Financial Statements Analysis of Competitors

Financial Statements Analysis of CompetitorsThe ii U.S. companies Lowes and stand depot ar two leading competitors on the DYI market who atomic number 18 both(prenominal) listed on the U.S. stock market. You ar to carry out a financial statement analysis of these two companies covering the period 2002 to 2006. Specifically, you are to1. Analyze and guess the balance wheel sheet for summations and liabilities that are not tempered.Kohlbeck (2004) argues that, employ the case of banks, few firms disclose the grade of their intangible assets, and few exit each information enabling investors to make an informed judgement as to the treasure of these assets. As such, assumption that companies volition tend to categorise and record the esteem of all their tangible assets, actually quantifying the value of any assets that are not record on the balance sheet is likely to be rattling difficult. Bodenhorn (1984) argues that non recorded assets can befuddle a value design ate to them from the future value of the notes flows that they pass on gene array. However, again companies rarely assign bullion flows to intangible assets, such as branding, further making this difficult. As such, the analysis and evaluation testament need to take on a qualitative nature.Both Lowes (Shareholder.com, 2008) and al-Qaida Depot ( sulphur, 2008) provide enlarge of m iodiny and bills equivalents, short- circumstance investments, and stocktaking in their current assets, and land, buildings, equipment, leasehold improvements and wind in progress in their fixed assets. However, Lowes does not take on any deal out receivables in their current assets. This could mean that the company does not create any clientele receivables, or it could imply that the company is universe prudent, and not recognising these receivables until they puzzle been paid. In addition, Lowes does not record any goodwill, which could mean that the company has every not make any acquisi tions, that it has unless paid market value for them, or that it is not recording the goodwill as it does not see it as a reasonable asset maybe the value of the goodwill will need to be downgraded. n any company has recorded any asset value for brand value, employee skills and knowledge, or customer loyalty. Whilst this is in accordance with international accounting system standards, it nevertheless fails to remark what could be a significant source of value for the companies (Quick, 2002).In basis of liabilities that are not recorded, the only potential events which may not attain been recorded are pension liabilities, with neither company including them as an item of their annual reports. Whilst the FASB issues Statement No 158 in 2007, which made it a indispensableness for employers to move pension liabilities onto the balance sheet (Miller and Bahnson, 2007a), this requirement may not yet have impacted on these accounts. Other than this, modern accounting standards gene rally require that all liabilities be kept on balance sheet, hence in that respect are unbelievable to be any otherwise liabilities which are not recorded by the balance sheets.2. Analyze and evaluate the balance sheet for the current value of assets and liabilities.When determining the current value of assets and liabilities, it is necessary to consider both their balance sheet value and their fluidity (Allen and Carletti, 2006). For example, if instrument has to be sold score quickly, it will rarely filiation upon its full valuation, and items such as goodwill will have no immediate current value. In contrast, banks can often call in loans and other liabilities at their full value. Applying this to the two balance sheetsCash and hard currency equivalents can be counted at full valueShort-term investments will be counted at 80% of value, to reflect losses and penalties on organisationReceivables will be counted at 90%, as bad debts will likely append in the event of a qui ck changeMerchandise inventories will be counted at 20% to reflect the clog in disposing of themOther current assets, deferred income imposees, and goodwill will be excluded, as they have no tangible saleable value.Property and associated fixed assets will be counted at 50%.Long term investments and notes will not be counted, as it may not be possible to detect this money in short order.LowesItemBook valueCurrent valueCash and property equivalents281281Short-term investments249200Merchandise inventory7,6111522Deferred income taxes2470Other current assets2980Property, less accumulated depreciation21,36110,681semipermanent investments5090Other assets3130Total assets30,86912,684Total liabilities14,77114,771 mesh topology value16,098(2,087)Home DepotItemBook valueCurrent valueCash and Cash Equivalents445445Short-Term Investments129Receivables, net1,2591,133Merchandise Inventories11,7312,346Other Current assets1,2270Net Property and Equipment27,47613,738Notes Receivable3420Goodwill 1,2090Other Assets6230Total assets44,32417,671Total liabilities26,61026,610Net value17,714(8,939)Whilst this analysis is slimly basic, and the assumptions contained within it have not been rigorously tested, it demonstrates that, in the event that either companys full liabilities became payable at short notice, both companies could have