Research Paper on "Company Resources and Competitive Position"

Research Paper 3 pages (1253 words) Sources: 3

[EXCERPT] . . . .

Netflix

Financial ratio analysis can shed insight into the operations of a company. Ratio analysis typically focuses on liquidity, solvency, profit margins, operating efficiency and returns as key metrics from which the analyst can draw conclusions about the firm's success. The financial ratios for Netflix for the past three years are contained in Appendix a. These ratios are focused on activity, leverage and profitability. In general, Netflix has seen improvements in profitability and leverage in the past year, but saw its level of activity decline in that same period.

Financial Ratio Analysis

Based on this analysis, Netflix has been a successful company in the past few years. Most of the financial metrics have improved in that time, and although the performance was not unanimously good, Netflix appears to have a strong position in the market. The company has seen its margins improve over the course of the past two years. This improvement is across the board -- gross, operating and net margins have all improved. This indicates that most of the improvement probably occurred at the top line, which indicates that Netflix has improved its pricing power over either sellers or buyers. That the top line improvements have trickled down to the net margin indicates that Netflix has grown its operations without an undue expansion in the company's cost structure.

In general, the company's returns are also strong. The firm's ROE increased sharply in 2009 and 2010, but this can be explained by the increase in the use of debt, as evidenced by the debt-to-equity ratio. The lower the amount of equity in the capital structure, the better the ROE will be, all other things being equal. More encouraging, then, is the improvement in the ROA and ROI over this same period of time. The leverage that the firm undertook in 2009 was partially paid down in 2010. The current level is perhaps high for a firm as young as Netflix, but the fact that the company has paid down some of the debt it took out (at least on a percentage basis) is encouraging. It is also possible that Netflix adopted this capital structure to take advantage of the low rates available at present. If this is the case, perhaps the firm is in a good position to adjust its capital structure back to a more equity-oriented one once the interest rates begin to climb. For now, the debt-to-equity ratio is more something to watch than something about which to be alarmed.

The main trouble point for Netflix in terms of its financial ratios is with respect to its activity levels. The company saw its inventory turnover decrease in 2010 from previous levels, and this expanded inventory levels to 48.66 days from 36.8 days in 2009. Expanding inventory levels can be a warning sign that the company's level of activity is slowing. Ideally, Netflix would recognize this reality and make adjustments to its inventory levels in order to bring the inventory turnover back to historic levels. It the inventory levels represent a temporary deviation from the norm, then there is no reason to be concerned. However, it is worth mentioning that Netflix would not want to see a trend of increasing inventory levels in particular, as movie rental inventory can become stale and in general diminishes in value over time. Turnover must be kept high, by moving out extra copies of slow moving titles, and getting the existing inventories out to paying consumers.

Netflix does not record accounts receivable on its balance sheet. This makes it impossible to calculate its average collection period. Thus, no judgment can be made with respect to the firm's ability to turn over its accounts receivable.

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