Financial Ratio Analysis: The Performance of General Motors
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Financial Ratio Analysis: The Performance of General Motors
The financial health of a firm plays a significant role in its survivability and long-term success. Companies record and track their operational activities on financial statements, such as the balance sheet and income statement. The Securities and Exchange Commission (SEC) mandates and enforces organizations that trade in the United States (US) to maintain accurate accounting statements and report them to the SEC. The SEC’s purpose is to protect investors and the public from fraudulent and manipulative business practices (Investopedia, 2017).
Although accounting statements show a glimpse of a company’s performance, they do not provide a complete representation of a firm’s financial standings. Investors, creditors, managers, and other users must apply various measuring tools to determine the overall strength of their companies. This report will evaluate the performance of General Motors (GM) by conducting solvency, turnover, and profitability ratio analyses of its financial statements. Managers that effectively utilize measuring techniques will make better decisions to improve the efficiency of their resources and increase the wealth of their shareholders (Ingram, 2017).
Company Background
GM is a Fortune 500 automotive company and one of the Big Three automakers in the US. Although GM experienced tremendous success, the 2008 Financial Crisis caused it to enter bankruptcy. The government decided to loan GM more than $50 billion to preserve a million jobs. Gasoline inflation and other factors led to a 37 percent decline in automotive sales by the end of 2008. GM continued to produce inefficient gas vehicles and failed to maneuver towards energy alternative automobiles. GM would not be in existence today without the bailout from the government.
However, it could have possibly predicted or avoided the consequences of the recession had its managers thoroughly assessed its accounting statements by conducting ratio analysis (Amadeo, 2017).
Financial Ratio Analysis
Ratio analysis tools help users make critical decisions, such as the investment or creditworthiness of a company. These techniques provide advantages for different users. Interested users may conduct a ratio analysis of GM’s accounting statements to form a comparison, identify industry trends, evaluate a stock, and make strategic decisions. Many individuals use ratio analysis to determine the solvency, asset utilization, and profitability of a business (Ingram, 2017).
Solvency Ratios
Solvency ratios are tools that help identify the liquidity and financial leverage of an organization. Solvency ratios reveal a company’s ability to meet its short and long-term debt obligations. Some current solvency measuring tools are current ratio, quick ratio, and debt equity ratio (Ross, Westerfield, Jaffe, & Jordan, 2016).
Current ratio. The current ratio measures short-term liquidity and is expressed in terms of dollars or time. The formula to calculate current ratio consists of dividing current assets by current liabilities. GM’s current assets in 2015 were $78.01 billion, and its current liabilities were $71.47 billion. GM’s current ratio is 1.09 times. GM has a $1.09 in current assets for every $1.00 in current liabilities. The current ratio shows that GM can meet its short-term obligations and is using its resources efficiently. Short-term creditors value a firm’s current ratio measurements because they can determine if they will recoup their money from a short-term loan (Ross, Westerfield, Jaffe, & Jordan, 2016).
Quick ratio. The quick ratio or Acid-Test measures short-term liquidity but omits inventory from the equation. GM had an inventory balance of $13.76 billion in 2015. The quick ratio computes to 0.90 times. GM’s remaining inventory might cause concern for creditors if it were in a different industry. However, slow moving inventory is a warning sign of short-term problems. GM should consider producing fewer vehicles that consumers are not buying to reduce its unsold inventory (Ross, Westerfield, Jaffe, & Jordan, 2016).
Debt equity ratio. The debt-equity ratio measures a company’s long-term ability to meet its debt obligations. The formula consists of dividing the total debt by total equity. GM’s total liabilities in 2015 were $154.2 billion, and its shareholders’ equity was $39.87 billion. GM’s debt equity ratio computes to 3.87 or 387 percent (Market Watch, 2017). The debt-equity ratio shows that most of GM’s capital was acquired through debt. GM’s large debt provides minimal leverage when acquiring new long-term loans but may spark the interest of additional investors because there is more equity. GM is also at high risk to default on paying its liabilities because of its debt utilization (Ross, Westerfield, Jaffe, & Jordan, 2016).