difficulty raising enough money to cover them. However, this is unlikely as both companies have a significant amount of their liabilities in the form of long term loans, which are unlikely to become imputable immediately.3. Analyze and act the effect on financial results and dimensions of the companies choices of accounting methods and assumptions made under these accounting methods.In accordance with the US GAAP, both companies introduce that they single-valued function estimates for determining the carrying value of assets and liabilities which cannot be otherwise determined (Miller and Bahnson, 2007b). As such, both companies acknowledge that the value they have applied to some(a) of their assets and liabilities may be incompatible from their actual value, which would depend on the circumstances in which these items were valued. This has had an effect on the financial results because, if the estimated value is incorrect, it will potentially have an impact on profits and net asset values, and hence fix all ratios which depend on these items.Furthermore, the companies have both declared specie and cash equivalents to be made up of actual cash, cash in deposit accounts, and investments with maturity dates of less than three months from the date of purchase. In addition, they have classified payments made by credit or debit observance around the time of preparation of the accounts as being cash equivalents, as they will generally be paid within two or three business days. This has impacted on the value of cash and cash equivalents, and also on the value of trade receivables and short term investments. As such, whilst it will not have stired the value of current assets, choosing different criteria would have led to a different value for cash and cash equivalents, and would thus have affected the quick ratio.When recording merchandise inventory, both companies record the value of their inventory at the lower value of the hail to purchase or the market value, based on the first-in, first-out (FIFO) method of inventory accounting. As such, and as demonstrated by Bruns and Harmeling (1991), the value of inventory recorded in the financial accounts will be different than in other method, such as LIFO, was used to calculate the value of the inventory. This will affect the value of current assets, and also of native and net assets, thus impact the majority of ratios related to the balance sheet. Lowes also records an inventory reserve, which is to be used to cover any loss associated with sell morose inventory at less than its book value. This reserve will affect the value of inventory, and will al so presumably affect the value of cash and cash equivalents if it is made up of liquid investments which are not held as such. As such, this may further affect several of the companys ratios.Finally, both companies use the straight line method to depreciate assets over their utilitarian economic lives. As such, they will produce different values for fixed, total and net assets than they would under different methods of depreciation accounting, which will affect or so ratios based on these values.4. Interpret indicators and determine the companies earnings character.According to Richardson (2003) some of the primary indicators of a poor earnings quality overwhelm an increase in trade receivables a link among growth in earnings and a reduction in the effective tax rate capitalising interest payments and a large number of significant one off items. In addition, an positive correlation amidst cash flow and earnings, as well as a high gross mete, indicate a high quality of earnin gs (Bao and Bao, 2004).Applying this to Lowes, there are no figures given for trade receivables in either of the past long time. This can be taken to indicate that the company is not owed any significant receivables, thus implying a high quality of earnings. Over the past three years, there has been no noticeable change in the tax rate experienced, however, whilst post tax earnings grew from 2006 to 2007, they fell from 2007 to 2008, which may indicate further future fall in earnings. There is no evidence of a capitalisation in interest payments by the company, and nor are there any major one off items, with the profit and loss account remaining fairly coherent from year to year. Gross margin has also consistently increased, going from 34.2% to 34.64%. However, there has been a larger increase in general expenses, which has caused a fall in overall earnings. There has also been an increase in cash flow over the three years, further indicating high earnings quality.Home Depot has experienced a significant fall in trade receivables over the past two years, and has had no significant change in its tax rate. However, its revenues have decreased over the past three years to a much greater degree than Lowes. Whilst part of this can be attributed to a fall in sales over the past two years, it is also due to a significant increase in selling and general expenses, which may also threaten earnings quality. Again, there is no evidence of capitalisation of interest payments or of major one off items. However, whilst Lowes has grown its gross margin, Home Depot has experienced no changes in margins, and its cash flows from direct have fallen more importantly than its earnings