PEPSICO is one of the most renowned brands in the world with its operations in almost every country of the world. PEPSICO is an American based, Fortune 500 company which is known for its carbonated and non-carbonated beverages. The company also deals in snacks and other food items. (Dena Votroubex 1994)
Q.1.2
Financial information of any company can be obtained from either internal or external sources. Internal sources of financial information can the finance department of a company or even the internal audit department. These departments usually have all the latest information regarding the financial aspects of the company. However, since the information is produced by a group of people fully dedicated to their company, anomalies are possible. A better and more reliable source of information with regard to the financial information of a company is the external ones. The external sources of information include the published financial reports for the shareholders. These reports are available to the general public and can be obtained easily from various sources including the company's website. Since these reports are always audited and signed by the auditors, they are more reliable.
Information is valid if it is obtained from a reliable source. In view of the fact that the sources internal to a company are always biased and loyal towards their own corporation, the chances of getting manipulated information are there. Some companies have an internal audit department whose role is ideally to act as an independent body from within the company and oversee the financial and control procedures of the company. However it is always argued that even an internal audit department can be influenced by the senior management and their role as an independent body can easily be inclined for the stake of the company.
On the other hand, external sources of information are free from prejudice and reviewed by the auditors, who are highly qualified and expert people in this field. The published financial statements are always signed off by the auditors who guarantee the quality and accuracy of the financial information in there. Therefore external sources of information are always reliable.
Q.2.1
Ratio Analysis (S. A. Siddiqui 2005)
Profitability Ratios
These ratios are used to measure the profitability performance of an organization and different profit figures with sale. These include;
Gross Profit Margin
This is a ratio that compares gross income to total sales and indicates how much profit after cost of goods sold is earned for every dollar of sale. Higher is better.
Gross Profit Margin= G.P/Sales * 100
Operating Profit Margin
This ratio is measured as operating profit to total sale and it indicates the operating profit earned for every dollar of sale. Higher is better.
Operating Profit Margin= O.P/Sale * 100
Net Profit Margin
This is a ratio of net profit to sales and indicates how much of net profit is earned for every dollar of sale. Higher is better.
Net Profit Margin= N.P/Sales* 100
Return on Equity
The ratio indicates the efficiency of company to earn against every single unit of investment made in it. A higher ratio is better.
Return on Equity= Net Income/Shareholders Equity
Liquidity Ratios
These ratios indicate the ability of an organization to meet its short term liabilities. The most commonly used liquidity ratios include the following;
Current Ratio
This is a ratio of current asset to current liabilities and indicates the ability of a firm to convert its current assets to meet its current obligations. A higher ratio is preferable by short term lenders.
Current Ratio= Current Assets/Current Liabilities
Quick Ratio
Quick ratio measures current assets excluding inventory to current liabilities. This measures the ability of a firm to meet its current obligation through its most liquid assets by assuming that inventory is not a very liquid item. A higher ratio is better.
Quick Ratio= (Current Asset - Inventory)/ Current Liabilities
Cash Ratio
This is a more conservative liquidity ratio because it only includes the definitive liquid items which are cash and cash equivalents. This is a measure of cash and cash equivalents to total current liabilities. A higher ratio is better.
Cash ratio= Cash & Cash Equivalents/ Current Liabilities
Efficiency Ratios
Efficiency ratio indicates the ability of an organization to manage the utilization of its assets. They are also known as Asset Utilization Ratios and Asset Management Ratios. Following are the efficiency ratios;
Receivable Turnover Ratio
This ratio indicates the effectiveness of the organization's collection policies and indicates how quickly it recovers its accounts receivables. A higher ratio is healthier
Receivable Turnover Ratio=Credit Sale/ Average Accounts Receivable
Payable Turnover Ratio
This ratio measures the efficiency of a firm to pay its payables and indicates its payables policy. A higher ratio is healthier
Payable Turnover Ratio= Cost of Goods Sold/Average Accounts Payable
Receivable Turnover Period
The ratio indicates the number days taken by a company to collect money from its receivables. A lower ratio is healthier.
Receivable Turnover Period= Accounts Receivable/Sales *365
Payable Turnover Period
This is the measure of number of days the firm takes to pay its payables. A lower ratio is healthier.
Payable Turnover Period= Average Accounts Payable/Cost of Goods Sold *365
Days Inventory Outstanding
The ration indicates the efficiency of a company to convert its inventory into sale. A lower ratio is healthier.
