CB 3041

Financial Statement Analysis

Lecture 5
Case Study
 Ratio Analysis
Analyze Profitability and Risk
Case Study
 Learning Objective
 Visualize the process of assessing financial
performance through an analysis of a publicly
traded actual company, Walmart

 Pay special attention to the interpretation of

various financial ratios
 About Walmart
 Walmart is the world’s largest retailer. It employs an
“everyday low price” strategy and operates stores as three
business segments: Walmart Stores U.S., International,
and Sam’s Club.
 Walmart Stores U.S.: Represents 62.3% of all sales in 2015, and
carries a variety of grocery, housewares, electronic equipment,
health and beauty products. Operates in all states and online stores.
 International: Subsidiaries in Argentina, Brazil, Canada, Chile,
China, India, Japan, Mexico, and the United Kingdom. Take a
similar strategy to that of the Walmart U.S. segment.
 Sam’s Club: Membership club warehouses. Offer bulk displays of
brand-name merchandise and provide discounted prices.
Balance Sheet (amounts in millions)
Balance Sheet (continued, amounts in millions)
Income Statements (amounts in millions)
Statements of Cash Flows (amounts in millions)
 Summary of Performance
$ mil

2015 2014 2013

Total Sales 482,130 485,651 476,294

Gross Profit 121,146 120,565 118,225

Operating Profit 24,105 27,147 26,872

Net Income 15,080 17,099 16,695

Net Income to
14,694 16,363 16,022
Common Shareholder
 Summary of Performance
$ mil

2015 2014 2013 2012

Total Asset 199,581 203,490 204,751 203,105

Common Share
80,546 81,394 76,255 76,343
Equity
Total Equity 83,611 85,937 81,339 81,738

Interest Expense 2,548 2,461 2,335

One-Time
Gains/Losses 285 144
(Net of Tax)
 Profitability – ROA

2015 2014 2013

Return on Assets
[(Net Income + Interest Expense * 8.30% 9.16% 8.93%
(1- Tax)] / Avg. Total Assets

Profit Margin for ROA

[(Net Income + Interest Expense * 3.47% 3.85% 3.82%
(1-Tax)] / Sales

Asset Turnover 2.39 2.38 2.34

(Sales / Avg. Total Assets)

Note: Tax rate 35%

 Profitability – ROA
(Exclude nonrecurring items)
2015 2014 2013
Return on Assets
[(Net Income + Interest Expense * 8.30% 9.02% 8.86%
(1- Tax) ± one-time losses or gains *
(1-Tax)] / Avg. Total Assets

Profit Margin for ROA

[(Net Income + Interest Expense * 3.47% 3.79% 3.79%
(1- Tax) ± one-time losses or gains *
(1-Tax)] / Sales

Asset Turnover 2.39 2.38 2.34

(Sales / Avg. Total Assets)

Note: Tax rate 35%

 Profitability – ROA
Profit Margin Decomposition
2015 2014 2013
Gross Margin 25.13% 24.83% 24.82%
(Gross Profit / Sales)
Operating Margin 5.00% 5.59% 5.64%
(Operating Profit / Sales)

SG&A Expense to Sales 20.13% 19.24% 19.18%

Interest Expense to Sales 0.53% 0.51% 0.49%

Effective Tax Rate 30.31% 32.20% 32.87%
(Income Taxes / Pre-tax Income)
 Profitability – ROA
Assets Turnover Decomposition
2015 2014 2013
A/R Turnover 77.75 72.19 70.85
(Sales / Avg. AR)
Days A/R Outstanding 4.69 5.06 5.15
Inventory Turnover
(Cost of sales / Avg. 8.06 8.11 8.08
Inventory)
Days Inventory Outstanding 45.30 44.99 45.19
Fixed Asset Turnover 4.14 4.14 4.06
(Sales / Avg. Net PP&E)
 Profitability – ROE
2015 2014 2013
Return on Equity
(Net Income Available to Common 18.15% 20.76% 21.00%
Shareholders) / Avg. Common Share Equity

Profit Margin for ROE

(Net Income Available to Common 3.05% 3.37% 3.36%
Shareholders) / Sales

Asset Turnover 2.39 2.38 2.34

(Sales / Avg. Total Assets)

