Courtnie Holman

Financial Analysis
Introduction
Ratio analysis is a comparison technique that can be used to analyze financial
statements to show how a company measures up when being compared to other
companies in the industry or against itself from one period in time to another. Ratio
analysis is a great technique to use if you dont want the size of the company to be
a factor. When using ratio analysis there are four categories that are looked at;
their ability to pay current liabilities, their ability to sell merchandise inventory and
collect receivables, their ability to pay long term debt and their stock as an
investment. Ratio analysis will be used in this paper to evaluate the company
International Business Machines (IBM) for the year 2014 compared to the prior year,
2013, and to the industry average.
Risk
Short-term risk
Short-term risk is also known as liquidity or the companys ability to satisfy their
current liabilities or their debts that will come due within one year. To measure how
liquid IBM is, or how able to pay their debts, three different ratios are looked at. The
first is the current ratio, which we get by dividing the assets by liabilities. In 2014
IBMs current ratio was $1.25 and $1.28 in 2013. That means that they were slightly
less risky in 2013 or better able to pay their debts off with assets than in 2014. For
example, for every dollar of debt in 2013 the company had $1.28 of resources to
satisfy that dollar of debt whereas in 2014 for that same dollar of debt they only had
$1.25 of resources to satisfy it. When comparing IBMs results with the industry
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average of $1.86 for 2014 it can be said that IBM is more risky than other
companies in the industry.
Secondly, we look at the acid-test ratio. The acid-test ratio evaluates the companys
ability to pay current liabilities, or debts, if they were to come due immediately.
This ratio can also be known as the quick ratio. The acid-test ratio for IBM in 2014
was $1.02 and $1.07 in 2013; again in 2013 the company was slightly less risky
than in 2014. They would have been better able to pay their current debts off if they
came due immediately in 2013 than in 2014. The industry average was $1.57 which
makes IBM appear to be significantly more risky. Lastly, the cash ratio could also be
used to analyze the companys ability to pay its current debts with their cash. It
could be said that generally speaking IBM has become slightly more risky in the
past year and has remained more risky than the industry average.
Long-term risk
Long-term risk is also known as solvency or the companys ability to satisfy all their
liabilities or debts. There are also three ratios in this category that can be evaluated
to analyze the companys long-term risk. The first ratio is the debt ratio which we
get by dividing the companys liabilities by its assets. The company prefers this
number to be lower rather than higher, a higher percentage could indicate that the
company is not as financially stable. In 2014 IBMs debt ratio was 90% and 82% in
2013. That means that for every $1.00 in an assets IBM had $0.90 in liabilities for
that $1.00 whereas in 2013 for that same $1.00 in assets they only had $.82 in
liabilities. The company became more risky from 2013 to 2014. The industry
average debt ratio was 59.3%, which is less risky than IBM.

