Activity sold will increase the ratio, signaling improved inventory

Activity Ratios are used to determine how efficiently a company uses its assets. They help provide an idea of the overall operational performance of a company. The activity ratios are “turnover” ratios that relate an income statement line item to a balance sheet line item. 1. Asset Turnover Ratio This measures the efficiency with which thecompany uses its total assets to generate revenues. 2017 2016 2015 2014 2013 2012 Total Asset Turnover 0.37 0.44 0.53 0.50 0.55 0.65 Industry – 0.55 0.61 0.63 0.67 0.71 Microsoft Corp.’s total asset turnover deteriorated from2015 to 2016 and from 2016 to 2017. The company’s ratio is also consistently lower than the industry standard each year. It could be attributed to two things. A low asset turnover ratio means that either Microsoft has been relatively inefficient in its utilization of assets or that the company is operating in a capital-intensive environment. Consistently low asset turnover ratios also indicate towards a strategic choice by management to use a more capital intensive as opposed to labor intensive approach. 2. Inventory Turnover This shows how effectively inventory is managed by comparing the cost of goods sold with average inventory for the period. 2017 2016 2015 2014 2013 2012 Inventory Turnover 15.71 14.56 11.38 10.18 10.45 15.42 Industry – 15.76 15.74 15.64 16.61 16.55 Microsoft Corp.’s receivables turnover deteriorated from 2015 to 2016 and from 2016 to 2017. The company’s inventory turnover is lower than the industry each year however some years the difference is significant (2013 &2014) where as in 2012 and 2016, Microsoft was operating very near to industry ratio. The industry in general has very high inventory turnover ratios because inventory does not get stale or obsolete very quickly. A higher turnover than the industry average means that inventory is sold at a faster rate, signaling inventory management effectiveness.Additionally, a high inventory turnover rate means less company resources are tied up in inventory. A decrease in inventory or an increase in cost of goods sold will increase the ratio, signaling improved inventory efficiency (selling the same amount of goods while holding less inventory or selling more goods while holding the same amount of inventory). 3. Payables Turnover Payables turnover measures how quickly a company pays off the money owed to suppliers. The ratio is calculated by dividing purchases (on credit) by average payables. 2017 2016 2015 2014 2013 2012 Payables Turnover 4.64 4.75 5.01 3.64 4.19 4.20 Industry – 7.65 7.29 6.56 7.04 6.97 Microsoft Corp.’s payables turnover declined from 2015 to 2016 and from 2016 to 2017.A high number compared to the industry average indicates that the firm is paying off creditors quickly, and vice versa. An unusually high ratio may suggest that a firm is not utilizing the credit extended to them, or it could be the result of the company taking advantage of early payment discounts. A low payables turnover ratio could indicate that Microsoft is having trouble paying off its bills or that it is taking advantage of lenient supplier credit policies. Liquidity Ratios They are a measure of a firm’s ability to meet its short-term obligations. The level of liquidity differs from company to company. 1. Current Ratio This ratio measures the company’s assets against its liabilities. The current ratio shows if the company can pay off its short-term liabilities in an emergency by liquidating its current assets. 2017 2016 2015 2014 2013 2012 Current Ratio 3.12 2.35 2.50 2.50 2.71 2.60 Industry – 2.82 2.75 2.52 2.56 2.28 Microsoft Corp.’s current ratio deteriorated from 2015 to 2016 but then improved from 2016 to 2017. Further investigation is required if a company has a consistently low current ration. A ratio below 1 indicated that even if a firm liquidates all its current assets, it would still be unable to cover its liabilities. Fortunately, Microsoft’s current ratio has been stable and positively consistent. A higher ratio indicates a higher level of liquidity and decreased chances of a cash squeeze. 2. Quick Ratio It is more stringent than current ratio. It considers the cash, short-term marketable securities and accounts receivable against the company’s current liabilities. 2017 2016 2015 2014 2013 2012 Quick Ratio 2.96 2.22 2.30 2.31 2.53 2.41 Industry – 2.66 2.55 2.28 2.34 2.07 Microsoft Corp.’s quick ratio deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. The thought behind the quick ratio is that certain line items, such as prepaid expenses, have already been paid out for future use and cannot be quickly and easily converted back to cash for liquidity purposes.The major line item excluded in the quick ratio is inventory, which can make up a large portion of current assets but may not easily be converted to cash. During times of stress, high inventories across all companies in the industry may make selling inventory difficult. In addition, if company stockpiles are overly specialized or nearly obsolete, they may be worth significantly less to a potential buyer. Solvency Ratios On the other hand, solvency ratios determine a firm’s ability to meet its longer-term obligations. This analysis provides insights into the company’s capital structure along with the level of financial leverage they might be using. 1. Debt-to-Equity This ratio measures the amount of debt capital a company uses in relation to the amount of equity capital utilized. 