part 2

Introduction

Lowes Company is a national store that was founded in the year 1948. The company was first opened in North Carolina and it was among the first retailer companies in America back then. The company mainly dealt with home equipment and appliances. Moreover, the company is said to have been generating huge revenues back then when it began. The company continued to thrive in its operations as it opened up approximately 2390 stores across the world. The company also promoted social responsibility in the society as it has so far employed around 310, 000 individuals in its stores worldwide. However, in the past years, the performance of the company began deteriorating and a financial analysis has to be carried out in order to know the problem.

Body

Common size income statement

A common size financial statement is a document that is used in doing comparison of financial information. The values of the common size income statement are normally converted as a percentage of the returns. From the common size income statement it is clear that the cost of sales increases over the years. The cost of sales in 2015 was 65.21 and in 2018 the cost of sales was 65.89. However, the gross margin is decreasing over the years. A gross margin is the amount that is the revenue that is collected in each commodity that is sold. The decrease in the gross margin is an indicator that the company is not performing well financially. Companies should have a high gross margin so that they can be able to meet other financial obligations.

Moreover, from the common size financial statement of analysis, it can be seen that the pretax earnings decreased slightly in 2015 and 2016 and then remained stable for the next two years[footnoteRef:1]. In addition, the interest net, interest income and the amortization are a clear indication that the company is carrying out proper investments using the shareholders property and wealth. The extra investments will enable the company to have a high debt to equity ratio and eventually the return on equity will increase greatly. Firms that have a high return on equity also have a greater ability to meet the day to day expenses. Therefore, firms are encouraged to increase their financial reserves so as to be able to meet the short term obligations that they have. [1: Profitability and liquidity and financial ratios for Lowes companies Inc. (LOW) from nasdaq.com. (2018). Retrieved from https://www.nasdaq.com/symbol/low/financials?query=ratios]

In addition, the depreciation expense is a clear indication that the company has got assets that it uses during the day to day activities of the firm. Depreciation is an expense that is inevitable but can be avoided if the assets are well taken care of. Also, the operating income rises steadily over the years. Operating income measures the profits that the company incurs after deducting all the other expenses. The increase in the operating income indicates that the profits rise too. Similarly, the net income also rises over the years. The net income for the year 2015 was 4.80% while that of 2018 was 5.02%. Though the difference is a slight one it is an indicator that the companies expenses are less than the incomes.

Trend analysis

Trend analysis of financial statements is a comparison that is done between different trading periods. The trend analysis measures changes and the performance of the companies. The trend analysis and the common size financial statement have similar calculations but in the case of the trend analysis all the values are normally converted using the sales, while in the common size statements the value are put as a percentage of profits. When calculating the trend analysis for just two years, the two values are subtracted then the value found is converted as a percentage of the base sales. In our case, we will do a trend analysis of the Lowe’s Company for a range of four years.

When calculating the trend analysis for more than two years, the trend percentage is calculated by the dividing the current year and the base year. In most cases, the base year is normally the last year of analysis in this case it is 2015. The percentage trend for operating income is calculated by dividing the operating income for the 2018 by the base year of 2015 then the solution is the percentage trend for operating income. The values will be useful in comparing the financial well-being of the company in the given four years.

Similarly, when calculating the percentage trend analysis of the net income for the Lowe’s Company the same process applies. The net income for 2015 is used as the base net income. The net incomes for the previous years are used to calculate the new percentage trends for the net income. The values will enable the company to determine the period where the finances were not available. All companies should make use of the trend analysis technique in order to come up with the financial status for their respective companies.

Financial analysis

Liquidity ratios

Liquidity ratios are used to determine the ability of a company to meet its short term needs as they arise. To begin with, current ratios compare a company’s assets to its liabilities. The liabilities and the assets compared are the current ones. From the table above, the current ratios given indicate that the Lowe’s Company doesn’t have a stable current ratio since it keeps on fluctuating and decreasing. However, the important issue is that the current ratios are above one. The highest current ratio for Lowe’s company is 1.1 and the lowest is 1.01[footnoteRef:2]. Quick ratios and cash ratios are a bit similar since they compare cash and the investments available to the short term obligations of the company. [2: Profitability and liquidity and financial ratios for Lowes companies Inc. (LOW) from nasdaq.com. (2018). Retrieved from https://www.nasdaq.com/symbol/low/financials?query=ratios]

It is clear that quick and cash ratios of the Lowe’s Company are not also stable. Such, may lead to problems in the company in the future when the company will be having debts. Companies are normally governed in such a way that they should be able to meet their obligations without lending from outside. Failure to meet the short and long term obligations will make the company to be in debt and it will be hard for the company to clear those debts. In the case of The Home Depot Company, the ratios are not also stable but at least there is some improvement noted. When comparing the two companies, the Home Depot Company will not have a hard time in meeting both short term and long term obligations but the Lowe’s company will not have an easy time[footnoteRef:3]. [3: Erskine, A., Camillo, A. A., Bajada, A. J., & Holt, S. (2015). The Home Depot: A Competitor’s Strategic Audit, A Case Study. In Global Enterprise Management (pp. 171-189). Palgrave Macmillan, New York.]

