Ford Motor Company, a large United States automotive corporation, strives for success each and every year. The success of Ford Motor Company, as well as other corporations, can be measured by analyzing the two most important goals of management, maintaining adequate liquidity and achieving satisfactory profitability. Liquidity can be defined as having enough money on hand to pay bills when they are due and to take care of unexpected needs for cash, while profitability refers to the ability of business to earn a satisfactory income.
To enable investors and creditors to analyze these goals, Ford Motor Company istributes annual financial statements. With these financial statements, liquidity of Ford Motor Company is measured by analyzing factors such as working capitol, current ratio, quick ratio, receivable turnover, average days’ sales uncollected, inventory turnover and average days’ inventory on hand; whereas profitability analyzes the profit margin, asset turnover, return on assets, debt to equity, and return on equity factors. LIQUIDITY Working Capital Ford Motor Company’s working capital fluctuated significantly in the years 1991-1995.
This phenomenon is directly attributable to the fact that Financial Services current assets and current liabilities are not included in the total company current asset and current liability accounts. For example, the fluctuation from 1994 ($1. 4 billion) to 1995 (-$1. 5 billion) of $2. 5 billion would suggest that Ford would be unable to pay liabilities during the current period. However, examination of the Financial Services side of the business reveals that surpluses of $13. 6 billion existed in both 1994 and 1995, convincingly mitigating the figures indicating negative working capital.
Current Ratio & Quick Ratio The current ratio in the years 1991-1995 has remained stable, fluctuating between 0. and 1. 1. The quick ratio has also remained stable, fluctuating between 0. 5 and 0. 6. The larger fluctuation in the current ratio versus the quick ratio is caused by inventories being included in the asset side of the equation. Although inventories were significantly higher in both 1994 and 1995, current liabilities were also higher. In addition, marketable securities decreased substantially in 1994 and 1995.
These factors resulted in the stability of both the current ratio and quick ratio. Receivable Turnover & Average Days’ Sales Uncollected An examination of trends in Ford Motor Company’s receivable turnover and average ays’ sales uncollected ratios reveal positive indicators of Ford’s liquidity position. The receivable turnover, a function of net sales and average accounts receivable, has nearly doubled in the years 1993-1995 versus 1991-1992. This trend indicates an extensive increase of net sales in relation to accounts receivable.
Receivables were relatively higher in 1994 than in any other of the five years, affecting the ratio for both 1994 and 1995. However, net sales increased 30% in 1994 and 34% in 1995 over the average net sales of 1991-1993. The average days’ sales uncollected ratio has decreased significantly over the ame period, from 16. 9 days in 1991 to 9. 7 days in 1995. The substantial decrease in average days’ sales uncollected ratio coupled with the near doubling of the receivable turnover ratio is a reflection of Ford’s strong sales and effective credit policies in years 1993-1995.
Inventory Turnover & Average Days’ Inventory on Hand An examination of trends in the inventory turnover and average days’ inventory on hand ratios also reveal positive indicators of Ford’s liquidity position. Inventory turnover, a function of cost of goods sold and inventories, has remained stable between 14. and 16. 0 times from 1992-1995. The average ratio over these four years (15. 1 times) is 40% higher than that of 1991. The average days’ inventory on hand, a derivative of the inventory turnover, has conversely decreased to stable level fluctuating between 23. and 26. 0 days in the years 1992-1995. Profit margin, which is net income divided by net ales, is a measure of how many dollars of net income is produced by each dollar of sales. As you can see in Appendix 12, Ford Motor Company had a substantial 4 year rise in profit margin.
Using horizontal analysis, the profit margin increased 98% from 1991 to 1992, 566% from 1992 to 1993 and then 79% from 1993 to 1994. Although the profit margin from 1994 to 1995 decreased 26%, that is more than acceptable when you look at the substantial increases in the past few years. In the first year, Ford had a profit margin of -3. 1%. That means for every dollar of sales, Ford lost $3. 10. This is obviously not a good position o be in. During 1991and then carried over into 1992, it cost Ford more money to make sales than it did when it recorded the income for those sales.
They realized at this time it was important for them to keep things such as selling and administrative expenses lower, as well as the cost of sales, which included their production, manufacturing, and warehousing costs. By following a plan more complex than I can describe here, Ford steadily increased it’s sales while it lowered it’s expenses and it’s cost of sales. This directly increased Ford’s profit margin at a substantial rate within the next three years. Asset Turnover Asset turnover involves Ford’s net sales divided by their average total assets. This ratio demonstrates the efficiency of assets used in producing sales.
