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Coca-Cola Accounting

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Category: Business

Autor: andrey 08 March 2011

Words: 4130 | Pages: 17

Ratio Analysis

Liquidity Ratios

Current Ratio: Over the past five year's Coca Cola company has had a current ratio hovering around .9 – 1.3. This ratio gives us an idea of the company's ability to pay back its short-term liabilities with its short term assets. A higher current ratio means that a company is more capable of paying its obligations. In 2006, 2007, and 2008 Coca Cola had a current ratio which was less then 1. This suggests that Coca Cola would not have been able to pay off its obligations if they had all come due at that point. In 2009 Coca Cola had a current ratio of 1.3, compared to Pepsi with a current ratio of 1.4 and the industry average of 1.26. This indicates that Coca Cola grew financially and became more financially stable in 2009 from its past years, and indicates that they made solid investments and were able to increase their current assets. Pepsi is able to meet its near-term operating needs slightly more easily then Coca Cola. However, this does not necessarily mean that Pepsi is doing better financially then Coca Cola. Generally, a current ratio greater then 1.5 suggests that a company is hoarding its assets instead of using them to grow a business and it is something that could have long-term effects.. When compared to the industry standard of 1.26, Coca Cola is doing slightly better in that they are more able to pay back their current debts then the rest of the industry. Coca-Cola is slightly more aggressive then Pepsi, but slightly more conservative then the rest of the industry.

Quick Ratio: The quick ratio also gives us an idea of how well a company is able to pay back its short-term debt and operate on a day-to-day basis. One problem with the current ratio is inventory. If a company has most of its liquid assets tied up in inventory, that company becomes very dependent on the sale of that inventory to finance its operations. By taking the inventory out of the equation a company can find out if they have sufficient liquid assets to meet their short term operating needs. The quick ratio is generally considered a more conservative standard than the current ratio because if the quick ratio is less than one, there generally is no danger that the firm would not be able to meet its current obligations. From 2005 to 2008 Coca Cola had a quick ratio that ranged from .9 to .7. ItThis does not necessarily mean that they wereCoca Cola was having extreme financial difficulties. A low quick ratio can also indicate that an organization has good long-term prospects and is able to enter the capital market and borrow against those prospects to meet obligations. In 2009, Coca Cola had a quick ratio of 1.1 and as did Pepsi did as well. This indicates that both Coca Cola and Pepsi were financially sound and able to carry out their day-to-day operations. Their operations were not dependent upon the sales of their inventories. Compared to the industry average quick ratio of .9, both Coca Cola and Pepsi are doing better than the industry and are more able to pay back their short-term debts. This indicates that both Coca Cola and Pepsi are slightly more conservative than the rest of the industry.

Cash Ratio: The cash ratio is a ratio of the company's total cash and its cash equivalents to its current liabilities. A strong cash ratio is useful for creditors when they are trying to decide how much debt, if any, they should be willing to extend to the asking party. The cash ratio is generally a more conservative measure than the current ratio or the quick ratio of a company's ability to cover its short-term liabilities. If this ratio is over higher than one, it is most likelycan indicate an indication that the company has too much cash on hand and that it is not making enough investmentsinvesting enough. Coca Cola had a cash ratio ranging from .3 to .5 between 2005 and 2009. This is a good ratio because it shows that they do haveCoca Cola has enough cash on hand allowing them to operate fromfor their day to day without having to take out loans, but theyoperations. It also do not have soshows that they are not holding on to too much cash that they are not makingcould be used for smart investments and business decisions. In 2009 Pepsi also had a cash ratio of .5.. No industry average was given for the cash ratio.Coca Cola had a cash ratio ranging from .3 to .5 between 2005 and 2009. This is a good ratio because it shows that they do have cash on hand allowing them to operate from day to day without having to take out loans, but they also do not have so much cash that they are not making smart investments and business decisions. In 2009 Pepsi also had a cash ratio of .5. No industry average was available for the cash ratio.

Leverage Ratios

Debt to Equity: This ratio provides information about a company's ability to pay back its long term debt and stay in business in the long run. Often, these ratios help us to determine the ability of an organization to generate new funds from the capital market. A very high debt to equity ratio can make future financing difficult, and generally means that a company has been aggressive with financing its own growth with debt. Coca Cola had a debt to equity ratio ranging from .1 to .2 between 2005 and 2009. Compared to with Pepsi's which has a debt to equity ratio of .4 in 2009, Coca Cola's debt to equity ratio of .2 is in 2009 is a little bit low. The industry average is even more aggressive with their debt to equity ratio being .7 in 2009. Coca Cola could probably make a couple more investments using debt rather then continuing to make investments using their own equity.