over the past two years. As such, Home Depot appears to have a much lower quality of earnings when compared to Lowes.5. prove which of the two companies think produce more reliable financial reporting and discuss which of them you would choose to invest in. You have to use many ratios (the more or less common ratios), you have not a limited number of ratios to use in your analysis.From the examination of the financial statements discussed above, there does not appear to be much difference between the reliability of the financial reporting methods of both companies. Both companies follow US GAAP regulations and standards, and both appear to interpret the rules in the same way. Both are publicly listed companies, and both sets of accounts include statements that they have followed accounting standards, been audited, and are Sarbanes-Oxley compliant. As such, the main differentiator between the two companies will need to be the ratio analysis of their financial accounts.The ratio analysis, detailed in the appendix below, reveals that both of the companies are very similar in their financial performance, which is probably largely due to the concomitant that they operate in the same industry and very similar markets. In terms of liquidity, Home Depot has a better current rati o and quick ratio, due to its trade payables. However, Lowes has a better operating cash flow, a fact which was commented on in the previous function regarding earnings quality. Home Depot has a higher rate of employee turnover for all five ratios, indicating that it is better at using its inventory and assets to rejoin sales, however Lowes higher gross margin and net margin (return on sales) indicates that Lowes is better at generating profits from these sales. In addition, Lowes has a lower debt to equity and debt ratio, as well as higher interest cover, which indicates that Lowes is better placed to withstand any travel in revenue and profit, which were also remarked on in the earnings quality section.As such, in conclusion, I would avoid investing in either of these companies based on the current falls in their earnings and the concerns round the wider performance of the US economy ( appear Markets Monitor, 2008). However, if I were forced to choose between the two companie s I would choose to invest in Lowes. This is because Lowes has shown itself to have better quality earnings, higher margins and lower debt ratios that Home Depot. As such, Lowes looks better placed to withstand any earnings shocks or economic issues in the US market and provide sustained long term value. In addition, Lowes is not carrying any goodwill or trade receivables on its balance sheet, which makes it less vulnerable to defaults from its debtors and enforced goodwill writedowns.ReferencesAllen, F. and Carletti, E. (2006) Mark-to-Market be and Liquidity Pricing. Working Papers Financial Institutions Center at The Wharton schooldays Preceding p. 1-31.Bao, B. H. and Bao, D. H. (2004) Income Smoothing, Earnings Quality and Firm Valuation. journal of Business pay invoice Vol. 31, young 9/10, p. 1525-1557.Bodenhorn, D. (1984) Balance Sheet Items As The turn in Value Of Future Cash Flows. Journal of Business Finance Accounting Vol. 11, Issue 4, p. 493-510.Bruns, Jr., W. J. and Harmeling, S. S. (1991) LIFO or FIFO? That Is the Question. Harvard Business School Cases p. 1.Emerging Markets Monitor (2008) US A Recession In All only Name. Datamonitor Emerging Markets Monitor Vol. 14, Issue 5, p. 1-2.Higgins, R. C. (1997) Analysis for Financial Management fifth Edition. Irwin / McGraw Hill.Kohlbeck, M. (2004) Investor Valuations and Measuring Bank Intangible Assets. Journal of Accounting, Auditing Finance Vol. 19, Issue 1, p. 29-60.Miller, P. B. W. and Bahnson, P. R. (2007a) pension Accounting. Journal of Accountancy Vol. 203, Issue 5, p. 36-42.Miller, P. B. W. and Bahnson, P. R. (2007b) Refining Fair Value Measurement. Journal of Accountancy Vol. 204, Issue 5, p. 30-36.Quick, C. (2002) Can You See The Value? Accountancy Vol. 130, Issue 1308, p. 47-48.Richardson, S. (2003) Earnings Quality and Short Sellers. Accounting Horizons 2003 Supplement, Vol. 17, p. 49-61.Shareholder.com (2008) Lowes Investor Relations. http//www.shareholder.com/lowes/edgar.cfm?Do cType=AnnualYear= Accessed 15th June 2008.SEC (2008) Home Depot Incorporated HD. http//secure.secfilings.com/company/checkout.php?step=2_offer_id=1CIK=354950fid=50002 Accessed 15th June 2008. addendumRatio Analysis (Higgins, 1997)RatioCalculation methodLowesHome DepotCurrent RatioCurrent Assets1.121.15Current LiabilitiesQuick RatioCash + S/T Inv + Receivables0.070.14Current LiabilitiesOperating Cash FlowCash Flows from Operations0.560.45Current LiabilitiesInventory TurnoverCost of Goods change / Inventory4.154.38Receivables Turnover Sales / Accounts ReceivablesN/A61.44Payables TurnoverSales / Accounts Payables13.0014.40Fixed Asset TurnoverSales / Fixed Assets2.172.61Total Asset TurnoverSales / Total Assets1.561.75Debt to EquityTotal Liabilities0.921.50Shareholders EquityDebt RatioTotal Liabilities / Total Assets0.480.60Interest CoverageProfit before income and tax63.9710.41Interest set downGross Margin(Sales COGS) / Sales34.64%33.61%Return on SalesNet Income / Sales5.82%5.68%Retu rn on AssetsNet Income / Total Assets9.10%9.92%