Homework Set #3: Chapters 6, 7, & 8

Free Cash Flow =Cash from operating activities-Capital expenditure

Apple Incorporation’s Free Cash Flow

An analysis of Apple Incorporation’s 2014 annual report indicates that the company’s cash flow from operations for the years ending September 28, 2014 and 2013 were $59,713 million and $53,666 million, respectively. Capital expenditures were $9,571 million and $8,165 million for the years ending 2014 and 2013, respectively (SEC, 2014a).

Free Cash flow;

For the year ending 2013;

Free Cash Flow= $53,666-$8,165

=$45,501 million

For the year ending 2014;

Free cash flow =$59,713-$9,571

=$50,142 million

Apple Incorporation had more cash inflows from its operating activities, because of its positive free cash flow, that could be spent on new capital investments. The increase in free cash flow from $45,501 million to $50,142 million between 2013 and 2014 is a sign of good financial performance.

Ford Motors Corporation’s Free Cash Flow

An analysis of Ford Motors Corporation’s 2014 annual report indicates that the company’s cash flow from operations for the years ending December 31, 2013 and 2014 were $10,444 million and $14,507 million, respectively. Capital expenditures were $ 6,597 million and $7,463 million for the years ending 2013 and 2014, respectively (SEC, 2014b).

Free Cash flow;

For the year ending 2013;

Free Cash Flow= Cash flow from operations- Capital expenditure

= 10,444-6,597

= $3,847 Million

For the year ending 2014;

Free cash flow = 14,507-7,463

=$7,044 Million

The positive free cash flow is an indication that the company had more cash inflows from its operating activities that could be spent on new capital investments like office equipment and machinery. The increase in free cash flow from $3,847 million to $7,044 between 2013 and 2014 is an indication of good financial performance. The company can use the free cash flow to pursue other opportunities that enhance the corporation’s growth and shareholders’ value.

Financial Ratios

Financial ratios are tools used by investors and analysts to perform quantitative analyses on the figures shown on the financial statements. With the help of ratios stakeholders can link the three financial statements of an organization together and get figures that are not only comparable between organizations, but also across industries. Financial ratios fall into four major categories namely, activity ratios, profitability ratios, liquidity ratios and solvency ratios (Brigham & Ehrhardt, 2017). Apple Incorporation and Ford Motors Corporations annual reports for the financial years ending 2016 and 2017 have been used to compute various profitability, asset management and liquidity ratios for the two organizations.

Profitability Ratios

Profitability ratios measure a company’s ability to earn adequate returns. Some of the common profitability ratios are the margin ratios like the gross, operating and net profit margin, return on assets as well as return on equity (Deegan, 2013). 

Net profit margin compares a firm’s net income to its net revenues (Deegan, 2013).  Apple’s net profit margins of 21.19% and 21.09% for the years 2016 and 2017, respectively suggests that for every 1 dollar of revenue generated by the company, $0.21 was created for the shareholders in 2016 and 2017 each. For Ford Motors, net profit margins of 3.03% and 4.85% for the years 2016 and 2017, respectively suggests that for every 1 dollar of revenue generated by the company, $0.03 and 0.485 were created for the shareholders in 2016 and 2017. For Apple, the higher net profit margin ratio is a source of strength because investors look for firms with strong plus consistent net profit margins. Ford must work towards improving its net profit margin ratio.

Return on assets measures how efficiently a company utilizes its assets. A high ratio implies that firm is able to efficiently generate revenues by using its assets (Deegan, 2013). Apple’s return on assets ratio declined from 14.93% to 13.87% between 2016 and 2017. It implies that for every $1 of the firm’s assets, the company generated approximately $0.15 and $0.14 in 2016 and 2017, respectively. These low returns mean that the company must efficiently utilize its assets to generate high revenues. Ford Motors registered an improvement in its return on assets from 1.99% to 3.07% between 2016 and 2017. This implies that for every $1 of the firm’s assets, the company generated approximately $0.02 and $0.03 in 2016 and 2017, respectively. However these are low returns, which implies that the company must efficiently utilize its assets to generate high revenues

Liquidity Ratio

Liquidity ratios measure a company’s ability to meet its short term financial obligations. The level of liquidity normally varies from one industry to another because some industries are more cash intensive compared to others. Some of the common liquidity ratios are current ratio, quick ratio and cash ratio (Deegan, 2013). 

