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Financial ratios are used by companies, investors, and by students. The purpose of financial ratios is to determine the whether a company is able to pay off debts, use its assets to regenerate cash, or determine how much profit a company is making from every dollar they make. A study of two internet giants, Google and Yahoo!, will show that although one company is not generating as much as the other is, there are ways that it can improve future cash flows.
Current RatioThe current ratio of an organization shows its ability to meet its short-term financial obligations (Investor Words, 2009), by taking the current assets divided by current liabilities. At the end of 2008, Google’s ratio was $8.77 million and $8.49 million at the end of 2007 (Google Finance, 2009). At the end of 2008, Yahoo’s ratio was $1,705.02 million and $1.41 million in 2007 (MSN Money, 2009), showing a growth. When comparing the financial statements of Google and Yahoo!, neither of the two had current liabilities greater than current assets, so both companies do not face the risk of not being able to meet short-term financial needs. However, the current ratio of Yahoo! is significantly higher than Google, therefore Yahoo! is considered more liquid or possesses greater assets that can be easily converted into cash if need be.
Quick RatioThe quick ratio, or acid-test ratio, is an alternative form of the current ratio. It also measures the short-term liquidity of an organization; however, it is a slight more accurate, because it accounts for inventories. To find the quick ratio, take current assets minus inventories and divide by current liabilities (Investopedia, 2009). The financial statements of both Google and Yahoo! show zero inventories for 2008 and 2007. Therefore, since the only difference in the current ratio and quick ratio is inventories, then the current ratio and the quick ratio are equal in this case.
Times-Interest EarnedAlso known as the interest coverage ratio or fixed-charged coverage, the timesinterest ratio (TIE) is “a metric used to measure a company’s ability to meet its debtobligations” (Investopedia, 2009, 1). A company’s inability to repay debts owed may result in bankruptcy. The formula to determine times interest earned is as follows.
EBIT (Earnings Before Interest and Taxes)TIE = —————————————————–Total Interest PayableThe two companies in study, Google and Yahoo!, have times interest earned figures that vary greatly with Yahoo trailing behind Google. Google has exceeded Yahoo by a difference of 1.56% for the year 2008 and 1.66% for the year 2007. After completing the formula, the figures are:20082007Google1.571.92Yahoo0.010.26By reading the figures, an analyst will see that Google is able to meet its debt obligations because its figure for each year is greater than 1 (one). Unfortunately, for Yahoo, a figure under 1 could discourage potential investors from initiating business dealings.
Debt-To-Equity RatioA debt to equity ratio is used to measure a company’s solvency and is closely watched by banks and investors. A high debt to equity ratio could mean a company is at risk of not being able to pay debts on time. A company calculates a debt to equity ratio by dividing its total liabilities by shareholders’ equity. Google’s total liabilities in 2008 were $3,528.71 million and its shareholders equity $28,238.86 million, which resulted in 12% debt to equity ratio. Yahoo’s total liabilities in 2008 were $2,438.91 million and its shareholders equity $11,250.94, which resulted in 22% debt to equity ratio. In comparing Google’s and Yahoo’s debt to equity ratios, Yahoo has a much higher ratio and therefore presents more of a risk. Based on this calculation, Yahoo carries more debt in relation to its assets.
By performing a trend analysis using the data gathered for the past three years it would predict what could happen in future productivity of both companies. Google’s debt to equity ratios from 2008 through 2005 was 12%, 12%, 8% and 9%. Yahoo’s debt to equity ratios in the same period was 22%, 24%, 26% and 26%. In analyzing Google’s debt to equity, its ratio increases through the years, which signify an increase in its debt after 2 years. In contrast, Yahoo’s ratio decreased as over the three-year analysis, which shows a decrease for debts the company carries in relation to its assets.
Net Profit MarginThe profit margin relates how much profit a company makes for every dollar it makes in revenue. To calculate a company’s net profit margin, net income after taxes is divided by its revenue. In 2008, Google’s net income after taxes was $4,226.86 million and its sales were $21,795.55 million, which resulted in a net profit margin of 19.4%. In the same year, Yahoo’s net income after taxes was $-166.92 million and its sales were $7,208.50 million which resulted in a negative 2% net profit margin. The higher a company’s net profit margin compared to its competitors the better. In comparing Google’s and Yahoo’s net profit margin, it is apparent that Google had a much more profitable 2008 than Yahoo.
