Financial Analysis of Microsoft Corporation

FINANCIAL ANALYSIS OF MS 1

Financial Analysis ofMicrosoft Corporation

Your Name (First M.Last)

School or InstitutionName (University at Place or Town, State)

Microsoftcorporation or commonly known as MS (Nasdaq: ‘MSFT’) is one ofthe largest software companies of the world. It is also one of themost profitable firms in terms of revenues (&quotFacts AboutMicrosoft&quot, 2016). MS was founded 41 years back, in 1975 by BillGates. The headquarters of MS is situation in Redmond, Washington.The company manufactures, develops, licenses, sells and supportscomputer software packages, personal computers, consumer electronics,mobile phones (recently acquired the ‘Lumia’ brand from Nokia),and provides after-sales supports and services all over the world.This technology giant is best known for its Windows Operating Systemsand MS Office Suites. In addition to that, MS’ most prominenthardware products include MS Surface tablets and Xbox GamingConsoles. As of June 2016, the company is worth around $200 billionand it employs 114,000 people worldwide. Financial analysis is animportant tool for both internal and external stakeholders (includingboth current and potential investors, and lenders). It gives them aclear picture about the profitability, financial strength andweakness, efficiency and productivity of the company (Nissim &ampPenman, n.d.). Trend and ratio analysis are the two most convenientand widely used financial analysis tools at the disposal ofinvestors, creditors, and other internal and external stakeholders ofa business. As a result, the main purpose of this paper is to providea thorough financial analysis (including both trend and ratioanalysis) of Microsoft Corporation. Here, the trend analysis willtake the three most recent years of operation of MS (2013, 2014 and2015) into account in order to enhance the comprehensiveness of theanalysis.

TrendAnalysis

Analysis of theIncome Statement

In the 2015 incomestatement of Microsoft Corporation, we can see a gradual increase inthe company’s revenue. MS’ total revenues for 2013, 2014 and 2015were $77,849, $86,833 and $93,580 millions respectively. From theincome statement, we can also see that the company’s cost ofrevenue also grew up steadily. In 2013, MS’ cost of revenue was $20,385 million, while this figure rose to $ 27,078 the next year, andin 2015, it was $ 33,038 million. On the other hand, we can observethat the net income of the company is going to the oppositedirection. In 2013, MS’ net income was $ 21,863 million. Thisfigure experienced a slight increase the next year. In 2014, the netincome was $ 22,074 (&quotMSFT Income Statement&quot, 2016). But in2015, there was a significant drop in the company’s net income ($12,193 million). This huge decline in net income can be attributed tothe company’s Impairment, integration, and restructuring costs. In2015, MS spent $ 10,011 million in Impairment, integration, andrestructuring costs, while in 2013 the company did not spend anythingin this sector, and in 2014 MS’ Impairment, integration, andrestructuring costs were only $ 147 million (&quotMicrosoft 2015Annual Report&quot, 2016).

Profit marginratio. Here, we will take the components of MS’ incomestatement in order to have an idea about the company’sprofitability. According to Nissim &amp Penman (n.d.), profit marginratio is one of the most widely used profitability ratio usedby financial analysts and investors. This ratio shows us how much ofeach dollar in sales remains after all costs are covered. Thecalculation of MS’ 2015 Profit margin ratio is as follows:

Profitmargin ratio = Net Income/Sales

=12,193/93,580

=13.03 percent.

From the abovecalculation we can see that MS turned just 13.03% of its salesrevenue into net profits in the year 2015.

