Financial Ratio Analysis
1.0 Financial Ratio Analysis Financial ratio analysis is a method used to evaluate a company’s financial performance by analyzing relationships between various financial data points in its financial statements. These ratios are calculated from the company’s balance sheet, income statement, and cash flow statement, and they provide insights into different aspects of the company’s operations, profitability, efficiency, liquidity, and solvency. Financial ratio analysis helps investors, creditors, and analysts understand a company’s financial health, identify trends over time, compare it to competitors, and make informed decisions regarding investment, lending, or partnership opportunities. However, it’s important to consider that no single ratio provides a complete picture of a company’s financial condition, and ratios should be analyzed in conjunction with other factors and industry benchmarks. Table 1.1 below displays Ecolab Inc. key financial ratios for the past four years, as well two competitors, Sealed Air Corp. and The Clorox Co., for comparison analysis of their key financial ratios during the most recent year. Table 1.1 – Key Financial Ratios 1.1 Liquidity Ratios Liquidity ratios are an important class of financial metrics used to assess a company’s ability to meet its short-term obligations and include the current ratio and the quick ratio. For liquidity, the ratios used were the current ratio, quick ratio, and net current assets. The current ratio measures a company’s ability to pay short-term debts, typically less than a year. Quick ratio measures a company’s capacity to pay its current liabilities without additional aid, like from other financing or selling inventory. Net current assets, as a percent of total assets, represent the difference between a company’s current assets and its current liabilities on its balance sheet. Current assets are assets that are expected to be converted into cash or used up within one year or one operating cycle, whichever is longer. Current liabilities are obligations that are due within the same time frame. The higher the ratio number, the better the company’s perceived financial health. Ecolab Inc. liquidity current and quick ratios are above the industry average. In 2022, Ecolab’s quick ratio was 0.78, compared to 0.50 and 0.48 from competitors Sealed Air Corp. and The Clorox Co., respectively. Ecolab’s current ratio was 1.30 compared to 1.02 and 0.97 from Sealed Air Corp. and The Clorox Co., respectively. The liquidity ratios’ 4-year trend, as shown in Figure 1.1, shows that Ecolab’s liquidity ratios has been declining since 2020. Figure 1.1 Liquidity Ratios 1.2 Profitability Ratios Profitability ratios measure a company’s ability to generate profit relative to its revenue, assets, equity, etc. The probability ratios go on to show the combined effects of liquidity, asset management, and debt on operating and financial results. The gross profit margin, return on assets, return on equity, return on investment ratios, and EBITDA Margin ratios are essential to understanding how profitable the companies are and are also helpful in comprehending the differences between the companies. The gross profit margin measures the percentage of revenue remaining after accounting for direct costs. The return on assets measures the overall efficiency of a company in using its assets to generate profit. Return on equity Measures the return on investment for shareholders. EBITDA margin measures a company’s operating profitability before accounting for interest, taxes, depreciation, and amortization. As seen in Figure 1.2.1, Ecolab Inc. has a higher profit margin on sales than its competitors at 37.76%, compared to 31.42% and 35.81% of Sealed Air Corp. and The Clorox Co., respectively. As seen in Figure 1.2.2, Sealed Air Corp. also has a favorable ROA of 7.90%, ROE of 165.76% and ROI of 23.99% compared to Ecolab Inc. and The Clorox Co., with ROA of 5.12% and 7.63%, ROE of 15.10% and 95.55% and ROI of 10.71% and 22.25% respectively. Additionally, per Figure 1.2.3, Ecolab Inc. has a higher EBITDA margin than its competitor The Clorox Co. Ecolab Inc. EBITDA margin in 2022 was at 17.86% compared to 13.18% from The Clorox Co. Figure 1.2.1 Profitability Ratios: Profit Margin Figure 1.2.2 Profitability Ratios: ROA, ROE, and ROI Figure 1.2.3 Profitability Ratios: EBITDA Margin 1.3 Debt Management Ratios Debt management ratios, which are also called leverage ratios, help identify a firm’s use of debt relative to equity and its ability to pay interest and principle. These ratios aid in judging the likelihood of defaults. For the Debt management, the ratio used are Debt Ratio, LT Debt to Equity, Total Debt to Equity, TIE Ratios. The debt ratio, also known as the debt-to-asset ratio, is a financial metric that measures the proportion of a company’s assets that are financed by debt. The debt ratio provides insights into the financial leverage of a company and its ability to meet its debt obligations. A higher debt ratio indicates that a larger portion of the company’s assets is financed by debt, which can increase financial risk, especially in times of economic downturns or when interest rates rise. Conversely, a lower debt ratio suggests a more conservative capital structure with less reliance on debt financing. The Long-Term Debt to Equity ratio measures the proportion of long-term debt relative to shareholders’ equity in a company’s capital structure. This ratio indicates the extent to which a company relies on debt financing versus equity financing for its operations and growth. A higher ratio suggests higher financial risk due to greater reliance on debt. The Total Debt to Equity ratio is a broader measure of a company’s debt relative to its equity. It considers both short-term and long-term debt in relation to shareholders’ equity. Similar to the LT Debt to Equity ratio, a higher Total Debt to