The next ratio looked at is the debt to equity ratio. This ratio will indicate whether
the company is more debt financed or equity financed. In 2013 and 2014 IBM was
more debt financed which makes them a risky company. However, their debt to
equity dollar amount doubled from $4.50 in 2013 to $8.78 in 2014. The difference
between IBM and the industry average was significant, the industry average only
had $1.46 in debts for every $1.00 in equity but IBM had $8.78 in debts for every
$1.00 in equity. This makes IBM look very risky when comparing them to the
industry.
The last ratio in the long-term risk category is the times-interest-earned ratio which
portrays how many times the company can earn it interest for the period. In 2014
the company earned its interest 35 times but in 2013 the company earned its
interest 51 times, making them more risky from 2013 to 2014. However, when
comparing 2014 to the industry average of 3 times, IBM is significantly less risky.
Profitability
Profitability may be the most important category to look at when analyzing a
companys financial statements. After all, the company can only stay up and
running if they are making a profit. Profitability looks at revenues earned verses
expenses incurred for a specific period in time. There are five ratios that can be
looked at under the profitability category when analyzing financial statements. The
first ratio evaluated is the profit margin ratio which you get by dividing net income
by net sales. This ratio indicates how much income is generated from $1.00 of
sales. In 2014 IBMs profit margin was 34% and 43% in 2013. That means in 2013
for every $1.00 in sales IBM earned $0.43 of income but in 2013 they only earned
$0.34 for every dollar in sales. From 2013 to 2014 IBM became less profitable. The
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industry average for the profit margin ratio was 1%, so every $1.00 in sales
generated $.01 of income. That makes IBM significantly more profitable than the
industry average.
The second ratio evaluated is the gross profit margin. The gross profit margin is
calculated by dividing gross profit (sales minus the cost of goods sold) by sales
revenue, the money generated by sales. This ratio indicates how much money is left
over after accounting for the cost for the product. In 2014 IBMs gross profit margin
was 50% and in 2013 it was 49%. That means that in 2013 the company had $0.49
left over after accounting for the cost of the good and in 2014 they had $0.50 left
over after accounting for the cost of the good. That is only a $.01 increase from
2013 to 2014, so IBM did become somewhat more profitable, but it wasnt a huge
increase. The industry gross profit margin average was 80%. That means for every
$1.00 of sales the industry average had $0.80 left over after the cost of the goods
were accounted for whereas IBM had only $.50 left over after the cost goods were
accounted for. IBM is fairly less profitable than the industry average.
The third ratio evaluated is the return on assets ratio. This ratio signals how much
net income is generated by their assets. In 2014 IBMs return on assets was 10.26%
meaning that for every $1.00 of an asset $0.10 of profit was generated whereas in
2013 the return on assets was 13.76% meaning that for every $1.00 of an asset
$0.13 of profit was generated. This shows that IBM became slightly less profitable in
2014 because they generated $0.03 less on every $1.00 of an asset. However, IBM
is significantly more profitable than the industry average of 1.6%.
The fourth ratio evaluated is the return on equity ratio. Equity can be described as
the value of shares a company issues. This ratio is calculated by dividing net income
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by average equity and indicates the amount of income generated for every $1.00 of
equity. In 2013 IBMs return on equity was 79.15% but only 69.37% in 2014. IBM
became less profitable with their return on equity. In 2014 they generated $0.69 for
every $1.00 of equity but the industry average was only 3.94% which is $0.03 for
every $1.00 of equity which makes IBM significantly more profitable than the
industry average.
The fifth ratio evaluated is the basic earnings per share ratio. This ratio indicates the
earnings per share for common stockholders. This ratio is a required to be reported.
IBMs basic earnings per share in 2014 were $11.90 and $14.9 in 2013. IBM once
again, became less profitable from 2013 to 2014. This number is preferred to be
higher because it is more attractive to investors. The industry average earnings per
share were $2.66 which is significantly less profitable than IBM.
The sixth ratio evaluated is the revenue per share ratio. This ratio indicates how
much revenue is earned off of the shares the company has outstanding. In 2014
IBMs revenue per share was $93.64 and $93.34 in 2013. There was only a slight
increase in the revenue per share but it still made the company more profitable
than the prior year.
Efficiency
Inventory Management
The first ratio analyzed when looking at how well a company manages their
inventory is the inventory turnover ratio. This ratio indicates how many times a
company turns their inventory over in a period of time. This number is preferred to
higher because it signals how quickly a company is selling its inventory. The

inventory turnover ratio for IBM in 2014 was 20.79 times and 22.58 times in 2013.
This indicates that the company was selling their inventory quicker, or more
efficiently, in 2014 than in 2013. The industry average inventory turnover was 17.56
times which is less efficient than IBMS 20.79 times for 2014.
The second ratio analyzed when looking at how well a company manages their
inventory is the days sales in inventory. This indicates how many days their
inventory sits on the shelves. This ratio preferred to be lower because they want to
get rid of their inventory quickly or hold their inventory for fewer days. In 2014
IBMs days sales in inventory was 17 days and in 2013 it was 16 days. The
company became slightly less efficient in managing their inventory but the
decrease probably wasnt significant enough to incur extra costs for storing their
inventory for a longer amount of time. The industry average days sales in inventory
were 20.79 times which is significantly higher than IBM. This makes IBM more
efficient in managing their inventory than the average industry.
Receivables and Collections
Receivable accounts are accounts that hold money amounts that customers or
people outside of the company owe to the company that will be collected in the
future sometime. The first ratio analyzed when looking at how efficiently a company
collects on their receivables is the receivables turnover ratio. This ratio is calculated
by dividing credit sales by accounts receivables. Higher results indicate that the
company is more efficient. IBMs receivables turnover ratio for 2014 was 10.21
times and 9.53 times for 2013. This indicates that the company collected their
receivables 10.21 times in 2014 and 9.53 times in 2013. IBM was more efficient in
collecting their receivables in 2014 than 2013. The industry average receivables
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turnover ratio was 5.89 times which makes IBM more efficient than the industry
average.
The second ratio analyzed when looking at how efficiently a company collects on
their receivables is the days sales in receivable. This ratio is calculated by diving
365 days by the accounts receivable turnover calculated above. This ratio indicates
how many days their receivables sit without being collected. This ratio is also
preferred to be a lower number because a company wants to collect their money as
fast as possible. IBMs days sales in receivable for 2014 were 38.46 days and 38.62
days in 2013. IBM was slightly more efficient in 2014 than 2013 but significantly
more efficient than the industry average of 62 days.
Asset Management
The ratio analyzed when looking at how efficiently a company turns their assets into
revenue for a period of time is the asset turnover ratio. This ratio is calculated by
diving sales by assets. This number is preferred to be higher because a company
wants to collect the revenue earned as fast as possible. IBMs asset turnover for the
2014 was .70 times and .80 times for 2013. This indicates that IBM was less efficient
on generating revenue from their assets in 2014 than in 2013. IBM is significantly
less efficient than the industry average of 1.6 times.
Cash Flow Management
The first ratio analyzed when looking at how efficiently a companys cash flow
management is, is the cash flow to asset ratio. This ratio is calculated by taking the
cash earned from operations divided by total assets. This ratio is used to show when
cash will be available and how much cash will be generated cash from its

