1. Final Project: Financial Analysis

 Review the annual reports for PepsiCo, Inc. and The Coca-Cola Company in Appendixes A & B, especially the Consolidated Statements of Income and the Balance Sheets on pp. A4, A6, B1, & B2 of Financial Accounting.

 Write a 1750- to 2,050-word paper in APA format with citations and references that provides a financial comparison of the two companies and your recommendations to improve the financial status of each.

 Include the following:

o An introductory paragraph with a statement of the purpose of your paper and a synopsis of what readers may expect to find in the paper – It is best to write this after writing the rest of the paper.

o Vertical analyses for both companies – You may use your calculations from the Checkpoint Ratio, Vertical, and Horizontal Analyses, providing you show your work.

o Horizontal analyses for both companies – You may use your calculations from the Checkpoint Ratio, Vertical, and Horizontal Analyses, providing you show your work.

 Due Date: Day 7 [post as an attachment to your Individual forum]

Please note that in conducting the analysis, I have used the current year’s figures instead of averages since the data for 2003 is not available.

In this paper, I have attempted to analyze the financial statements of two industry leaders in the field of soft drinks, Pepsico, Inc., and The Coca-Cola Company. In this analysis, I have conducted a vertical analysis (also called common-size analysis) which is a technique that expresses each financial statement item as a percent of a base amount.i In this analysis, the base for assets is Total Assets, for liabilities and stockholders’ equity, the base is the Total Liabilities, and Stockholders’ Equity, and finally for Income Statement accounts, the base is Net Sales or Net Revenues. I have also conducted a horizontal Analysis (also known as Trend Analysis) which is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place. This change may be expressed as either an amount or a percentage.ii

Through examining the financial statements of Pepsico, Inc, and The Coca-Cola Company, I would like to present the following analysis: Overall, both companies seem to be improving which can be seen from the Horizontal Analysis and Vertical Analysis on the attached excel sheet. Almost all items on Pepsico’s balance sheet have favorably increased between 2004 and 2005; yet it is obvious that current assets have not increased with the same rate as current liabilities, which would explain why the current ratio have decreased from 2004 to 2005. For Coca-Cola, however current assets have decreased from $12,281 in 2004 to $10,250 in 2005, while current liabilities have decreased from $11,133 in 2004 to $9,836 in 2005. For Pepsico, Inventories have increased from $1,541 in 2004 to $1,693 in 2005, this could be a favorable sign especially when we see the improvement in the inventory turnover ratio and days’ sales in inventory. The increase in inventory is usually unfavorable, but in this case it appears that the increase in inventory is to meet increased demand for the company’s products. For Coca-Cola, inventories have increased from $1,420 in 2004 to $1,424 in 2005 which shows that he expected demand Coca-Cola’s management is expecting is not as high as the one expected by Pepsico’s management. For Pepsico, Cash and Cash Equivalents have increased from $1,280 in 2004 to $1,716 in 2005 (34.06% increase), while Accounts Receivables have increased from $2,999 in 2004 to $3,261 in 2005 (a 8.74% increase) while sales have increased from $29,261 in 2004 to $32,562 in 2005 (a 11.28% increase). This explains the increase in inventory as Pepsico seems to be an increase in the demand for its products. The larger increase in cash and cash equivalents in comparison to the increase in receivables is probably due to a stricter measures in the company’s credit policy. Also, as a result of the increase in demand, Pepsico is probably in a stronger position and can therefore ask its customers to purchase its products in cash. For Coca-Cola, cash and cash equivalents have decreased from $6,707 in 2004 to $4,701 in 2005 (29.91% decrease), while receivables have increased from $2,244 in 2004 to $2,281 in 2005 (8.2% increase). This is coupled with an increase in sales from $21,742 in 2004 to $23,104 in 2005 (6.26% increase). Coca-Cola management should seek new ways to regain its market share as Pepsico seems to be acquiring more market share as clear from comparing the percentage increase in sales of the two companies. For Pepsico, Retained Earnings as a percentage of Total Liabilities and Stockholders’ Equity have decreased from 66.92% in 2004 to 66.56% in 2005 which indicates that Pepsico is maintaining a constant payout ratio of dividends. For Coca-Cola, however Retained Earnings as a percentage of Total Liabilities and Stockholders’ Equity have increased from 92.57% in 2004 to 106.36% in 2005 (7.54% increase), this means that Coca-Cola is decreasing its payout ratio so as to meet future expansion needs.

Additionally, and by conducting a ratio analysis of each company, I came to notice the following:

First: Liquidity Ratios: By examining the current ratio (which measures the company’s short-term debt-paying ability), and the acid test ratio (quick ratio which measures the immediate short-tern debt-paying ability of the company), we realize that both companies have suffered a drop in their current and quick ratios, yet again for companies, the receivables turnover ratio (which measures the liquidity of receivables), days’ sales in receivables (which measures the number of days it takes the company to convert its receivables into cash) , inventory turnover (which measures the liquidity of inventory), and days’ sales in inventory (the number of days merchandise remain in inventory until sold) ratios have improved. This means that both companies are collecting their money faster, and therefore are able to turnover its receivables quicker in 2005 than 2004. The same can be noticed for the inventory turnover figures. For Pepsico, however the percentage of current assets to total assets have increased from 30.87% in 2004 to 32.95% in 2005. This is a good sign because it means that the company is trying to lower its investments in noncurrent assets.