Continuing the trend analysis for both companies to calculate net profit margin for the years 2008 through 2005 provides an interesting outlook on both companies’ profitability. Google’s net profit margin from 2008 through 2005 was 19.4%, 25.3%, 29%, and 23.9%. Yahoo’s net profit margin from 2008 through 2005 was a negative 2%, 7%, 10%, and 34%. Google’s net profit margin seemed to stay consistent until 2008 when its margin sunk to 19.4%, which was well above Yahoo’s margin of negative 2%. In 2008 the United States government stated that December 2007 was the beginning an economic recession. This analysis is a great example of using a trend analysis and taking account of current events.
Return on EquityFinancial ratios analyze the financial performance of an organization. The management effectiveness of organizations such as Google Inc. and Yahoo! Inc can be measured by factors such as the return on equity (ROE) and the total return on assets. The return on equity is the ratio that measures an organization’s ability to generate earnings from investments dollars; it is the most important to stockholders. In 2007 and 2008, Google Inc. had a ROE of 19% and 15% respectively in comparison to Yahoo! Inc.’s ROE of 9% and 8%.
Although Google’s ROE declined by 4% in 2008, the average percentages indicate that over the past two years, Google had a stronger profitability margin when compared to Yahoo! Inc. A ROE of 15% or higher is considered strong; Yahoo! Inc.’s profitability margin over the past two years has been relatively low, which shows that Yahoo! is no match for Google when it comes to generating earnings per its investment dollars.
Total Assets TurnoverThe total assets turnover measures the efficiency of a company and its effectiveness to produce income from reinvestments of dollars back into an organization. In 2007 and 2008, Google had a total asset turnover 69% and 59% respectively. For the two-year period combined, Google generated an average of 64% return on its money, which indicates that Google has the assets needed to generate earnings.
In total return on assets, Yahoo! is not trailing far behind Google. Yahoo! had a total asset turnover of 57% in 2007 and 53% in 2008. This was an average total asset turnover of 55% for the two-year period. As with Google, Yahoo! Inc. has the ability to use assets to generate necessary earnings. The high return numbers for Google and Yahoo! prove that both companies have earning power that will result in creating shareholder wealth and value.
Return on AssetsReturn on assets (ROA), or return on investment, ratio “gives an idea as to how efficient management is at using its assets to generate earnings” (Investopedia, 2009, 1). The return of assets ratio is used to determine the strength of assets in a company he/she has invested in or is considering. Additionally, “the ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income” (2009, 4). The formula for ROA used to determine the figures in this study is as follows.
Net IncomeROA = —————Total AssetsDetermining the ROA figure for Google and Yahoo is reasonable, as the two companies are both internet giants. However, Google still overpowers Yahoo according to the calculated ROA figures. Google was in the lead by 1.64% in 2008 and by 0.12% in 2007. The actual figures are:20082007Google1.670.17Yahoo0.030.05Although the figures prove that Yahoo is not as successful as Google, the company still remains a competitor. Its higher ROA figure means that Google “is earning more money on less investment” (Investopedia, 2009, 4). Investors who are not afraid to take risk or who see potential in Yahoo may consider investing in the company despite its lower ROA figures.
Cash Generated From Operating, Investing, and Financing ActivitiesThe cash flow is generated in three different ways- operating activities, investing activities, and financing activities. The three activities are represented on the cash flow statement and reflects cash generated and paid because of a company’s core business function (Financial Education 2007).
Google ranks number one in cash flow in comparison to Yahoo. Google ended 2007 and 2008 with free cash flow in the amount of $3.37 billion and $5.5 billion respectively. Yahoo! ended 2007 with free cash flow in the amount of $1,316.6 million and $1,205.4 million in 2008. Yahoo struggles to match Google’s massive cash flow.
According to Google’s cash flow statement for 2007 and 2008, Google’s cash flow from its operating activities totaled $5.7 billion and $7.85 billion (Google Inc. 2009). The increase of Google’s operating activities in 2008 over 2007 shows that Google generates its cash flow from company’s operations.
In 2007 and 2008, cash from Google’s financing activities totaled $403.1 million and $87.6 million (Google Inc. 2009). Cash from financing activities is cash flow that takes place between organizations and stockholders and includes loans from bondholders and other creditors (Financial Education 2007). According to Google’s numbers, the company is under no risk since the company does not rely solely on outside sources to generate its cash flow.