Asset Utilization
Investors are more interested in a company’s ability to manage its resources to generate sales. Turnover ratios measure the efficiency of a firm’s assets. Some critical tools are inventory turnover, receivables turnover, and total assets turnover (Ross, Westerfield, Jaffe, & Jordan, 2016).
Inventory turnover. The inventory turnover ratio involves dividing the costs of goods sold by a company’s remaining inventory. GM’s cost of goods sold was $125.34 billion, and its inventory was $13.76 billion (Market Watch, 2017). GM sold its inventory 9.11 times during 2015.
A higher inventory turnover ratio suggests that managers are efficiently maximizing GM’s assets. An efficient turnover is attractive to investors because they will get higher returns on their investments (Ross, Westerfield, Jaffe, & Jordan, 2016).
Receivables turnover. The receivables turnover ratio consists of dividing revenue by accounts receivable. GM’s sales in 2015 were $152.36 billion, and its accounts receivable were $26.39 billion (Market Watch, 2017). GM’s receivable turnover is 5.77 times or a collection period of 63 days. GM collects cash on its credit sales on average every 60 days, which is the norm in the auto industry. The faster a business can collect cash for its sells, the better its cash flow (Ross, Westerfield, Jaffe, & Jordan, 2016).
Total assets turnover. The total asset turnover ratio involves dividing sales by total assets. GM’s sales in 2015 were $152.36 billion, and its total assets were worth $194.52 billion (Market Watch, 2017). GM generates $0.78 in annual sales for every dollar in total assets and takes 1.3 years to turnover its assets completely (Ross, Westerfield, Jaffe, & Jordan, 2016).
Profitability
A company’s profitability is essential to investors, creditors, managers, and other users. An organization’s ability to generate profits and maximize its resources is crucial to its ongoing operational success. Some key profitability measuring tools are profit margin and Return on Assets (ROA) (Ross, Westerfield, Jaffe, & Jordan, 2016).
Profit margin. The profit margin ratio analysis involves dividing net income by net sales. GM’s net income was $9.69 billion, and its profit margin was 6.36 percent. GM generated more than 6 cents in net income for every dollar in sales. GM’s profitability is relatively low compared to its revenue (Market Watch, 2017).
ROA. To calculate the ROA of a company requires dividing net income by total assets. GM’s net income is $9.69 billion, and its total assets are worth $194.52 billion (Market Watch, 2017). GM has a 5 percent ROA, which may or may not be acceptable in its industry. The goal of operating a business is to maximize profits and returns. Users expect higher percentages when they interact with organizations (Ingram, 2017).
Evaluation of GM
After conducting the ratio analysis, one may determine the following in regards to the performance of GM. GM can quickly convert its current assets into cash but not its inventory. It can readily meet its short-term debt obligations. GM’s long-term liabilities pose a significant risk to its leveraging power to borrow money, but it has enough equity to attract new investors. GM has efficient asset utilization and is profitable, but it could invest in strategies to reduce its costs and increase its net income. GM provides a great opportunity for short-term creditors and investors, but may not be worth the risk to long-term creditors (Ross, Westerfield, Jaffe, & Jordan, 2016).
Conclusion
Ratio analysis tools benefit various users in making critical decisions, such as investing, loaning money, and managing resources. Because of the SEC a company’s financial statements provide the basic information individuals need to apply specific measurements. Creditors may use solvency tools, Investors may use profitability techniques, and managers may prefer asset utilization tools. The assessment must be accurate to achieve the desired goal regardless of the method. GM may or may not be a financially successful business, but it takes more than an observation of its accounting statements. Diligent users conduct ratio analysis and other techniques to make the best decisions (Ingram, 2017).