Second: Profitability Ratios: Again, by examining the analysis in the attached excel sheet, we can see that the profit margin ratios (which measures the percentage of net income that is generated by each dollar of sales) of both companies have dropped between 2004 and 2005, this could be the result of the fierce competition between those two industry leaders. This is also due to the fact that the cost of goods sold have also increased for both companies between 2004 and 2005. The Asset turnover (which measures how efficient is management in managing its asset base to generate sales) for Pepsico had dropped from 1.05 in 2004 to 1.03 in 2005, while for Coca-Cola, the asset turnover has increased from 0.69 in 2004 to 0.79 in 2005. This shows Coca-Cola is better managing its assets base. This is also reflected in the fact that for Pepsico, the return on assets (which measures the overall profitability of assets) have dropped from 15.05% in 2004 to 12.85% in 2005, while it increased for Coca-Cola from 15.42% to 16.56% for the same period. The return on equity (this is probably one of the most important measures of profitability form many investors as it measures the profitability of their investment) have dropped for both companies between 2004 and 2005; this is probably due to the drop in the profit margin for both companies. The earnings per share (a ratio that measures net income earned by each share of stock) has dropped for Pepsico from $2.48 in 2004 to $2.44 in 2005, while the price earnings ratio (the ratio of the market price per share to earnings per share. The higher the price earnings ratio, the higher the confidence of investors in the company’s operations) have increased from 25.15 in 2004 to 25.57 in 2005 which is an indication that the investors have an increased confidence in the company’s future performance. The opposite is true for Coca-cola where the earnings per share have increased from $2.00 in 2004 to $2.04 in 2005, yet the price earnings ratio have dropped from 26.39 to 25.88 for the same period, which could be interpreted as the investors’ not feeling optimistic about the company’s future operations. Although both the increase and the drop in those ratio is not significant, management of both companies need to explore the reasons behind such increase/decrease in the profitability ratios. Third: Solvency ratios: The debt to assets ratio (the percentage of total assets financed by creditors as opposed to the percentage financed by investors) for Pepsico had increased from 0.52 in 2004 to 0.55 in 2005, management should review their capital structure because the increase of debt in the capital structure is not favorable. An increase in the debt ratio signifies a heavier reliance on debt; the interest paid on debt obligations have to be paid whether the company’s operations are successful or not. A huge increase in this ratio (although this has not happened yet) could expose the company to the threat of bankruptcy if it cannot meet such obligations. The times interest earned ratio has also decreased from 34.21 in 2004 to 25.93 in 2005, this proves the point about the debt ratio since the times interest earned ratio measure the company’s ability to meet interest payment obligations as they become due. For Coca-Cola, however the debt to assets ratio have decreased from 0.49 in 2004 to 0.44 in 2005, which is a favorable outcome since the debt ratio measures the percentage of total assets provided by creditors and the lower the ratio the safer the company. The times interest earned ratio have also decreased from 32.74 in 2004 to 28.88 in 2005. This is probably due to an increase in the cost of debt which is evident by the fact that although debt had decreased, the interest paid on debt had increased from $196 in 2004 to $240 in 2005. Management should conduct the necessary analysis to investigate such an issue and try to lower its interest payments.

In conclusion, both market leaders Pepsico, Inc., and The Coca-Cola Company are almost as successful although as from the above it seems that Pepsico has succeeded in attracting more customers than Coca-cola. This is probably due to better advertising and marketing plans. Both companies have engaged in stock repurchase plans which would lead to an increase in the earnings per share since the amount of shares outstanding is now lower. This is probably a good move especially when the stock market had seen some declines during those years, and to be able to keep its investors happy, the best way to backup the stock was to engage in such repurchase plans. The industry seems to be a stable industry since the market for soft drinks is almost unaffected by the economy to a great extent. Although the market is stable, both Pepsico and Coca-Cola have to be very cautious when increasing debt in the capital structure to ensure that their stockholders’ interests are well protected. I would also recommend that management try to analyze the components of their current assets so as to increase both the current and acid test ratios, maybe lower their inventories a bit. Both companies should try to increase their acid test ratio to at least 1:00 to 1:00 to ensure they have enough liquidity to meet sudden short-term financing needs. Both companies seem to be a good investment, yet we must not forget that the ratios examined above should be compared to the industry ratios to see if they are within the industry ratios (which is probably the case since both companies are the industry leaders) i Financial Accounting, 6e, By Kimmel, Weygandt, & Kieso, P.703 ii Ibid, P.700