Term Paper on "Financial Analysis of Walmart"

Term Paper 7 pages (1826 words) Sources: 8 Style: MLA

[EXCERPT] . . . .

Financial Analysis of Walmart

WalMart was ranked #1 by Fortune 500 in 2006 and made over $300 billion in sales and over $11 billion net income , in the same year. Considered to be one of the largest private employer in the world, the Wal-Mart's personnel size reached 1,900,000 last year. With these kind of figures, one can have an idea about the size of WalMart's operations, which can be a direct impact on the company's financial figures and ratios.

TOP 5 in 2006

Rank

Company

Revenue ($ millions)

Profits ($ millions)

Wal-Mart Stores

Exxon Mobil

General Motors

Chevron

Conoco Phillips

The company has more than 1,100 discount stores, 1,900 supercenters, 95 neighborhood markets and 575 Sam's club locations in USA and it established strategic presence in 13 foreign markets with 2,750 retail units, reaching over 175 million consumers. Its global expansion has been constant over the last couple of years, with China as one of the markets with the highest potential growth in the future.

Part a Liquidity

Liquidity expresses the company's capacity to cover its short-term financial obligations. The two most important liquidity ratios are the current and quick ratios. The current ratio is computed as follows:, while the quick ratio also known as the acid test:

From the investors' point-of-view a high current ratio is desirable because it reflects a small risk business, while from the shareholders point-of-view the same ratio is desired to be lower. That way, more of the company's capital is working for the business growth.

To have a better picture of the company's short-term capacity to meet financial obligations, inventories are subtracted from current assets as they may be difficult to liquidate fast if needed.

A small current ratio is not necessarily a sign of bankruptcy. It may be a sign of difficulty of turning products into cash. It can be the case of companies that have large inventories and for that we compute the acid test or it can be the case of companies that have troubles getting paid.

At WalMart, in 2006, the current ratio was 0.898, while in 2005, this amounted to 0.9. As we can see, the current ratio remains at almost constant levels throughout the period

2005-2006 and close to 1. This shows that the company is taking a cautious approach and is ensuring that its current assets value can cover any short-term liabilities that the company might contract. Although the accounts receivables (showing the extent of credit for clients) have increased by around 55%, this did not significantly decrease the current ratio value. The company's management intention of stabilizing the current ratio at values around 1 is clear.

On the other hand, the quick ratio was 0.238 in 2006 and 0.21 in 2005. Again, we can notice the small difference in value from one year to the other, a sign that the liquidity policy at WalMart remains within the same interval constraints.

A low level of risk in terms of the adopted liquidity policy is well indicated in WalMart's case. The reason for this is given both by the size of WalMart's operations, which implies the necessity to be able to adequately balance its financial position, and the fact that any potential problems that might appear in terms of liquidity might later on impact the medium and long-term financial situation. In this sense, it is recommended that current ratio values close to 1, as is the case in the present, be maintained in the future as well at WalMart.

Part B Solvency

Debt to Assets is computed as the ratio of total debt to total assets and it shows the percentage of assets that was paid by creditors as opposed to the percentage of assets credited by business owners. Basically, it provides information of the debt load related risk: If this indicator is higher than 1, then the total debt is higher than the total asset. When the debt is very high and is increasing compared to the previous years, it is possible that lenders will refuse future borrowing to such a company. Unlike liquidity ratios, the solvency ratios pay respect to long-term debt, which says to which extent the company's financial commitment is covered from shareholders' investments.

Interest coverage ratio expresses the company's capacity to pay the outstanding debt. The ratio is computed as follows: It is recommended that this ratio has a value higher than 1.5. If a company is generating a small profit before interest and tax (EBIT), after paying the loan expenses, there is little to be divided between shareholders.

It may be possible for a company to have high debts, and yet to be able to cover interest expenses and that is an important detail for lenders. The company has to show that is able to generate enough resources to pay its obligations.

Also, it is possible for a company not to be able to generate a high enough profit to cover the interest expenses in a given period, but to have low debt to asset ratio. In that case, the assets may stand as a guarantee of payment for lenders.

In 2006, the debt to assets ratio at WalMart was 0.225, with a value of 0.198 in 2005. The change in the debt-to-assets ratio shows a small increase in the financial leverage that the company is using. This can be explained by increases both in long-term debts due within a year, as well as in long-term debts with over 1 - year maturities. The latter increase is more significant, amounting 31.6%.

While this increase is not affecting the financial stability of the company, it is indicated that this ratio be kept under control and that the management ensures that the company's total assets can cover, at any given time, the long-term contracted by the company.

At the same time, the interest coverage ratio is 15.8 in 2006 and 17.33 in 2005. There are several conclusions that can be drawn from these values. First of all, the value is significantly higher than the 1.5 value generally recommended. This is not necessarily a negative aspect, indeed it shows that the proportion of interest expense in the total earnings value before interest and taxes is significantly small. This is encouraging, in the sense that the shareholders will have a much larger operational income to use for other purposes than interest expense. On the other hand, it also shows that, despite the increase in long-term debt from 2005 to 2006, the interest expenses remain proportionally small as a segment of operational income.

Part C Profitability

ROA (Return on Assets) measures the management's efficiency in using to use the company's assets to generate earnings. It is expressed as follows:

ROE (Return on Equity) measures the management's efficiency to generate profit with the shareholders money. It is expressed as follows:

Gross profit margin ratio expresses the size of profit derived from sales and can be calculated as follows: In this case, the higher is the ratio, the higher is the profitability. The profit margin can be improved either by reducing the costs of goods sold or by increasing selling prices.

The first two profitability ratios indicate the management efficiency to generate income over the assets and shareholders' equity, whereas the third ratio indicates the company's profit margin to the goods sold. The assets and equity account for more than just the company's sold goods, they also include stocks. Thus, a high gross profit margin, despite showing that the company is capable to generate high profits from the goods sold, it doesn't imply that the company has a high capacity to sell. For an investor or lender it is very important to see that a company has the capacity to sell proportional to its capacity to produce or stock merchandise.

ROA and ROE come to complete this picture. They measure the extent to which net income is generated relatively to the capital employed. Nevertheless, these two indicators alone can't offer a detailed analysis about the sales activity, which generates the largest part of the profit. The image is a general one, of the average profitability of all activities going on in a firm.

The return on assets was 0.134 in 2006 and 0.142 in 2005, a small decrease from 2005 to 2006. For a company the size of WalMart, the value is more than encouraging. Indeed, it virtually shows that approximately 13-14% of the company's total assets are directly translated into generated income.

On the other hand, the company's return on equity amounted to 0.35 in 2006 and a similar value (0.35) in 2005. This values show WalMart as a very profitable company for its shareholders, with 35% of the equity transformed into operational net income.

Finally, the gross profit margin was 29.96% in 2006 and 29.76% in 2005. The values for the gross profit margin sustain the idea that WalMart has been a very profitable company in 2005 and 2006. This can be most likely explained with a policy that combined low costs and, as such, the… READ MORE

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