Debt to Asset: This ratio indicates what proportion of a company's assets are being financed through debt. A ratio less then one means that a majority of the company's assets are financed through equity, and a ratio above one means that they are mostly financed through debt. Coca Cola has an extremely low debt to asset ratio. In 2005 and 2006, this ratio is zero meaning that none of their assets are backed by debt, and in 2007, 2008, and 2009 this ratio is .1. Coca Cola uses very little of other peoples money to back their assets. Pepsi has a debt to asset ratio of .2. This is slightly more aggressive because they are backing more of their assets with other people's money rather then their own, and they do need to pay back that debt at some point. Neither of these firms is a highly debt levered firm. There was no debt to asset ratio industry information available.

Times Interest Earned:

This ratio indicates how well a company can cover its interest payments on a pretax basis. The larger the times interest earned, the more capable a company is at paying the interest on its debt. This ratio is a measure of a company's ability to continue to service its debt, and it is an indicator to tell if a company is running into financial trouble. A high ratio indicates that earnings are significantly greater then annual interest obligations. However, a high ratio can also mean undesirably low leverage or indicate that the company pays down too much of its debt with earnings that could be used for other investment opportunities to get a higher rate of return. A low ratio means fewer earnings are available and this company may be forced into bankruptcy if it cannot meet these interest obligations. Coca Cola has a ratio ranging from 18 to 30 between 2005 to 2008, indicating that they are financially healthy and able to pay back their interest. In 2009 Coca Cola had a ratio of 26, Pepsi had a ratio of 21.3 and the industry average was 11.3. This indicates that Coca Cola is more conservative than Pepsi, and both Pepsi and Coca Cola are more conservative then the industry. They could both try using some of that cash to invest in different opportunities. They are both in conservative positions showing that they can continue to service their debt.

Performance

Margins: Generally it is important for gross margins to remain stable and have little fluctuation. This shows us the revenue obtained from the items sold minus the direct costs of producing and selling that item. Coca Cola has very little range in its gross margin between the years 2005 and 2009, ranging only from 63.9% to 66.1%. This stability shows that the company is most likely in good health. Pepsi has a gross margin of 53.5% in 2009 and the industry average is 51.4%. This shows that Coca Cola is doing better than the industry and making more profit from sales of their products. This could suggest a more streamlined manufacturing process or more effective internal processes. Coca Cola's operating margin and net margin are also fairly stable, with neither margin fluctuating by more than 4% between 2005 and 2009. In 2008 Coca Cola's net margin was slightly lower than usual, but this is most likely due to the poor performance of the economy. Coca Cola has an operating margin in 2009 of 26.6% compared to Pepsi who has an operating margin of 18.6% and the industry which has an operating margin of 17%. This again suggests that Coca Cola may have more streamlined and efficient processes which produce lower costs. In 2009 Coca Cola had a net margin of 22% compared to Pepsi at 13.8% and the industry at -3.1%. These margins indicate that Coca Cola is doing extremely well compared to competitors and has clearly kept/profited from their competitive edge.

Turnover: Turnover measures the efficiency of a company. For example, Wwhen a company has a low inventory turnover for example there is a risk that they are holding obsolete inventory which is difficult to sell. A high inventory turnover ratio means that the company is efficiently managing and selling its inventory, and less funds are tied up by it. However, they must also be conscious of stock outs. Coca Cola has a high accounts receivable turnover ranging from 10.2 to 9.1 over 2005 to 2009. This a healthy number and shows that they turnover their accounts receivable every 36 – 40 days. Compared to Pepsi which has an accounts receivable turnover of 9.3 and the industry which has a turnover of 8.4 Coca Cola is performing on par with Pepsi and both Pepsi and Coca Cola are performing over the industry. Coca Cola has slightly lower inventory turnover ranging from 5.8 to 4.9 over 2005 to 2009. They turnover their inventory every 63 to 75 days, compared to Pepsi who turns over inventory every 36 days and the industry who turns over inventory every 49 days. Coca Cola has lower inventory turnover than both Pepsi and the industry indicating that they should look into improving their inventory management system and coming up with better inventory management processes to remain competitive with Pepsi and other firms in the industry. Accounts payable for Coca Cola is significantly lower than inventory and accounts receivable, meaning that it takes a long time for them to pay suppliers. This could suggest that it is difficult for them to pay suppliers or that they do not take advantage of discounts. Coca Cola has accounts payable turnover ranging from 198 to 213 days while Pepsi has accounts payable turnover of 148 days. While it is appears to be normal for accounts payable turnover to be lower, Coca Cola is significantly lower when compared to Pepsi and they could benefit from looking its means for improving this process.