2017 2016 2015 2014 2013 2012 Debt-to-Equity 1.19 0.75 0.44 0.25 0.20 0.18 Industry – 0.42 0.39 0.32 0.32 0.32 A ratio of 1.00x indicates that the firm uses the same amount of debt as equity and means that creditors have claim to all assets, leaving nothing for shareholders in the event of a theoretical liquidation. The value of Microsoft’s debt-to-equity ratio is increasing consistently which is not a very positive sign. This indicates a rising degree of debt financing. 2015 onwards Microsoft’s ratio has been higher than the industry standard as well. Lower ratios (0.4 or below) are considered better debt ratios for a firm. Microsoft has been able to pay shareholders dividends every year since 2003 since fewer interest and debt payments contest for the same cash pile. While Microsoft stock may not have performed as well as some of its peers over the years, the so-called bird-in-hand dividend payments should have compensated shareholders no less than what larger capital gains would have, thanks in part to the company’s successful debt management. 2. Debt-to-capital It measures the amount of a company’s total capital (liabilities plus equity) that is provided by debt (interesting bearing notes and short- and long-term debt). 2017 2016 2015 2014 2013 2012 Debt-to-Capital 0.54 0.43 0.31 0.20 0.17 0.15 Industry – 0.30 0.28 0.24 0.24 0.24 Here, again a high ratio means a higher level of financial risk and leverage. We can see that Microsoft’s debt-to-capital ratio is on the rise each year but a very slow rate. As of 2015 onwards, Microsoft’s ratio is even higher than the industry which means that the players in the sector are better at controlling their debt financing. On the flip side, although financial leverage creates additional financial risk by increased fixed interest payments, the main benefit to using debt is that it does not dilute ownership. In theory, earnings are split among fewer owners, creating higher earnings per share. However, the increased financial risk of higher leverage may hold the company to stricter debt covenants. These covenants could restrict the company’s growth opportunities and ability to pay or raise dividends. Profitability Ratios These ratios measure a firm’s ability to earn an adequate return and are perhaps the most widely used ratios in investment analysis. 1. Gross Profit Margin This is simply an indication of the percentage of revenue available to cover operating and other expenditures. Gross Profit Margin 2017 2016 2015 2014 2013 2012 Microsoft 61.91% 61.58% 64.70% 68.82% 73.99% 76.22% Apple 38.47% 39.08% 40.06% 38.59% 37.62% 43.87% Google – 61.08% 62.44% 61.07% 56.78% 58.88% Microsoft Corp.’s gross profit margin deteriorated from 2015 to 2016 but then slightly improved from 2016 to 2017. For majority of the firms, gross profit margin will suffer as competition increases. If a company has a higher gross profit margin than is typical of its industry, it likely holds a competitive advantage in quality, perception or branding, enabling the firm to charge more for its products. We can see that Microsoft has relatively very high gross profit margins as compared to its major competitors. Microsoft holds a competitive advantage in product costs due to efficient production techniques, economies of scale and first mover advantages. Technology companies with unique products can usually achieve relatively high gross margins because of the pricing power accompanying such products. On a trailing 12-month basis, Microsoft has a gross margin of almost 65%, compared to about 40% for Apple and more than 50% for IBM, with both companies also having distinctive brands and products. 2. Operating Profit Margin This is a profitability ratio calculated as operating income divided by revenue.Operating margin examines the relationship between sales and management-controlled costs. 2017 2016 2015 2014 2013 2012 Operating Profit Margin 24.82% 23.65% 19.41% 31.97% 34.38% 29.52% Industry – 25.14% 23.39% 27.14% 26.98% 25.76% Microsoft Corp.’s operating profit margin improved from 2015 to 2016 and from 2016 to 2017. Increasing operating margin is generally seen as a good sign, but investors should simply be looking for strong, consistent operating margins. 3. Return on Equity (ROE) ROE measures net income less preferred dividends against total stockholder’s equity. 2017 2016 2015 2014 2013 2012 Return on Equity 29.29% 23.33% 15.23% 24.59% 27.69% 25.58% Industry – 21.83% 22.66% 22.74% 23.34% 21.82% Microsoft Corp.’s ROE improved from 2015 to 2016 and from 2016 to 2017.This ratio measures the level of income attributed to shareholders against the investment that shareholders put into the firm. It considers the amount of debt, or financial leverage, a firm uses. Financial leverage magnifies the impact of earnings on ROE in both good and bad years. The ROE issue is really a case in point for Microsoft, which illustrates the potential downside for ROE due to mediocre business acquisitions. 4. Return on Assets (ROA) ROA is yet another measure of a firm’s ability to efficiently utilize its assets. 2017 2016 2015 2014 2013 2012 Return on Assets 8.80% 8.67% 6.92% 12.81% 15.35% 14.00% Industry – 10.47% 10.97% 11.62% 12.61% 11.53% Microsoft Corp.’s ROA improved from 2015 to 2016 and from 2016 to 2017.A high ratio means that the company can efficiently generate earnings using its assets Microsoft’s ROA value has been lower than the industry average 2015 and beyond. 


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