Financial Statement Analysis Project
The two companies that I will be comparing in this project are McDonalds and WendyЎ¦s. Both of these companies are competitors in the same industry. IЎ¦m using the information from their 2001 Financial Statements.
When comparing the debt-to-assets ratio of McDonalds and WendyЎ¦s, you have to divide the firmЎ¦s total liabilities by their total assets. Essentially, the debt-to-assets ratio is the primary indicator of the firmЎ¦s debt management. As the ratio increases or decreases, it indicates the firmЎ¦s changing reliance on borrowed resources. The lower the ratio the more efficient the firm will be able to liquidate its assets if operations were discontinued, and debts needed to be collected. In 2001 WendyЎ¦s had $2,076,043 worth in total assets and $846,264 in total liabilities. When divided, WendyЎ¦s has the lower ratio of the two competitors at 40%. This means that they would take losses of 40% if operations were shut down, and the cash received from valuable assets would still be sufficient to pay off the entire debt. It also means that 40% of WendyЎ¦s assets are made through debt. McDonalds in 2001 had $12,545.3 (in millions) of total liabilities and $22,534.5 (in millions) of total assets. After doing the math, McDonalds ends up with a ratio of 56% which is higher than WendyЎ¦s by sixteen percent. This means that there is more default on McDonaldЎ¦s liabilities, which can be a costly event from lenderЎ¦s perspective. McDonalds makes 56% of all its assets through debt. In reality, itЎ¦s not good to have a debt-to-assets ratio over 50%. ItЎ¦s also not good to have a debt-to-assets ratio that is too low because that shows that you have money that isnЎ¦t being used to gain future economic profit. So a stable percentage closest to 50% is wanted. When looking at both of the financial statements, even though McDonalds may have a higher debt-to-assets ratio, it doesnЎ¦t necessarily mean that McDonalds is in a worse situation than WendyЎ¦s.
To calculate the current ratio, which is one of the most popular liquidity ratios you divide all of firmЎ¦s current assets by all of its current liabilities. McDonalds has
$1,819.3 (*everything is in millions for McDonalds) of current assets and $2,248.3 in current liabilities making the firmЎ¦s current ratio .81. In 2001 WendyЎ¦s has current assets of $266,353 and current liabilities of $296,687 making their current ratio .90. Current ratios are used to represent good liquidity and financial health. Since current ratios vary from industry to industry, the industry average determines if a firmЎ¦s current ratio is up to par, strength or a weakness. In any event if the current ratio is less than the industry average than an analyst or individual interested in investing might wonder why the firm isnЎ¦t balancing its current assets and liabilities better. On both McDonaldЎ¦s and WendyЎ¦s website is says that the industry average for a current ratio is .60. So when comparing both firms, based on the industry average, McDonalds and WendyЎ¦s are doing well and can both be efficiently liquidated. Liquidity refers to how quickly the firmЎ¦s current assets can be converted to cash. Now as far as being compared to each other by McDonalds having a lower current ratio, that itself doesnЎ¦t indicate that McDonalds is in a worse financial situation. Lower liquidity may be offset by a variety of other financial indicators, because McDonalds still ranks higher on its overall financial stability and financial health.
To find the quick ratio, which is often called the acid test; only cash & cash equivalents as well as accounts receivable are added and then divided by current liabilities. The purpose of the quick ratio is to indicate the resources that may be available in the short term. Essentially quick ratio is sort of a Ў§worse case scenarioЎЁ that might apply if no other resources are available. In 2001 WendyЎ¦s had a quick ratio of .66 while McDonalds came through with a quick ratio of .76. What does this mean? When comparing McDonalds and WendyЎ¦s it shows that even though WendyЎ¦s had the higher current ratio, like I mentioned earlier, this doesnЎ¦t mean that McDonalds is in worse financial condition. McDonalds based on its quick ratio shows that without using any other resources are able to pay their current liabilities due within a year better than WendyЎ¦s. Considering that the industry average in 2001 of quick ratios is .40, WendyЎ¦s didnЎ¦t do badly at all in 2001. Many analysts say that quick ratios shouldnЎ¦t be less than .30. If lower than .30 and trends keep declining then many concerns would be addressed about the firm.