Financial Leverage
(Avg. Total Assets / Avg. Common Share 2.49 2.59 2.67
Equity )
 Profitability – ROE
(Exclude nonrecurring items)
2015 2014 2013
Return on Equity
(Net Income Available to Common 18.15% 20.40% 20.81%
Shareholders ± one-time losses or gains
* (1-Tax)) / Avg. Common Share Equity

Profit Margin for ROE

(Net Income Available to Common 3.05% 3.31% 3.33%
Shareholders ± one-time losses or gains
* (1-Tax)) / Sales
 Comments on Profitability
 The ROA increased from 8.93% in 2013 to 9.16% in
2014, then decreased to 8.30% in 2015.
 These fluctuations reflect a similar increase and decrease
in the profit margin for ROA across the three years
(3.82%  3.85%  3.47%).
 Total assets turnover is relatively stable, but in slightly
increasing trend (2.34  2.38  2.39).
 Comments on Profitability (continued)
 Profit margin for ROA: The common-size analysis for
income statement suggests reasons for its change: Gross
Margin continually increased (24.82% 24.83% 
25.13%), but Operating Margin continually decreased
(5.64%  5.59%  5.00%), which is driven by increasing
SG&A Expense to Sales (19.18%  19.24%  20.13%)
 The benefit of increased Gross Profit (24.82%  25.13%)
is offset by increased SG&A Expense (19.18% 20.13%),
with a net effect being – 0.64%, which drives the decline in
ROA Profit Margin from 2013 to 2015 (3.82%  3.47%).
 Comments on Profitability (continued)
 Reasons for the increase in Gross Margin:
• Lower inventory shrinkage and less markdown activity as a result
of more effective merchandising in the Walmart U.S. segment.
• Walmart U.S. segment yields a higher Gross Margin than
Walmart International or Sam’s Club segments. And there is
higher growth in store numbers for the Walmart U.S. segment.
Thus, it suggests a shift in sales mix toward higher-margin
products through the Walmart U.S. segment.
• Given Walmart’s increased size and bargaining power with
suppliers, there are more favorable purchase prices. Walmart
credits worldwide sourcing through its distribution centers as part
of the reason for the decreased purchase prices.
 Comments on Profitability (continued)
 Reasons for the increase in SG&A Expense to Sales:
• Increase in advertising and other promotion costs under the
increasingly competitive environment, especially as Walmart
expands.
• Increase in compensation costs. Walmart has come under attack in
the press for its low wages. In response, Walmart raised the wages
of its employees. The financial report attributes increased
operating expenses to “an increase in wage expense at the Walmart
U.S. segment due to the new associate wage structure and
increased associate hours to improve the overall customer
experience.”
• Increase in coordination costs as the company expands
internationally. The financial report indicates that continued
expenditures in digital retail and information technology
contributed to the increase in operating expenses relative to sales.
 Comments on Profitability (continued)
 Profit margin for ROA:
 Interest Expense to Sales remains stable with small increasing
trend (0.49%  0.51%  0.53%).
 Effective Tax Rate shows declining trend (32.9%32.2%30.3%)
 Walmart does not clearly identify the reason for this declining
trend. All that is noted in the financial report is, “Our effective tax
rate fluctuates from period to period and may be impacted by a
number of factors, including changes in our assessment of certain
tax contingencies, valuation allowances, changes in laws,
outcomes of administrative audits, the impacts of discrete items
and the mix of earnings among our U.S. and international
operations.”
 Comments on Profitability (continued)
 Total Assets Turnover:
 The change in total assets turnover (2.34  2.38  2.39) reflects a
combination of increasing accounts receivable turnover
(70.8572.1977.75) combined with relatively flat inventory
turnover (8.088.118.06) and fixed assets turnover
(4.064.144.14).
 Accounts receivable is a relatively small fraction of the total
assets, so the big increase in accounts receivable turnover has
little effect on the total asset turnover.
 Comments on Profitability (continued)
 The ROE is stable between 2013 and 2014 at 21.00% and
20.76%, but fall to 18.15% in 2015.
 This fall reflects both the decrease in profit margin for
ROE (3.36%  3.37%  3.05%) and the decrease in
financial leverage (2.67 2.59  2.49).
 The decline in profit margin for ROE is consistent with
the decline in profit margin for ROA.
 Comments on Profitability (continued)
 Financial leverage :
 The decrease in financial leverage results from a combination of
decreased long-term debt (including current maturities) and
short-term borrowing, slightly offset by increased capital lease
and financing obligations (lower numerator).
 In addition, the increased level of retained earnings contributes
significantly to the decline in financial leverage (higher
denominator).
 Short-term Liquidity Risk
2015 2014 2013

