Financial Statement Analysis - Identify the Industry

Financial ratios and reports are usually specific for companies operating in different economic sectors and industries. Composition of the balance sheet and income statement varies significantly for banks, manufacturing companies, retail businesses and service providers. In this case we will analyze financial data of companies representing ten different industries and define their business sectors based on the financial ratios and common-size reports for three-year average statements.

The following table represents the matching list of companies and industries based on the analysis of financial statements and ratios given in the case:

Matching Company 1 with the commercial airline industry is based primarily on the evidence that airline firms are mostly highly indebted entities as they lease necessary equipment and finance their activities by long-term loan contracts. The firm has a high leverage ratio (equal to 4.43). Besides, the profitability of airline companies is critically dependent on the fuel prices which fluctuate considerably (Office of Inspector General 2012). Positive capital surplus along with the negative retained earnings illustrates this point. Also, the firm has a negative value of raw materials on its averaged balance sheet that may occur due to market devaluation of inventories by the year end.

Company 2 is obviously a banking institution. It has the highest leverage ratio among all represented entities, which cannot be sustained by an organization operating in the non-financial sector of economy. The “assets to stockholders’ equity” ratio achieves as much as 11.53. A commercial bank’s assets consist of cash reserves and loans to the bank’s clients or receivables which should correspond with the deposit base of the bank or payables (Rose 2002). In the case we see that company 2 has total 85.59 of current assets (cash, marketable securities, receivables – loans, and other current assets) financed by 77.86 current liabilities (notes payable – time deposits, and accounts payable – demand deposits). Besides, the day’s receivable ratio (equal to 2,540.75) makes it straightforward that the company’s receivables are commercial bank loans.

We have defined Company 3 as an integrated oil and gas entity. The company has the highest value of inventories (equal to 20.12) that are mostly concentrated in raw materials (equal to 11.13). Also, there is a significant volume of intangibles, which could be goodwill of the integrated company. This conclusion comes out from the fact that oil and gas companies usually generate “superior earnings or income” proved by strong profitability ratios (Hermanson, Edwards & Maher 1998).

The next example, Company 4 is defined as a semiconductor manufacturer for several reasons. First of all, the entity has the highest volume of property, plant and equipment with the respective accumulated depreciation, which clearly demonstrates that it is a manufacturing firm. Also, as a semiconductor producer (a well-known and developed product), the company does not need to bear significant expenses on the research and development. This costs account for only 0.32 per cent of the firm’s net sales volume. Analyzing financial ratios, one notes that data on asset management is typical for a stable producing and selling company with no excessive terms of receivables or inventories processing. The company has a rather high coverage ratio as well, which is usually achieved by the large manufacturing firms.

A mobile phone service providing sector is represented by Company 5. The average balance sheet of the organization shows zero amount of inventories, which is logical for a service provider, especially for a telephone operator. The company has the day’s receivable ratio equal to 71.39 or approximately two months of prepaid phone calls. This ratio is used to define the “frequency of collection cycle” and to “monitor credit policies”, which should be strong in a mobile services providing company (Walther & Skousen 2009).

Company 6 has several figures on its balance sheet and income statement, which allows matching it with the pharmaceutical preparations industry. The firm has work in progress on the balance sheet, which defines it as a producing (or preparing) entity. This is also supported by high volume of property and equipment along with the significant intangible assets amount (equal to 9.41 per cent of the total assets). Moreover, the firm’s income statement includes serious expenditures aligned for the research and development. It is a distinctive feature of a pharmaceutical organization.

The following Company 7 has one of the longest inventories processing cycle totaling to around 230 days. Along with the existence of work in progress, this allows concluding that the company represents the liquor manufacturing industry. This firm also invests high volumes in the research and development process, which is necessary to keep with the market demand for alcohol products and survive in the very competitive environment. The company’s day’s receivables are in the frames of a retailing organization. Therefore, we can characterize this entity as a liquor distributor as well.

One more exemplified entity has significant research and development expenses (equal to 17.18) as well as intangible assets (equal to 5.20) showed in the financial statements. We define Company 8 as an IT service provider for two reasons. First, the firm has low volume of tangible assets which is a usual practice for a service provider with assets concentrated in the money equivalents or intangibles. Second, the company has very strong liquidity ratios, mainly due to the extensive volume of marketable securities (equal to 52.44). The current ratio of the organization’s financials achieves as much as 3.26, which is the highest proportion among the companies represented in the case. Abnormally high liquidity ratios reflect that the company has a business that needs to respond to the clients’ requests very fast and, thus, requires high volume of immediate liquidity (Mongiello 2009).

Company 9 has very low receivables and inventories cycles (11.99 and 10.79 days respectively). This characterizes the firm as a retailing business which is the retail grocery stores in the discussed case. Also, the company has mortgages on the balance sheet (equal to 2.83) which are necessary to establish a network of grocery stores. There is no work in progress, and the intangible assets volume is rather low.

The last analyzed entity, Company 10 is similar to the previous example in a way that it also has short inventory cycle and around two months-long receivables management ratio. However, the firm has extensively high volume of intangibles that constitute more than 60 per cent of the balance sheet assets. That is why we relate this company to the computer software industry. Here, the intangible assets should be represented by a certain amount of developed and purchased software for the company’s business.

As a summary of the case, we can note that generalized financial statements have proved to be very helpful in analyzing investment opportunities and comparing them across different economic sectors and industries. However, preparing of the three-year averaged, common-sized financial reports may require significant time and effort. At the same time, financial ratios provide quick and comparable information on the companies’ stability, profitability, liquidity, solvency, and management effectiveness indicators and can be obtained from the firms’ annual reports directly.