Profitability ratios

Profitability ratios are used to assess whether businesses and companies are able to generate returns that cover the costs that are incurred. From the information provided in the table above, it is clear that though the Lowe’s Company is profitable, the Home Depot is far much profitable[footnoteRef:4]. A simple analysis can be done using the return on asset figures for the four years. The values for return on assets for Home Depot are about twice those of the Lowe’s. This is a clear signal that it is not at all times that Lowe’s company is able to generate profits that exceed the expenses. All companies should work towards ensuring that the profits generated in that given financial period are enough to cover expenses and remain for future use[footnoteRef:5]. [4: Tamulevičienė, D. (2016). Methodology of complex analysis of companies’ profitability. Entrepreneurship and sustainability issues, 53-63. ] [5: Course, M. A. (2016). Return on Assets Ratio–ROA.]

In addition, the return on assets ratio basically comprises of the income that a company earns while making use of their assets. From the information collected from the two companies, it is clear that companies should make proper use of the assets that they have and use them to do production or to offer services in order to generate income. A company is beneficial only when there are profits. A company that always makes losses is likely to have very few customers since there is the fear of closure if the losses persist. Therefore, companies should always carry out analysis with a company in the same sector and know if you are on the right track or not.

Besides, managers have a role to play in ensuring that the financial performance of a company improves. There are two main roles of the company manager. To begin with, the management of the company can organize benchmarking sessions for their companies. The benchmarking organized should be financial only in this case. Moreover, this is an open forum where individuals share ideas concerning financial matters and brainstorm. In such a program one is able to learn new things which might be of help if applied to the respective company. Moreover, the benchmarking sessions should be carried out among companies that are in the same sector of the economy. This is because it is easy to brainstorm when you are handling an issue that is common to all the parties. Additionally, the benchmarking sessions should be carried out frequently not only when need arises.

Similarly, the management can organize for training sessions for the employees on the importance of maintaining standard financial performance and at the same time increasing awareness on the benefit of maintaining standard financial performance. Past research indicates that in most financial organizations, employees just work some of them don’t even know anything about the financial statements. Only if such individuals can be empowered the general performance of the company will improve. For instance, if employees are taught the importance of generating more income, they will improve on the income levels and the employees may also benefit through bonuses and incentives

Return on equity

It is clear that the return on equity has changed in the last three year of operation of both Lowe’s and Home depot. Both companies have registered an increase in their returns on equity. However, that of Home Depot is far much higher than that of Lowe’s[footnoteRef:6]. The main reason that has led to the high return on equity is the increase in financial leverages over the years[footnoteRef:7]. The financial leverages have also increased in our case. For instance, the financial leverage of Lowe’s Company has increased from 1.14 to 2.89. The financial leverage of Home depot has increased from 1.85 to 18.59. Companies are normally advised that in order to grow financially, investments and new opportunities must be taken advantage of. [6: Profitability and liquidity and financial ratios for the Home Depot Inc. (HD) from nasdaq.com (2018) Retrieved from https://www.nasdaq.com/symbol/hd/financials?query=ratios] [7: Heikal, M., Khaddafi, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), 101.]

Return on equity is gains that a company acquires when it ventures and invests using debts and equities. For instance, a company may take the money that shareholders have left with them and start up something profitable for the company. In this manner all the individuals of the company will have benefited and the company will build a good reputation. Also, the company can ask for loans from banks and use them to carry out investments and generate profits. Investments are just like risks, they have to be taken carefully so that the benefits can be seen at the end of it all.

Besides, Companies are now being encouraged to make use of external sources of funds and invest in huge projects. There are various means by which an organization can increase their financial leverages. To begin with, the company can make use of the cash balances that are not put into use and are with the company. Also, the companies can borrow from other outside sources and invest in something. Also, the company can use the owners capital to invest before the money is needed back. By so doing, the financial leverage of the company will increase and eventually the return on equity will increase too.

Summary

Recommendation

In order to ensure that almost all companies become stable financially I would ensure and urge managers to carry out frequent analysis while at the company. The frequent analysis will make it easy to detect a problem before it becomes too hard to handle. Also, I would recommend companies to diversify their businesses. The major aim of carrying out a business is to generate more profits. A company can therefore benchmark with others and know what you can do in order to generate huge profits in a given financial period. Diversity is important as it will enable a company to think and initiate something that no one else has ever done.

Reflection

The topic has been very beneficial as i have been able to learn why there are disparities in the profit levels of different organizations. Also, the study on financial analysis has equipped me with knowledge on how to carry out the analysis for various financial statements. The topic has also been of help personally as I have been able to learn about the benefit of benchmarking and brainstorming whenever there is an issue that needs to be solved.

References

Course, M. A. (2016). Return on Assets Ratio–ROA.

Erskine, A., Camillo, A. A., Bajada, A. J., & Holt, S. (2015). The Home Depot: A Competitor’s Strategic Audit, A Case Study. In Global Enterprise Management (pp. 171-189). Palgrave Macmillan, New York.

Heikal, M., Khaddafi, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), 101.

Tamulevičienė, D. (2016). Methodology of complex analysis of companies’ profitability. Entrepreneurship and sustainability issues, 53-63.

Profitability and liquidity and financial ratios for Lowes companies Inc. (LOW) from nasdaq.com. (2018). Retrieved from