Equity ratio indicates higher financial leverage and potentially higher risk for investors. The Times Interest Earned ratio measures a company’s ability to cover its interest expenses with its earnings before interest and taxes (EBIT). The TIE ratio indicates how easily a company can pay the interest charges on its debt obligations from its operating income. A higher TIE ratio suggests better financial health and lower risk of default, as the company generates sufficient earnings to cover its interest obligations. Conversely, a lower TIE ratio indicates a higher risk of default if the company’s earnings decline or if interest rates rise. Ecolab’s debt ratio in 2022 is lower than its competitors at 42.05% while Sealed Air Corp. and The Clorox Co. have a 2022 debt ratio of 50.39% and 60.37% respectively. Per Figure 1.3.1 shows that Ecolab has been improving on its debt ratio since 2021. As seen in Figure 1.3.2, Ecolab have a favorable long-term debt to equity, and total debt to equity ratio compared to competitors Sealed Air Corp. and The Clorox Co. Management wants that Times-Interest-Earned (TIE) ratio to be sufficiently high so that there is little risk of default. Ecolab’s TIE ratio was 6.33 times in 2022, which is down significantly from 7.13 times in 2021. Over the 4-year period between 2019 and 2022, Ecolab’s TIE ratio has ranged from a low of 4.81 in 2020 to a high of 9.08 in 2019. Compared to its competitors Sealed Air Corp. and The Clorox Co. Netflix has a better TIE ratio than Sealed Air Corp at 6.33 versus 5.30, but The Clorox Co. has a TIE ratio of 6.73. Figure 1.3.1 Debt Management: Debt Ratio Figure 1.3.2 Debt Management: LT Debt to Equity, Total Debt to Equity, TIE Ratios 1.4 Asset Management Ratios Asset management ratios, also known as turnover ratios, are financial metrics used to assess how effectively a company is managing its assets to generate revenue or sales. These ratios provide insights into the efficiency and effectiveness of a company’s asset utilization. For assessment management, we considered four distinct aspects of the companies. Inventory turnover, accounts receivable turnover, PPE turnover, and asset turnover were our focus concerning this matter. Inventory turnover measures the number of times during a period that total inventory is turned (sold). Accounts receivable turnover measures the efficiency of a company in collecting receivables. PPE turnover provides insights into asset utilization and how efficiently a company operates given its production technology. Lastly, asset turnover is a helpful ratio to understand how smoothly a company uses its assets to create profit. In 2022, Ecolab’s inventory was 5.38 times, compared to 4.86 and 6.05 from competitors Sealed Air Corp. and The Clorox Co., respectively. The asset management ratios’ 4-year trend, as shown in Figure 1.4, shows Ecolab’s accounts receivable turnover, PPE turnover and asset turnover has been improving since 2020, while the inventory turnover has been slightly declining. Comparing Ecolab from its competitors in 2022, Ecolab has a lower accounts receivable turnover ratio at 5.48, while Sealed Air Corp. and The Clorox Co. are higher at 9.30 and 11.06 respectively. Ecolab has a lower PPE turnover ratio at 3.82, while Sealed Air Corp. and The Clorox Co. are higher at 4.27 and 4.29 respectively. Ecolab has a lower asset turnover ratio at 0.66, while Sealed Air Corp. and The Clorox Co. are higher at 0.91 and 1.14 respectively. On the other hand, the 2022 inventory turnover for Ecolab is higher than its competitor at 5.38 compared to 4.86 from Sealed Air Corp. Figure 1.4 Asset Management Ratios 1.5 Market Value Ratios Market value ratios are financial metrics used by investors and analysts to evaluate the market price of a company’s stock in relation to its financial performance and fundamentals. These ratios help investors assess whether a stock is overvalued, undervalued, or fairly valued compared to its peers or the overall market. The market value ratios used are price/earnings, price/cash flow and price per book ratios. The P/E ratio compares a company’s current market price per share to its earnings per share (EPS). It indicates how much investors are willing to pay for each dollar of earnings generated by the company. A higher P/E ratio suggests that investors are willing to pay more for each dollar of earnings, indicating potential growth prospects or market optimism. The P/CF ratio compares a company’s market price per share to its operating cash flow per share. It measures how much investors are willing to pay for each dollar of a company’s cash flow from operations. The P/CF ratio is often used as an alternative to the P/E ratio, especially for companies with volatile earnings or large depreciation expenses. The P/B ratio compares a company’s market price per share to its book value per share (total assets minus total liabilities divided by the number of outstanding shares). It provides insights into whether a stock is trading at a premium or discount to its book value. A P/B ratio of less than 1 may indicate that the stock is undervalued, while a ratio greater than 1 may suggest that it is overvalued. As shown in Figure 1.5.1, Ecolab has a higher PE ratio than its competitors at 38.01 compared to 14.80 and 37.42 of Sealed Air Corp and The Clorox Co., respectively. Ecolab also has a higher price per cash flow ratio than its competitors at 38.60, whereas Sealed Air Corp and The Clorox Co., price/cash flow ratio of 19.36 and 32.29 respectively. These ratios have a direct impact on Ecolab’s market per share as shown in Figure 1.5.2. It’s book value per share has increased since 2020 from 21.71 per share to 25.51 per share. Ecolab has a higher book value per share than Sealed Air’s 2.38 per share and The Clorox’s 5.92 per share. Figure 1.5.1 Market Value Figure 1.5.2 Market Value per Share
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