Current Ratio (Current Assets / 0.93 0.97 0.88

Current Liabilities)

Quick Ratio 0.22 0.24 0.20

(Quick Assets / Current Liabilities)

Cash Ratio 0.13 0.14 0.10

(Cash / Current Liabilities)

CFO to Current Liability 0.42 0.42 0.33

(CFO / Avg. Current Liabilities)
 Short-term Liquidity Risk
2015 2014 2013
A/R Turnover 77.75 72.19 70.85
(Sales / Avg. AR)
Days A/R Outstanding 4.69 5.06 5.15
Inventory Turnover 8.06 8.11 8.08
(Cost of sales / Avg. Inventory)
Days Inventory Outstanding 45.30 44.99 45.19
A/P Turnover 9.37 9.64 9.51
(Purchases / Avg. AP)

Days A/P Outstanding 38.95 37.87 38.37

Cash Conversion Cycle 11.05 12.17 11.98

 Long-term Solvency Risk
2015 2014 2013
Liabilities to Assets 0.58 0.58 0.60
(Total Liabilities / Total Assets)
Liabilities to Equity
(Total Liabilities / Total Shareholders’ 1.39 1.37 1.52
Equity)
Long-term Debt to Equity
(Long-Term Debt / Total Shareholders’ 0.53 0.51 0.55
Equity)
Interest Coverage Ratio
[(Net Income + Interest Expense + Tax 9.49 11.08 11.56
Expense)] / Interest Expense
 Bankruptcy Risk: Altman Z Score
2015 2014 2013
Altman Z Score
(1.2*Working Capital
+ 1.4*Retained Earnings +
3.3*EBIT + 0.6*Market
Leverage + 1.0* Sales) 4.53 4.81 4.41

all variables are scaled by total assets

except for leverage
 Comments on Risk
 Short-Term Liquidity Risk:
 Walmart’s short-term liquidity ratios suggest fluctuations but
little change over the three-year period.
 A current ratio below 1.0 and a quick ratio around 0.2 might
appear troublesome for some firms.
 However, Walmart is essentially a cash business since it turns
over accounts receivables and inventory very quickly (every 5
and 45 days on average, respectively). Thus, its inventory is
almost as liquid as the receivables of most other businesses.
 Its cash flow from operations to current liabilities is about 40%,
which suggests a healthy retailing firm.
 Overall, Walmart subject to very low short-term liquidity risk
 Comments on Risk (continued)
 Long-Term Solvency Risk:
 Walmart’s total liabilities to total assets ratio decreased slightly
between 2013 and 2015 (0.60  0.58  0.58). Similarly, the long-
term debt ratio decreased (0.55  0.51  0.53), consistent with a
slight shift in Walmart’s capital structure away from long-term
borrowings.
 This is understandable given anticipated increases in interest
rates during that period.
 Its interest coverage ratio is very high, although it has steadily
decreased (11.62  11.19  9.49).
 Altman’s Z score is far above cut-off of 2.99 for healthy firms.
 Thus, long-term solvency risk is also low for Walmart.
 Market Ratios
2015 2014 2013
EPS
[Net income to common shares /
weighted avg. # of common 4.58 5.07 4.90
shares]
Price-Earnings 14.74 16.76 15.24
(Stock price / EPS)

Dividend Yield 2.91% 2.25% 2.51%

(Dividend per share / Stock price)

Dividend Payout 0.43 0.38 0.38

(Dividend per share / EPS)