The price-to-earnings ratio is calculated by taking the stockЎ¦s market price per to its earnings per share. As an investor ratio itЎ¦s a convenient and widely accessible way to compare alternative investment opportunities. They are usually used to assess growth, risk, and earnings quality. P/E Ratios vary with the expected future growth of the firm in earnings. If investors expect a firmЎ¦s future earnings to grow rapidly, then the current earnings understate the future earning power of the firm. Stock price, on the other hand reflects investor expectations of future earnings and cash flows. So firms with a high expectation of earnings will have higher ratios. In 2001 McDonald had a market price of $26.47 and earned $1.27 per share. When dividing the market price by its earnings per share, McDonalds ends up with a ratio of 20.1 which means that McDonalds was selling at a price 20.1 times its earnings per share. WendyЎ¦s had a market price of 29.17 and earned 1.72 per share in 2001, therefore making its ratio 17. This also means that WendyЎ¦s sold stock at a price 17 times its earnings per share. What does all this mean? Well for starters it means that McDonalds is making more money off its common stock, and that investors feel that McDonalds has higher future earnings for growth. WendyЎ¦s isnЎ¦t doing badly at all on the other hand, they are barely behind McDonalds. Do investors see WendyЎ¦s as a high-risk investment? That would be determined by the industry average P/E. High risk firms are expected to have lower-than-average P/E multiples, while low-risk firms like a McDonalds are expected to exhibit higher-than-average P/E multiples.
Earnings per share are perhaps the most widely cited number in corporate financial reports. EPS basically focuses on the common stock and indicates the portion of total company income that is applicable to a single share of common stock. IЎ¦ve also heard that its one of the only pieces of info on the front page of a financial statement. To calculate Basic EPS you divide income available to the common stockholders by the average number of shares outstanding. In 2001 McDonalds reported a net income of $1,637 (in millions) and had 1,280.7 million shares of common stock outstanding throughout the entire year. With those numbers McDonalds ends up with an EPS of $1.27 for 2001. WendyЎ¦s on the other hand reported a net income of $193,649 with 112,275 shares of basic common stock calculating to an EPS of $1.72 for 2001. When comparing McDonalds and WendyЎ¦s, firms usually want EPS to be high because EPS represents what the firm will earn per share on common stock.
This project has helped me understand essentially why financial statements are analyzed. These ratios give us investors a process to assess the potential risks and returns from investing in a firm. With these simple and appropriate ratios, itЎ¦s easy for a potential investor to develop a general framework that can be used to conduct a comprehensive financial analysis. When comparing the two firms, weЎ¦ll start with McDonalds and WendyЎ¦s debt-to-assets ratio. Although WendyЎ¦s might have a lower debt-to-assets ratio, doesnЎ¦t necessary mean theyЎ¦re in better financial condition. WendyЎ¦s debt-to-assets ratio being at 40% may mean they have extra assets that could be used to produce more profit. McDonaldЎ¦s debt-to-asset ratio at 56% shows that they are utilizing all of their assets to make future profit, while staying around the 50% mark. Both of the firmsЎ¦ current ratios are better than the industry average of .60; WendyЎ¦s being at .90 and McDonalds being at .81. When comparing the two ratios they show that WendyЎ¦s would be able to pay off there debtЎ¦s quicker than McDonalds. There are two strengths that McDonalds had in 2001 with both their quick and P/E ratios better than WendyЎ¦s. Under a worse case scenario McDonalds would be able to liquidate its assets quicker and pay off debts better. As an investor, the company with the higher earnings on a per share basis will be more likely to have more investors. After comparing the two firms as an investor I would invest in McDonalds. Based on McDonaldЎ¦s debt-to-assets ratio, I believe that McDonalds is actively using all its assets to maximize profits. As an investor McDonaldЎ¦s stock is also cheaper and gives a greater return. WendyЎ¦s isnЎ¦t far behind and seems like a firm with economic success and great debt management, but with the money in my pocket I would use it on McDonalds. Now foodЎKЎKЎKЎKЎK. sometimes might be a different story! ѓє