operations. IBMs cash flow to total assets ratio for 2014 was $13.80 and $14.20 for
2013. This indicates that IBM was significantly less efficient from 2013 to 2014.
The second ratio analyzed when looking at how efficiently a companys cash flow
management is, is the cash flow per share ratio. The cash flow per share ratio
indicates the cash a firm generates on each share of stock outstanding. IBMs cash
flow per share for 2014 was $17.04 and $16.59 for 2013, indicating that IBM
became more efficient from 2013 to 2014.
The third ratio analyzed when looking at how efficiently a companys cash flow
management is, is the price to free cash flow ratio. This ratio evaluates a companys
price per share (talking about stocks) to its free cash flow per share price discussed
above. This is a ratio investors would in interested in looking at to see how
expensive the company is or if the companys stock appears to be increasing its
value soon. In 2014 IBMs price to free cash flow ratio was $12.82 but it was $13.80
in 2013. This indicates that IBM became less efficient from 2013 to 2014. However,
when comparing IBM to the industry average of $30.20, IBM appears to be
significantly less efficient than the industry average.
Investment Attraction
There are five ratios that can be evaluated when analyzing how attractive a
companys stock is as an investment. The first ratio is the price/earnings which
describes how much investors are willing to pay for $1.00 of current earnings. The
price/earnings ratio for IBM in 2014 was $13.48 and $12.55 in 2013. From 2013 to
2014 the value did rise making IBM a more attractive investment but when
comparing IBM to the industry average of $19.30 it could appear to investors that
IBM is undervalued or less attractive.
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The second ratio is the dividend yield. According to Horngrens Accounting, dividend
yield measures the percentage of a stocks market value that is returned annually
as dividends to shareholders. This is a ratio that stockholders are very interested in.
The higher the percentage the more money back to the shareholders. In 2014 IBMs
dividend yield was 2.68% and 2.05% in 2013. This means that in 2014 investors
were getting back more money than in 2013, which makes IBM more attractive. If
the ratio were to keep increasing investors would be very intrigued in investing with
the company. When comparing IBM to the industry average of 2.2% IBM still fairly
more attractive.
The third ratio is the dividend payout ratio. According to Horngrens Accounting,
dividend payout is the percentage of earnings paid annually to common
shareholders as cash dividends. Like above, this percent if preferred to be higher,
signally more money back to shareholders. IBMs dividend payout ratio was 36.2%
for 2014 and 25.8% for 2013. Once again their percentage increased making IBM
more attractive to investors. The industry dividend payout average was 42.1%
which is significantly higher than IBM, which makes IBM looks less attractive to
investors however IBMs increase from the prior year still makes them look
attractive as a company.
The fourth ratio is the dividend per share ratio is calculated by taking the entire
amount of dividends paid by the amount of shares outstanding. This ratio indicates
how much each share is worth at a specific point in time. In 2014 IBMs dividend per
share was $4.31 and $3.85 in 2013. This means that the value of the dividend per
share went up, making IBM more attractive for an investor.

The fifth ratio is the book value per share which is calculated by dividing common
stockholders equity by the number of common shares outstanding. This ratio tells
us the value per share based on stockholders equity. In 2014 IBMs book value per
share was $11.99 and $21.62 in 2013. This makes IBM appear significantly less
attractive from 2013 to 2014.

Conclusion
In conclusion, it could be said that overall IBM is stronger is some areas and weaker
in some areas. In terms of analyzing how risky IBM is as a company it can be said
that they are very risky. Not only are they more risky from one year to the next, but
also compared to the industry average in every ratio analyzed. In terms of analyzing
how profitable IBM is as a company it could be said they are more profitable in some
areas than others but overall from 2013 to 2014 they were in general more
profitable. When analyzing IBMs profitability compared to the industry average it
jumps all over the place. In some areas IBM is more profitable and in some areas
they are less profitable, it depends on what areas an investor or outsider wants to
focus on, they are good at making a profit off of sales but not as profitable on their
equity compared to the industry. In terms of analyzing how efficient IBM is as a
company it could be said that they are very efficient with tier inventory
management and receivables or collections management. In both of those areas
IBM was more efficient compared to itself and to the industry average; however IBM
was not as efficient in managing their assets. The company was less efficient
compared against itself and compared against the industry. In general for cash flow
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management IBM was less efficient compared against itself although they did have
some areas where they were more efficient here and there. In terms of analyzing
how attractive IBMs investments were it could be said that they became more
attractive from 2013 to 2014 as a company but in general they were less attractive
than the industry average.

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