Return

Return on Assets: This ratio measures the money a company can generate from the employment of all of the assets it has on its books. Because companies have limited resources they should put them to use. Because of this, this ratio can be used to decide whether or not to initiate a new project. If a company is going to start a new project, they expect to earn a return on it, which is ROA. Coca Cola has an ROA ranging from 13.8% to 17% between 2005 and 2009. In 2009 their ROA is 14% compared to Pepsi which has an ROA of 14.9%. This suggests that Pepsi is using their assets slightly more effectively then Coca Cola and generating more money with them then Coca Cola. However, both Pepsi and Coca Cola are doing much better with their ROA than the industry average, which is at -6.6%. Clearly these companies are making the correct project decisions with their assets compared to the rest of the industry.

Return on Equity: This ratio tells us the rate of return that shareholders are earning on their shares. This ratio gives us an idea of how management is balancing profitability, asset management, and financial leverage. Coca Cola has had an ROE ranging from 26.9% to 30% between 2005 and 2009. This indicates that they are generating revenue on each dollar. Compared to Pepsi which has a ROE of 34.1% in 2009, Coca Cola's ROE of 26.9% is close, but they are not generating as much return on each dollar as Pepsi. Compared to the industry average in 2009 of -2.7% however, both Pepsi and Coca Cola show that they are outperforming their competitors. Both of these ROE's are strong and indicate a good financial health for the companies when compared to the industry.

Accounting Choices Analysis

Accounts Receivable:

Coca Cola has gotten slightly more aggressive with their allowance for doubtful accounts over the years. In 2005 the allowance account was estimated to be about 3% of their gross accounts receivables. In 2006, 2007, 2008, and 2009, the percentages were 2.4%, 1.7%, 1.7%, and 1.3% respectively. This movement of Coca Cola's bad debt from 3% to 1.3%, or from 72 million to 51 million, indicates that Coca Cola was collecting most of the bad debts they were estimating to be uncollectible and the adjusted their bad debt accordingly. This is because they want to ensure they are accurate in the information they give to shareholders on the financial statements. In 2009 Pepsi had estimated their allowance for doubtful accounts to b e 1.9% of their gross accounts receivables. Coca Cola has aswas slightly more aggressive in the estimation of their bad debts than Pepsi, because they only estimated 1.3% of accounts receivable to be uncollectible. A lower percentage of allowance for doubtful accounts results in a lower bad debt expense, which results in a higher net income, making it more aggressive.

Inventory:

Coca Cola Company values their inventories at the lower of cost or market which is a more conservative method and determines its cost of goods sold using the first-in, first-out (FIFO) method. This is a more aggressive decision because in periods of rising prices the FIFO method would result in you having a lower cost of goods sold, and thus a higher net income. The cost of goods sold under the last-in, first-out method can be estimated as follows. COGS LIFO = COGS FIFO + (beginning inventory FIFO * inflation rate) (from investopedia.com). Annual inflation rate in 2009 was -0.4% given by UsS Inflation Calculator. COGS LIFO = 11,088 + (2,187 * (1-.04)) = 13,266. This is an estimation of what COGS would be if LIFO was used and it would make the LIFO reserve be 2,178. Pepsi values their inventory at lower of cost or market which is a conservative method and uses either the average, first-in, first-out (FIFO) method or the last-in, first-out (LIFO) method. They also stated that 10% of their cost of goods sold in 2009 was computed using the LIFO method. They also stated that the differences in these inventory valuation methods were not materially different in any way. In 2009 because Pepsi used mostly the FIFO method, which is they used the more aggressive method assuming rising prices. b This is more aggressive because the rising prices would cause their cost of goods sold to be lower. Because Since Pepsi calculated 10% of its cost of goods sold using the LIFO method their cost of goods sold would be slightly higher than if they had used 100% of the FIFO method (again assuming rising prices) so they used a slightly more conservative number when compared to Coca Cola. However, with 90% of the cost of goods sold still being calculated using the LIFO method the differences between these two would most likely be considered negligible.