Analysis of theBalance Sheet

MicrosoftCorporation’s total assets were $ 142.4 billion in 2013. The nextyear, we can see a massive rise in the company’s total assets ($172.4 billion). However in 2015, MS’ total assets increased only by$ 3.8 billion, reaching $ 176.2 billion. This lack of growth in thecompany’s total assets can be attributed to its $ 3.1 billiondecline in Short Term Investment Cash, and increase in thedepreciation of the fixed assets compared to the previous years(&quotMSFT Balance Sheet&quot, 2016). On the other hand, MS’total liabilities also increased gradually. From 2013 to 2015, thecompany’s total liabilities were $ 63.5 billion, $ 82.6 billion,and $ 96.1 billion respectively. However, there is no obvious trendor pattern in MS’ total shareholder’s equity. For example, in2013 the company’s total shareholder’s equity was $ 78.9 billion,in 2014 the number rose to $ 89.8 billion, but in the next year,total shareholder’s equity dropped to $ 80.1 billion. The mainreason behind this decrease was a significant buy-back of the commonshares outstanding by Microsoft Corporation in 2015 (&quotFactsAbout Microsoft&quot, 2016).

Debt-equityratio. As the name suggests, this ratio compares the business’equity financing to its debt financing. It is also known as theleverage ratio. According to Nissim &amp Penman (n.d.), theDebt-equity ratio is the most appropriate measure of a firm’scapital structure. The calculation of MS’ 2015 Debt-equity ratio isas follows:

Debt-equityratio = Total debt/Total equity

=96.1/80.1

= 1.2

The calculationabove shows that Microsoft Corporation’s Debt-equity ratio ispretty high. Nissim &amp Penman (n.d.) mentioned that, the businessrelies more on debt financing than equity financing. It can be riskyfor MS, because during the times of financial crisis the company hasto keep paying interests to its lenders and must pay back its debtsno matter if the company is incurring loss or earning profits.

Analysis of theCash Flow Statement

In 2013, MS’ Netcash from operating activities was $ 28,833 million. This increasedto $ 32,231 million the next year. However, this figure dropped to $29,080 in 2015. This decline can be attributed to the company’sincreased Goodwill and asset impairments in 2015 (&quotMSFT CashFlow&quot, 2016). MS gradually increased its financing activities,as from the Net cash used in financing section of the cash flowstatement it is apparent that in 2013 the company used $ 8,148 infinancing activities, while in 2015, this figure rose to $ 9,080million. This is mostly because in 2015, MS repurchased $ 14,443worth of common stocks. In the same year, MS also spent more cash ininvesting activities as well compared to 2014. However, the company’sspending in investing activities in 2015 ($ 23,001 million) was stillless than that of 2014’s ($ 23,811 million). Finally, the company’s2015 year-end cash balance was $ 5,595 million, which was $ 3074million less than the year-end cash balance of 2014. The reasonsbehind this decrease in cash balance was discussed above.

Current ratio.It is one of the most widely used liquidity ratio. This ratioindicates how strong a company is in meeting its short-termliabilities and also in meeting the cash requirements in order tocarry out its day to day activities (Nissim &amp Penman, n.d.).Current ratio is a very important indicator of a company’sfinancial strength. The calculation of MS’ 2015 current ratio is asfollows:

Currentratio = Current Assets/Current Liabilities

=124,712/ 49,858

= 2.5

It is a well-knownfact that a current ratio greater than 1 means the company has enoughassets to cover all current liabilities should the need arise. Inthat sense, MS is in a great position to cover all its currentliabilities as the company’s current ratio is 2.5.

RatioAnalysis

Beta

According to YahooFinance, Microsoft Corporation’s beta is 1.26 (&quotMSFT : for Microsoft Corporation&quot, 2016). A beta greater than 1suggests that the company is more volatile or risky than the market.This means, when the stock market index goes down by 1 point, MS’stock return will go down by 1.26 percent or point and vice versa.

Quick Ratio

Apart fromthe current ratio, the quick ratio is also an indicator of theshort-term liquidity of a company (Nissim &amp Penman, n.d.). Thisratio shows how capable a business is in meeting its short-termliabilities with the current assets, especially the most liquid ones.Since, inventories are the least liquid form of current asset,therefore they are excluded from total current assets for calculatingthe quick ratio. MS’ 2015 quick ratio is calculated below:

Quickratio = (current assets – inventories) / current liabilities

=(124,712 – 2902) / 49,858

= 2.44

From the abovecalculation it is obvious that MS is very much capable of meeting itsshort-term obligations.