*The weighted average shares outstanding: 3,207 (2015), 3,230 (2014), 3,269 (2013)
*Closing stock prices: 67.50 (2015), 84.98(2014), 74.68(2013)
Cross-sectional Comparison-Competitors
 Carrefour, headquartered in France, at that time, is the
Europe’s largest retailer and the second largest retailer in
the world. It has 4 segments based on store formats, which
include the following (number of stores in parentheses):
 Hypermarkets (1,481): Offer a wide variety of household and food
products at competitively low prices.
 Supermarkets (3,462): Sell traditional grocery products under the
Market, Bairro, and Supeco store brands.
 Convenience Stores (7,181): Offer a limited variety of food
products in smaller stores at aggressively low prices.
 Cash & Carry (172): Provides professional restaurant and shop
owners with food and non-food products at wholesale prices.
Cross-sectional Comparison-Competitors
 Target, headquartered in the United States, is a retailer
that offers a wide variety of clothing, household,
electronics, and entertainment.
 Attempt to differentiate itself from Walmart by pushing
trendy merchandising with more brand-name products.
Target emphasizes customer service, referring to its
customers as “guests” and focusing on the theme of
“Expect More, Pay Less.”
 Attempts to differentiate itself from competitors by
providing wider aisles and a less cluttered store appearance.
 Discontinued its operations in Canada in 2014, which led to
a significant nonrecurring loss in that year.
 Target
Walmart
 Cross-sectional Comparison on ROA

For cross-sectional analysis, you can compare only one year

for the group project to ease the work
 Cross-sectional Comparison on ROA

For cross-sectional analysis, you can compare only one year

for the group project to ease the work
 Cross-sectional Comparison on ROA
 Walmart vs. Target:
 Walmart’s ROA is more steady, ranging from 8% to 9%. Target’s
ROA spans a wider range and is disproportionately affected by a
large charge for closing its operations in Canada in 2014.
 You can adjust the non-time charge for Target before comparison.
 Cross-sectional Comparison on ROA
 Walmart vs. Target:
 For COGS, Walmart is 75%-76% of sales, higher than Target’s
70%. Walmart’s COGS would be even higher if benchmarked
against sales excluding the other revenues from membership fees.
 Walmart has lower SG&A expense to sales than Target
 Cross-sectional Comparison on ROA
 Walmart vs. Target:
 Walmart has higher COGS than Target:
 Target places greater emphasis on selling trendy, brand-name
products, which allows it to obtain a higher markup on cost.
In addition, it offers a more pleasant shopping experience,
which should increase customers’ willingness to pay higher
prices.
 In contrast, Walmart emphasizes an everyday low-price
strategy. Even if, as is likely, Walmart can obtain more
favorable purchase terms from suppliers because of its large
size, it chooses to pass along the purchase price advantage to
customers through lower selling prices.
 Cross-sectional Comparison on ROA
 Walmart vs. Target:
 Walmart has lower SG&A expense than Target:
 Target incurs more costs to its staff to make the shopping
experience easier and more pleasant for customers. In
contrast, Walmart started to improve employee compensation
gradually during that period.
 Target is considerably smaller than Walmart, which does not
allow Target to realize economies of scale on fixed SG&A
expenses at the same level as Walmart.
 Cross-sectional Comparison on ROA
 Walmart vs. Target:
 Walmart has higher Assets Turnover than Target:
 Target’s accounts receivable are so immaterial that no
separate disclosure is made
 Walmart’s faster inventory turnover could result from a
larger proportion of sales from grocery products. It also
might result from more effective inventory control systems
 Walmart’s higher fixed asset turnover could result from
higher sales per square foot since it does not strive as Target
to provide wide aisles and improve shopping experience
 Cross-sectional Comparison on ROA
 Walmart vs. Carrefour:
 Walmart’s higher ROA over Carrefour results from higher Profit
Margins for ROA and faster Assets Turnover.
 Cross-sectional Comparison on ROA
 Walmart vs. Carrefour:
 Walmart’s higher Profit Margin for ROA results from higher
Gross Margins.
 Walmart has slightly higher income tax since the U.S. has one of
the highest corporate tax rates in the world.
 Cross-sectional Comparison on ROA
 Walmart vs. Carrefour:
 Two firms have similar SG&A expenses, while it is slightly higher
for Carrefour each year. This could be due to the wider store
concepts that Carrefour has, which likely increases marketing and
other administrative expenses.
 Cross-sectional Comparison on ROA
 Walmart vs. Carrefour:
 Walmart has higher accounts receivable turnover than
Carrefour: in some regions, Carrefour conducts wholesale
business to provide large quantities of products to business
customers, which needs a longer time to collect receivables than
the retailing of Walmart
 Walmart has a slightly lower inventory turnover than Carrefour:
Carrefour has a higher proportion of its sales coming from
grocery products and convenience stores, which turns over more
quickly
 Walmart’s fixed asset turnover is slightly lower than Carrefour’s:
Walmart has more investment in self-owned properties and
warehouses, instead of franchising some operations like Carrefour
 Cross-sectional Comparison on ROE