Operating Assets:

Coca Cola Company has several different operating assets on their books. Their depreciable assets are depreciated using the straight line method over their estimated useful lives. This is a more aggressive method when compared to the double declining method. These useful lives are estimated to be 40 years or less for buildings and improvements, 15 years or less for machinery and equipment, and 10 years or less for containers. Land and construction in progress are not depreciated. The average life of these assets in 2009 is calculated to be 15,006/832 = 18 years. 832 is the deprecation expense for 2009 (6,906 – 6.074) and 15,006 is the value of the depreciable assets which is (total assets – land and construction in progress) (16,467 – 1,461). Pepsi also uses the straight line method of depreciation over the assets estimated useful lives. Their property plant and equipment are all recorded at historical cost, and their land and construction in progress are not depreciated. Pepsi also uses the more aggressive method of depreciation when compared to the double declining balance methods. Under the straight line method of depreciation expense is the same each year, where under the double declining method depreciation expense is higher in beginning years and lower in the later years. The useful life of Pepsi's assets for 2009 is total assets – land and CIP (24,912 – 1,441 – 1,208/1,500) = 14.84 years. Pepsi has estimated that their land and improvements useful lives are 10 – 34 years, their buildings and improvements useful lives are 20 – 44 years and their machinery and equipments useful lives are 5 – 14 years, generally more conservative useful life estimations for their assets.

Further Analysis of Coca Cola Decisions

After analyzing the accounting decisions made by Coca Cola we were able to see that Coca Cola tends to make more aggressive choices. This causes their expenses to be lower, and thus net income to be higher. While none of these choices are in violation of GAAP, it is interesting to analyze the profile of the company using more conservative choices.

Accounts Receivable:

The method used to determine the bad debt expense by Coca Cola is the percentage of receivables method. Their estimate of bad debts slowly decreased over the period of 2005 to 2009 from 3% to 1.3% of accounts receivable or from 72 million to 51 million respectively, showing a more aggressive approach. Had they used the percentage of sales method, and estimated that one quarter of one percent of credit sales would have been uncollectible they would have gotten a bad debt expense of 77 million. This in turn would decrease net income, and have a negative effect on both the operation margin and net margin. Operating margin would fall from 26.6% to 26.4%. The net margin would also be affected by this change. It would fall from 22.0% to 21.9%. While this is not a greatly significant expense, drastically affecting margins, but it does change them - demonstrating that even a small adjustment to an accounting method can change the way the financial statements are interpreted. The important thing to note here is that based on different decisions made by the accounts, which could be more dramatic than this, the financial statements can be manipulated, which is why it is important to read the statements and the notes in their entirety.

Inventory:

Another choice which can be made by the accountants is whether to use the LIFO or FIFO method of inventory valuation. LIFO is considered to be more conservative than FIFO en LIFO in times of rising prices, because this method results in a higher cost of goods sold, again reducing the net income. This will have an effect on ratios such as inventory turnover, accounts payable turnover, and the margins. A formula to calculate what cost of goods sold under LIFO is as follows: COGS LIFO = COGS FIFO + (beginning inventory FIFO * inflation rate). This would give 2009 a cost of goods sold of 13,266 and it would make the LIFO reserve be 2,178. Under this more conservative method the inventory and accounts payable turnovers would be 5.8 percent and 2.06 percent respectively. Both of these turnover rates make the company look better, simply because the method for calculating cost of goods sold changed. The new gross, operating, and net margins would be 57.2%, 19.5%, and 14.9% respectively. This would decrease all of the margins, thus making the company look less streamlined and not as profitable in their processes. If a certain investor focused mainly on these margins to make an investment decision, simply changing the method for calculating cost of goods sold could affect the investor's decision. ROA and ROE would also be affected by the change in net income. Since the ending value of inventory cannot be calculated, due to a lack of information for the calculating cost of goods sold, the new ratio cannot be determined, but it would be affected. This change would also have an effect on the current ratio because current assets would change due to ending inventory having a new value. In this case, cost of goods sold would be increased, ending inventory would decrease, making the current assets smaller, and driving down the current ratio. Asset to debt ratio would also be affected because total assets would be reduced, making the ratio higher and thus making it appear that more of the asset would be financed by debt.

Operating Assets:

Another common accounting choice which can have an effect upon the financial statements and ratios is the method used for depreciation. Coca Cola chooses to use the aggressive method of straight line depreciation for calculating their cost of goods sold. Had they used the double declining balance method their depreciation expense would have been higher in the first years of owning the asset, making net income lower, resulting in a more conservative approach. This would also make the value of the total assets decrease because net operating assets would not be worth as much.

A higher depreciation expense would have an effect upon many of the ratios. The asset to debt ratio would increase because total assets would decrease due to a greater value in accumulated depreciation. This would make it look like more of the assets were backed by debt rather than equity. The operating and net margins would also be affected because it would appear that operating income and net income were lower due to a higher depreciation expense. Both of these margins would decrease making the company look less profitable. This would also cause ROE to change because net income would be decreased. ROA would not change because the change in net income would be cancelled out by an equal change in total assets due the net value of the asset being decreased by the same amount.

Overall, it is important to note that changes in accounting decisions have a large effect on the interpretation of the financial statements and therefore the apparent financial health of the company itself.

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