Current ratio measures a firm’s current assets against its current liabilities. This ratio is especially significant to creditors as it measures a company’s ability to meet its short term financial obligations in case of an emergency by using its current assets. A current ratio below 1.00 is an indication that a company may have hard time paying its short term obligations in the short run and should be investigated (Bragg, 2012). Apple’s current ratio for 2016 and 2017 were 1.35 and 1.28, respectively. It means that for every $1 of current liability, the company had $1.35 and $1.28 in current asset in 2016 and 2017, respectively. Therefore, the company was in a better position to meet its short term financial obligations by using its current assets. Ford Motors current ratio increased from 1.20 to 1.23 between 2016 and 2016. It means that for every $1 of current liability, the company had $1.20 and $1.25 in current asset in 2016 and 2017, respectively. As such, the company was in a better position to meet its short term financial obligations by using its current assets.

Quick ratio is more stringent than current ratio. It compares cash and cash equivalents, short term marketable securities as well as account receivables to the current liabilities. It excludes inventory, which may make up a large percentage of current assets but cannot be easily converted into cash (Bragg, 2012). Apple’s quick ratios of 1.05 and 0.91 for 2016 and 2017, respectively means that the firm could cover 105% and 91% of its current liabilities by using its cash and cash equivalents, short term marketable securities as well as account receivables. This is a sign of sound financial performance. Ford Motors quick ratios for 2016 and 2017 were 0.55 and 0.52, respectively. This means that company could only cover 55% and 52% of its current liabilities in 2016 and 2017, respectively by using its cash and cash equivalents, short term marketable securities as well as account receivables. This implies that the company is holding a lot of inventories which is a weakness.

Asset Management Ratio

Also known as activity ratio, asset management ratios measure how efficiently a firm utilizes its assets. In other words, these ratios measure the rate at which a firm is turning over its assets and liabilities. Investors use these ratios to get an insight of the overall performance of a company. The most common turnover ratios are inventory turnover, receivables turnover, total asset turnover, fixed asset turnover and payable turnover (Bragg, 2012).

Asset turnover ratios help in measuring how efficiently a firm uses its total assets for revenue generation (Deegan, 2013). Apple’s turnover ratios of 0.67 times and 0.61 times in 2016 and 2017 respectively, imply that the company generated $0.67 and $0.61 of revenue for every $1 of asset owned by the company. These high asset turnover ratios mean that the company is efficient in its use of assets. Ford Motors also efficiently utilized its assets as indicated by high asset turnover ratios of 0.64 times in 2016 and 0.61 times in 2017.

Receivables turnover measures how quickly and efficiently a firm collects its outstanding bills. A high ratio is preferable (Deegan, 2013). Apple’s receivable turnovers of 13.69 times in 2016 and 12.82 times in 2017 is an indication that receivables were fully collected 13.69 times or 27 days (365/13.69) during 2016 and 12.82 times or 29 days during 2017. These high turnover ratios mean that the company was quick and efficient in collecting its outstanding bills, which is good. Ford Motors also was quick and efficient in collecting its outstanding bills in 2016 and 2016 as demonstrated by high turnover ratios of 13.67 in 2016 and 14.79 in 2017. It took the company 27 days and 25 days in 2016 and 2017, respectively to collect its outstanding bills.

References

Bragg, S. M. (2012). Financial analysis: a controller's guide. Hoboken, NJ: John Wiley & Sons.

Brigham, E. F.,& Ehrhardt, M.C. (2017). Financial management theory & practice. (15th Ed.). Boston, MA: Cengage Learning.

Deegan, C. (2013). Financial accounting theory. Sydney, Australia: McGraw-Hill Education.