A company like Ford Motor Company has an enormous amount of assets. Computers to heavy equipment to buildings. All of those assets, plus many more, are all taken into consideration when figuring asset turnover. For example, Ford would like to know that if it decides to purchase 20 new computer-aided engineering stations for a cost of about $2,400,000, they would like to see a higher asset turnover to give them the proof that the investment is being used at maximum fficiency.
Ford’s asset turnover steadily increased in incremental amounts between the years of 1991-1995 (see appendix 12), but on average it was about. 3 for the entire 5 year period. Using trend analysis to understand this ratio would give you a pretty good idea that the asset turnover of Ford Motor Company is stable. Trend analysis would give you an index number for 1992 of 100, while the index number for 1995 would be 112. These index numbers would result in a slightly positive but relatively straight line across the page. As a prospective investor this would probably cause you to investigate more deeply as o why Ford can’t more efficiently use their assets to produce sales.
As a current stockholder, this trend over the past five years may give you some comfort because of the incremental increases (at least it isn’t going down). Return on Assets Return on assets is a very good profitability ratio. It is comprehensive when compared to profit margin and asset turnover. Return on assets overcomes the deficiency of profit margin by relating the assets necessary to produce income and it overcomes the deficiency of asset turnover by taking into account the amount of income produced.
Mathematically, return on assets is equal to net ncome divided by average total assets, or more simply put, profit margin times asset turnover. Ford can improve it’s overall profitability by increasing it’s profit margin, the asset turnover, or both. Looking at the numbers, it was actually Ford’s increase in profit margin that really gave it the boost it needed to raise the return on assets from the black to the red. A steady increase in return on assets from -1. 3% in 1991 to an acceptable 2. 2% in 1994 is a good sign to investors. This steady climb of 169% resulted in an overall increase in the earning power of Ford Motor Company.
Ford’s increase in rofitability shows satisfactory earning power which results in investors continuing to provide capital to it. Debt to Equity The debt to equity ratio shows the portion of the company financed by creditors in comparison to that financed by the stockholders. It is total liabilities divided by stockholder’s equity. Ford’s debt to equity ratio is relatively high (see appendix 12). When measuring profitability, a high debt to equity ratio means the company has high debt and must earn more profit to protect the payment of interest to it’s creditors.
This high debt to equity ratio would also nterest stockholders because it shows what part of the business is financed through borrowing or in other words, is debt financed. Of the five years we analyzed, the lowest debt to equity ratio was during 1991 (6. 65) and the highest was in 1993 (11. 71). In comparison to return on assets, a higher creditor financed year such as 1991 did not have an positive effect on profitability. It seemed that through increased borrowing in 1993, a higher debt to equity ratio was produced, but overall profitability also went up. Debt to equity is only one part in a full profitability analysis.
The only real information that the ebt to equity ratio can produce is it can show how much expansion is possible through the borrowing of long term funds; basically it show’s a company’s long- term solvency. A higher debt to equity ratio essentially means that the company will be able to borrow less money. The company must rely more on stockholder investment. Ford was able to lower it’s borrowing of funds from 1993 through 1994 and into 1995, while still effectively increasing it’s profit margin and return on assets. This means Ford was able to use stockholder’s investments to increase it’s profitability rather than borrow the funds to do it.
Return on Equity Return on equity is the ratio of net income divided by the average stockholder’s equity. This ratio is of great interest to stockholders because it shows how much they have earned on their investment in the business. In the years of 1991 and 1992, stockholders lost money on their investment in Ford Motor Company (see appendix 12). No one likes to lose money, even if it is a couple of cents on the dollar. A major stockholder could incur quite a loss because of this. In the next three years, return on equity was on the positive side, the peak being in 1994 when stockholders earned about 28% on every dollar invested.
Quite a ood return considering some investors are happy with a steady 8% return. Considering the previous years, the return on equity for Ford seems to be positive. Common knowledge dictates that most companies experience a downturn every now and then. Ford’s investors are able to remain invested in the company because it’s overall 5 year return on equity is high enough to give investors the high returns they seek. A return on equity consistently above 16% with a few negative years mixed in is certainly lucrative enough to maintain a strong profitability measurement and project a positive image to the investors of Ford Motor Company.