Return on Equity(ROE)

According to Nissim&amp Penman (n.d.), return on equity is a profitability ratio thatshows how much profit the company is generating with the moneyinvested by its equity holders or shareholders. The higher this ratiois, the more profitable the company is. A higher ROE poses thecompany as a lucrative investment option to the investors. MS’ 2015ROE is calculated below:

Returnon Equity = Net income / Total equity

=12,193 / 80,083

=15.23 percent

The ROE calculationabove shows that Microsoft Corporation provides 15.23% of return toits investors on their investments.

EBIT Return onAssets

This ratiorepresents the pre-tax return on the total net investment in the firmfrom operations or alternatively, how efficiently management has usedassets. This is another profitability ratio and Nissim &amp Penman(n.d.) stated that, the EBIT Return on Assets indicates how effectivethe company is in using its assets for generating profits, beforepaying its contractual liabilities. The 2015 EBIT Return on Assetsratio for MS is calculated below-

EBITReturn on Assets = EBIT / Total assets

=18,507 / 176,223

= 10.5percent

That means, inproportion to its total assets, MS is generating 10.5% EBIT Return.This shows the company’s high profitability.

Conclusion

The trend andfinancial analysis conducted above have provided some valuableinsights about Microsoft Corporation. For instance, MS’ net incomeis going down year-by-year, which can harm the company’sprofitability in the near future if this situation is not improved.The drop in net income was mostly because of the significant increasein some of the company’s operational costs. MS should keep thesecosts down to enhance its profitability. In addition to that,Microsoft’s total assets is growing per year, but its heavyreliance on debt-financing is also growing. This can be a majorconcern for the company and it can compromise the company’sfinancial strength eventually. On top of that, MS’ cash balancealso declined in 2015, which can negatively impact the liquidity ofthe company. Liquidity is very important for any company as itsignals the financial strength and stability of a company. As aresult, MS should focus on increasing its cash reserve to an extent,which makes sure that the company is in a position where it caneasily deal with its short term obligations. Fortunately, MS’ verystrong current and quick ratios suggest that the company can stillrecover. And all the profitability ratios show that the company is ina sound position in terms of generating profits. When it comes toBeta, MS is in a good position, because maintaining a negative betaor a beta of “1” is just theoretically possible. Therefore, inthe lights of the discussion above, it can be said that if Microsoftcan improve the weaknesses outlined in this paper, then it canenhance its profitability and financial strength even more.

References

Facts About Microsoft.(2016).&nbspMicrosoft.Retrieved 3 September 2016, fromhttp://news.microsoft.com/facts-about-microsoft/#sm.00000961grrstdgnt5e17h78b6j2d#L5ju2JsqqTKlO87y.97

Microsoft 2015 Annual Report.(2016).&nbspMicrosoft.com.Retrieved 3 September 2016, fromhttps://www.microsoft.com/investor/reports/ar15/index.html

MSFT : Summary for Microsoft Corporation.(2016).&nbspYahooFinance. Retrieved 3 September 2016,from http://finance.yahoo.com/quote/MSFT?ltr=1

MSFT Balance Sheet.(2016).&nbspYahooFinance. Retrieved 3 September 2016,from http://finance.yahoo.com/quote/MSFT/financials?p=MSFT

MSFT Cash Flow.(2016).&nbspYahooFinance. Retrieved 3 September 2016,from http://finance.yahoo.com/quote/MSFT/financials?p=MSFT

MSFT Income Statement.(2016).&nbspYahooFinance. Retrieved 3 September 2016,from http://finance.yahoo.com/quote/MSFT/financials?p=MSFT

Nissim, D. &amp Penman, S. Ratio Analysis andEquity Valuation.&nbspSSRNElectronic Journal.http://dx.doi.org/10.2139/ssrn.161222