For cross-sectional analysis, you can compare only one year

for the group project to ease the work
 Cross-sectional Comparison on ROE
 Walmart has a more stable and higher ROE, while
taking less aggressive Financial Leverage.
 Walmart, with its higher ROA, has a greater capacity to
take advantage of financial leverage. The higher ROA
would likely provide it with a larger excess of the return
on asset over the cost of borrowing and thereby increase
the returns to common shareholders.
 However, Carrefour has higher proportion of liabilities
in its capital structure; therefore, of the three companies,
it has used financial leverage most aggressively. Note
that Carrefour has the smallest ROA in 2015, which
might lead the analyst to expect that it would not take on
such high proportions of debt in its capital structure.
 Cross-sectional Comparison on ROE
 Walmart has a more stable and higher ROE, while
taking less aggressive Financial Leverage.
 Walmart, with its higher ROA, has a greater capacity to
take advantage of financial leverage. The higher ROA
would likely provide a larger spread over the cost of
borrowing, therefore, increasing leverage is likely to
increase the ROE.
 However, Carrefour has the highest leverage ratios
(despite its ROA is smallest in 2015), suggesting that its
financial leverage is the most aggressive, and there could
be related risks.
 Cross-sectional Comparison on Risk

For cross-sectional analysis, you can compare only one year

for the group project to ease the work
 Cross-sectional Comparison on Risk
 Carrefour has the highest short-term liquidity risk.
Carrefour’s current ratio is considerably less than 1.0,
and its cash flow from operations is much less than the
40% found for healthy retailing companies.
 Cross-sectional Comparison on Risk
 Carrefour has the highest short-term liquidity risk.
Carrefour’s current ratio is considerably less than 1.0,
and its cash flow from operations is much less than the
40% found for healthy retailing companies.
 Carrefour stretches out payments to suppliers to 80 days,
which is much longer than either Target or Walmart.
 Cross-sectional Comparison on Risk
 Carrefour has the highest short-term liquidity risk.
Carrefour’s current ratio is considerably less than 1.0,
and its cash flow from operations is much less than the
40% found for healthy retailing companies.
 Carrefour stretches out payments to suppliers to 80 days,
which is much longer than either Target or Walmart.
 Carrefour’s low cash flow from operations is the result
of weak profitability, which tends to reduce cash flow
from operations.
 Neither Target nor Walmart displays much short-
term liquidity risk.
 Cross-sectional Comparison on Risk
 Carrefour also has relatively higher long-term
solvency risk.
 Its total liabilities to total assets ratios are the highest
of the three companies and its interest coverage ratios
are the lowest.
 Cross-sectional Comparison on Risk
 Carrefour also has relatively higher long-term
solvency risk.
 Its total liabilities to total assets ratios are the highest
of the three companies and its interest coverage ratios
are the lowest.
 Carrefour’s size and market dominance in Europe
suggest that it is not likely to go bankrupt, but its risk
ratios are worrisome.
 Neither Target nor Walmart displays much long-term
solvency risk.
As you have seen, the ratio analysis in real cases involves
judgments, e.g., to adjust certain items or not, to consider
total equity or common equity, etc.

Therefore, for the group project, there could be no standard

answers to some ratio numbers. The important thing is to
provide your reasoning to explain the financial ratios
(change or difference).

However, for the final examination, there would be no such

ambiguity in ratio calculations.