, the balance sheets and income statements of two companies will be presented to you. If you have a clear idea on the structure of financial statements and want to build the statements by yourself, you may also enter the data to their corresponding cells directly, which should generate the same results.

After you have completed the creation of financial statements, the ratios have already being prepared for you. You need to select the “Ratios” tab at the bottom of the screen, which will lead you to the third spreadsheet. The major ratios and Du Pont analysis results have been prepared for the companies. Thus you can save yourself from the tedious calculation and focus on analysis of the content.

Interpretations

A brief look at these ratios suggests that Wal-Mart is in a much better financial situation than Kmart. In 1998, the return on equity was 21% for Wal-Mart, while it was only 8.7% for Kmart. Why Wal-Mart can achieve a much better performance than Kmart, and what is the key to its success? To have a more conclusive answer, we of course need further research on various aspects of firm operations and strategies. However, these ratios have already give us some indications.


First, there are similarities between two companies. Both have almost identical capital structure, with debt representing 58% of total investment. However, because of its better profitability, Wal-Mart has the fixed cost coverage ratio equal to 10.2, which is much better than Kmart’s ratio of 3.72. While Kmart covers its fixed charges by a low margin of safety, the company may face difficulties if it wants to borrowing additional funds. In terms of liquidity ratios, Kmart seems to be more liquid and have the cash ready to pay for its short-term debts.

The turnover ratios usually reflect the firm’s efficiency in utilizing assets employed in business operations. However, they may also have limitations. For example, Wal-Mart has a lower fixed assets turnover ratio, which probably is due to its expansions in the more recent period. As fixed assets are expressed in the balance sheet on a historical cost basis, the new facilities will to have a higher value in comparison with the old facilities, which thus has an unfavorable effect on the new firm’s fixed assets turnover ratios. On the other hand, the inventory turnover is presented on a more comparable basis. It indicates that Wal-Mart is more efficient in generating sales from its inventory carried in comparison with Kmart (8.15 vs. 5.15). Overall, Wal-Mart has total assets turnover slightly better than that of Kmart (2.784 vs. 2.38).

The Du Pont analysis helps identify the main source of different performance levels. There is not much difference between these two companies in terms of total assets turnover. How, Wal-Mart’s 3.18% net profit margin is twice as much as Kmart’s (1.54%), which lead to a major difference on return on assets (8.88% vs. 3.66%). Notice that both have markup representing as low as 20 percent of retail prices, which is relatively low and indicate that they are discount retailers and seek to make profit on volume. However, Wal-Mart has a better control of operation cost, or gains from economies of scale, which lead to a better net profit margin. This difference is multiplied given financial leverage is used in business operations.

Notice the error message “#DIV/0!” in cell H16. It is due to a zero value shown in Kmart’s account receivable. Due to its nature of business, the retailer generally does not carry a significant amount of account receivable. For Kmart’s case, that account has a zero balance, which results in an error message as the computer in executing the formula in the cell is asked to do a division with a zero in the denominator. If another company has non-zero value in its account receivable, then an appropriate number will appear in that cell.

Overall, Wal-Mart is a solid company with better financial performance. The analysis above is purely based on the presentation of financial statements. Additional information will be needed to have a more thorough study of the firm. More information can be further found from various sources, including the analyst report provided by Moody, Standard and Poor, Business Week, and Fortune. Additional web sites where you may find useful information are listed at the end of this case study.


The printout of spread sheet “Source” from file “Tool-Analysis”

Look Up Company Information in the Website W

Step OneClick the Hyperlink button (the globe) to connect youto Yahoo Finance-Company Search =>

Step TwoType the company's name in the search box and click Search

Step ThreeIf the search result shows the company, click Quote to get the currentstock price information and general trend. Click the Back button.

Step FourClick Profile to get the company's brief information.

Step FiveClick Historical Quote Data to get the past stock price data. You mayspecify the period, and daily or weekly or monthly of the data required,and then click Get Historical Data. Click the Back button.

Step SixClick Raw SEC Filings and 10K file to get the company's 10-K report filed with SEC, which includes all the financial statements.