Cash flow from Google’s investing activities negatively increased in 2008 as it did in 2007. In 2007, the company had net investing activities of ($3.68) billion and ($5.32) billion in 2008 (Google Inc. 2009) – a negative increase of $1.6 million. Based on Google’s history and the company’s ability to generate cash flow, the negative increase in investing activities may be attributed to long-term investments and purchases that will ultimately generate cash flow.
In comparing the 2007 and 2008 fiscal year of Google to Yahoo!, it appears that Google still remains Yahoo!’s top competitor as in past years. At year-end 2008, Yahoo! had a total cash flow provided by operating activities of $1,880.2 million and $1,918.9 in 2007. This was a decrease in cash flow of 2% over 2007 (Seyboldonline 2009). As with Google, cash used for Yahoo!’s investing activities continue to negatively increase. In 2007 and 2008 investing activities for Yahoo! totaled ($1,311,783) million and ($572.5) million respectively (Yahoo! Inc., 2009) causing Yahoo!’s cash flow to decrease twice as much over 2007. Based on Yahoo!’s past financial history, this could be an indication that Yahoo! incurred losses from investments made in an effort to generate more cash flow to compete with Google.
Over the past two years, 2007 and 2008, Yahoo! has managed to generate its cash flow from its operations. The company’s cash flow from financing activities of $322.4 in 2008 million and $1,442 million in 2007 compared to its cash flow from company operations (Yahoo! Inc. 2008) is an indication that Yahoo! is following the financial pattern of Google and is not depending on it financing activities to generate its cash flow.
Business Changes that Altered Cash UseBusiness changes that occurred may have altered the use of cash from one year to the next. The financial statements of Google have showed that the company has had steady growth. Revenue and profits have increased, as well as administrative, research and development expenses. Slight operating expenses have increased from 2007 to 2008. The cash flow statement shows cash from investing activities remained in the negative only greater. Additionally, more taxes were paid in 2008 than in 2007; however, there was no change in net cash.
The financial statements of Yahoo!, shows that short-term and long-term investments have drastically increased. The cash flow statement shows that Yahoo! issued or repurchased capital stock. Google and Yahoo! are constantly striving to beat out competitors using innovation and new products and services. Therefore, both companies invest heavily in research and development. Google has launched a new Android Smartphone (Kolakowski, 2009), while Yahoo! is going “green” (TriplePundit, 2009). These innovations, business practices and changes could require the use of cash.
Discussion of Cash Generated in a Sustainable Manner
The use of ratios and trend analysis alerts viewers of Google’s and Yahoo’s financial health. Google has maintained its profitability in the double-digit percentiles, although it slightly increased its debt. Yahoo has not been doing as well as Google over the past three years. Although Yahoo decreased its debt to equity ratio by 4%, its net profit went from 34% to negative 2%, quite a drastic fall. In comparing the two internet giants, it is obvious that Google generating cash in a much more consistent manner than Yahoo.
Recommendations to Improve Cash FlowsKeeping track of any cash that flows of any company is important if managers want to achieve financial goals. While the task may require a daily count of receipts, there are several recommendations a company can improve its cash flows.
Before any company tries to improve its cash flow, it is important that managers determine how cash flows through the company. Inflows are cash collections added to the company’s existing cash while cash leaving the company are its outflows (Toolkit Media Group, 2009). Cash flow will improve when companies collect cash owed to them. The longer cash stays uncollected, the less cash the company has to reinvest. Companies can offer incentives such as free specialized services or discounts on products. This move will encourage consumers to pay debts on time and as agreed.
Google and Yahoo are similar companies offering the same services such as free email, quick searches, and up-to-date news reports. Google leads in the industry as most students and adults searching the internet for gifts or solutions to everyday problems. Although Google leads the way, Yahoo can improve its cash flows by becoming more appealing to consumers and investors alike. Adding new products features like detailed street maps, easy access to personal accounts such as emails, and collaborating with smaller companies that offer wireless internet connections may improve cash flows for Yahoo.
ConclusionAs the study and calculations shows, the financial position of Google greatly exceeds that of Yahoo. While both companies offer the same products, Yahoo can improve its cash flows by offering similar products that Google offers. While the ratios can somewhat predict future financial gains or losses, consumers and the economy will have the final say on how cash is invested into the company. The two internet giants will remain competitors for as long as studies such as these are needed by managers, students, and investors.
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