Ratio Analysis And Statement Of Cash Flows

Ratio Analysis and Statement of Cash Flows

Financial ratios are "just a convenient way to summarize large quantities of financial data and to compare firms' performance" (Brealey & Myer & Marcus, 2003, p. 450). Financial ratios are very useful tools in order to determine the health of a company, help managers to make decision, and help to compare companies that belong to the same industry in order to know about their performance.

Home Depot and Lowe's are two home improvement chains in the United States. Home Depot is the leading company in this industry followed by Lowe's as the second largest. This paper uses financial ratios to compare these companies regarding operating profitability, asset utilization, and risk management in the years 2005 and 2006. The evaluation compares the performances of these stores against the industry.

Operating Profitability

Home Depot closed the fiscal year of 2006 reporting that its sales were $90.8 billion, which was a 10% increase from fiscal year 2005. The Home Depot's operating profit was $27,427 million for 2005 and $29,907 million for 2006 (MarketWatch, 2007). Lowe's closed the fiscal year of 2006 reporting sales of $46.9 billion, an 8.5% increase compared to fiscal year 2005. Lowe's gross operating profit was $16,273.00 million for 2005 and $12,307.00 million for 2006 (MarketWatch, 2007). Both companies increase sales from the previous year. Home Depot had greater sales and higher operating profit than Lowe's.

Profitability Ratios

Profitability ratios determine the companies' earnings. The Net Profit Margin is calculated by dividing net income by sales. Home Depot's portion of revenue from profits equaled 7.2% in 2005 and 6.3% in 2006. Lowe's portion of revenue from profits equaled 6.4% in 2005 and 6.6% in 2006. Home Depot had a decreased in profit margin while Lowe's increased its profit margin in 2006.

* Home Depot's Net Profit Margin for 2005 =

* Home Depot's Net Profit Margin for 2006 =

* Lowe's Net Profit Margin for 2005 =

* Lowe's Net Profit Margin for 2006 =

Another measure of profitability is the return on equity which is calculated by net income/average equity. This measure shows that Home Depot had a better return on equity in 2005 while Lowe's had a better return on equity in 2006. Nevertheless, Home Depot reinvested earnings to generate additional earnings in a better way than Lowe's in 2006.

* Home Depot's Return on Equity 2005 =

* Home Depot's Return on Equity 2006 =

* Lowe's Return on Equity 2005 =

* Lowe' s Return on Equity 2006 =

Asset Utilization

Efficiency ratios determine how efficiently companies are using assets. A high efficiency score shows a company is working close to capacity and is useful for comparing to companies in the same industry (Brealey & Myer& Marcus, 2003).

Efficiency Ratios

The asset turnover ratio shows how well companies are using assets. The ratio is calculated by dividing sales by average total assets. This ratio shows that both companies were using their assets more efficiently in 2005 than in 2006. Home Depot's turnover ratio is higher than Lowe's in 2006 so Home Depot uses assets better.

* Home Depot's Turnover Ratio 2005 =

* Home Depot's Turnover Ratio 2006 =

* Lowe's Turnover Ratio 2005 =

* Lowe's Turnover Ratio 2006 =

The inventory turnover ratio helps managers to monitor "the rate at which the company is turning over its inventories" (Brealey & Myer & Marcus, 2003, p. 457). Inventory turnover = cost of goods sold / average inventory.

Home Depot's 2005 = 54191 / ((9076 + 10076) /2) = 3.84

Home Depot's 2006 = 61054 / ((11401 + 12822)/2) = 5.04

Lowe's 2005 = 24165 / ((4584 + 5982) /2) = 3.19

Lowe's 2006 = 30729 / ((6635 + 7244) /2) = 4.43

Risk Management

The risk of investing in a company can be determined by some leverage ratios. Leverage ratios measures how much financial leverage the companies have take on (Brealey & Myer & Marcus, 2003). Home Depot's and Lowe's risk management can be analyzed by calculating their leverage ratios.

The long-term debt ratio measures the long-term debt to total long-term capital. Home Depot long-term debt ratio in 2005 was 0.9 and 0.32 in 2006. Lowe's long-term debt ratio was 0.20 in 2005 and 0.22 in 2006. It can be concluded that in Home Depot, 32 cents of every dollar of long-term capital is in the form of long- term debt in 2006 and in Lowe's, 22 cents of every dollar of long-term capital is in the form of long-term