RemarkAny time, you may click File, Save As command to save the data in a separate file. You may also copy part of text and/or data to anotherfile by moving the cursor to the start of the paragraph, holding theleft mouse button, dragging the selection to the end of the paragraph,releasing the button, click Edit, Copy, and making the file which youintend to copy to an active file and click Edit, Paste.


The printout of spreadsheet “Report” from file “Tool-Analysis”

A comparative analysis for fiscal year of 1988

Comparative Balance Sheets Comparative Income Statements

Kmart Wal-Mart Kmart Wal-MartASSETS Total Revenue 33,674 139208Cash 710 1879 Cost of Goods Sold 26,319 108725Receivables 0 1118 Profit Margin 7,355 30483Inventory 6,536 17076Other C. Assets 584 1059 EXPENSES Total C. Assets 7,830 21132 Operating Expenses 6,245 22363

Other Expenses 19 0Net Plant+Equipmt 5,914 23674 Interest Expenses 293 529Other Assets 422 5190 Other Fixed Charges 0 268

Total Expenses 6,557 23160 Total Assets 14,166 49996

Income before Taxes 798 7323LIABILITIESC-Liabilities 3,691 16762 Income Taxes 230 2740L/T Liabilities 4,496 12122 Other Interests 50 153 Total Liabilities 8,187 28884

Net Income 518 4430EQUITY

Stockholders' Equity 5,979 21112

Total Liability+Equity 14,166 49996


The printout of spreadsheet “Ratios” from file “Tool-Analysis”

Ratio Analysis

LIQUIDITY RATIOS Kmart Wal-Mart1 Current Ratio = Current Assets/Current Liability 2.121 1.2612 Quick Ratio = (C. Assets - Inventory)/C. Liabilities 0.351 0.242

LEVERAGE RATIOS3 Debt to assets ratio = Total debts/Total assets 0.58 0.584 Debt to equity ratio = Total debt/Total equity 1.37 1.375 Fixed Charge Covd =(Income bf Tax+Interst+Lease)/Int+Lease 3.72 10.19

ACTIVITY RATIOS6 Inventory turnover = Sales/Inventory 5.15 8.157 Total assets turnover = Sales/Total assets 2.38 2.788 Fixed assets turnover = Sales/Fixed assets 5.31 4.829 Account receivable turnover = Sales/Acct Receivable #DIV/0! 124.52

PROFITABILITY RATIOS10 Gross profit margin = (Sales - Cost of goods sold)/Sales 21.84% 21.90%11 Net profit margin = Net income/Sales 1.54% 3.18%12 Return on total assets = Net income/Total assets 3.66% 8.86%13 Return on stockholders equity = Net income/equity 8.66% 20.98%

Du Pont AnalysisReturn on Assets = Net Profit Margin X Assets Turnover

Kmart 3.66% = 1.54% X 2.377Wal-Mart 8.86% = 3.18% X 2.784

Return on Equity = Return on Assets X ( 1 + Debt-Equity Ratio )Kmart 8.66% = 3.66% X 2.369Wal-Mart 20.98% = 8.86% X 2.368


Additional Websites:

http://www.pathfinder.com/fortune/fortune500/http://www.moodys.com/http://www.nytimes.com/library/financial/glossary/bfglosa.htmhttp://wal-mart.comhttp://www.kmart.comhttp://dir.yahoo.com/Business_and_Economy/Companies/Retailers/Wal_Mart_Stores__Inc_/http://www.spglobal.com/index.htmlhttp://biz.yahoo.com/fin/l/w/wmt.htmlhttp://www.wsrn.com/http://www.lib.umich.edu/libhome/Documents.center/stecind.htmlhttp://www.rpi.edu/~holmec/finrat.html#under


http://www.rpi.edu/~holmec/finrat.html#under

http://www.lib.umich.edu/libhome/Documents.center/stecind.html

http://www.wsrn.com/

http://biz.yahoo.com/fin/l/w/wmt.html

http://www.spglobal.com/index.html

http://dir.yahoo.com/Business_and_Economy/Companies/Retailers/Wal_Mart_Stores__Inc_/

http://www.kmart.com/

http://wal-mart.com/

http://www.nytimes.com/library/financial/glossary/bfglosa.htm

http://www.moodys.com/

http://www.pathfinder.com/fortune/fortune500/

Additional Problems:

1.

2.

Research Problem