Days Inventory Outstanding= Average Inventory/Cost of Goods Sold *365
Leverage Ratios
Leverage ratios indicate the ability of firm to meets its long term liabilities and generate further finance. Following are the leverage ratios;
Debt to Equity Ratio
This is a ratio of total debt to total equity and is an indication of financial leverage of a company and helps the management to decide the proportion of debt and equity to raise finance. A lower ratio is healthier.
Debt to Equity= Total Debt/ Shareholder's Equity
Equity to Total Asset
This is a measure of equity to total asset of a company and as is an indication of financial stability of a company. The higher ratio is better for investors.
Equity to Total Asset=Shareholder's Equity/Total Asset
Investor's Ratios
Earnings per Share
The ratio indicates the amount of profit owed to each common share. It is regard as the most important share price ratio. The greater the ratio, better the performance!
EPS= Net Income - Dividend on Preferred Stock/ Average Outstanding Shares
Price to Earnings Ratio
It is a ratio of market price of a company's share to the earning per share. It is an important tool used by investor to determine the demand of a company's share. The ratio divides the market value of each share to the earning per share. Therefore the lower the ratio the better it is for the investor, because investor gets more return on the amount invested.
Price to Earnings Ratio= Market Value per Share/ EPS
Dividend Yield
This is a ratio of dividends paid per share to the price of share. This ratio indicates the return on the investment of each share. It shows the amount of yield which an investor can expect to get on every share purchased. The higher the ratios the better the results!
Dividend Yield= Annual Dividend per Share/ Price per Share * 100.
Q.2.2
Gross Profit Margin
Calculation:
((43232-20099)/43232)= 53.51%
Comments:
A gross profit of 53.51% is an indication of good income generation and solid performance.
Net Profit Margin
Calculation:
(5975/43232)= 13.82%
Comments:
13.82% of the total revenue is left after deducting all the expenses. This net profit is quite a healthy figure for the shareholders.
Return on Equity
Calculation:
(4946/16908)= 29.25%
Comments:
Every unit of investment made by shareholders is earning them a good return of 29.25% of the total equity.
Current Ratio
Calculation:
(12571/8756) = 1.44
Comments:
The current ratio greater than 1 is an indication that the current assets of the company are highly liquid and more than enough to cover the current liabilities.
Quick Ratio
Calculation:
[(12571-2618)/8756]= 1.14
Comments:
Inventory is quite a liquid item for PEPSICO; it certainly is as its products have almost become a necessity for us now!
Receivable Turnover Ratio
Calculation:
[43232/ ((4683+4624)/2)]= 9.29
Comments:
The ratio of 9.29 indicates that PEPSICO needs to improve in its debt collection. However a comparison with the prior years and industry averages can give a better performance indication is this area.
Payable Turnover Period
Calculation:
[20099/ ((8127+8273)/2)]= 2.45
Comments:
Comparing the ratio of 2.45 with 9.29 of that of receivables ratio, PEPSICO seems to be quite efficient in paying out its payables. However a better picture will only be possible by comparing with previous year's results and industry averages.
Debt to Equity Ratio
Calculation:
(22406/16908)= 1.33
Comments:
Total debts are higher than the total equity by a ratio of 1.33. This means 33% more debt than total equity! This is alarming situation as the gearing is high.
Earnings per Share
Calculation:
(22406/16908)=$ 381
Comments:
The EPS of $ 381 is quite a good figure for the investors. The company has good earning potential for its shareholders.
Price to Earnings Ratio
Calculation:
60.96/3.81= 16
Comments:
This figure in isolation cannot indicate any performance. A better picture can be obtained by comparing with previous years and industry averages.
LO 1.3
Q.3.1
Gross Profit Margin
Gross Profit Margin for PEPSICO was 52.95% in FY 2008 but the position in FY 2009 improved a little when the company reported a Gross Profit of 53.51%. The company has improved in this area as compared to the previous years and the reason is reduced cost of production and better profit margin.
Net Profit Margin
PEPSICO reported a net profit of 11.94% in FY 2008. However an improvement was seen in FY 2009 when the ratio was 13.82%. The better performance can be linked to the decrease operating cost and reduced interest expenses as the company reduced its borrowing level during the year 2009.
Return on Equity
The Return on Equity ratio for PEPSICO was 42.14% in FY 2008 but fell to 29.25% in 2009. The company vigorously started repurchasing its common stock and reduced its total equity during the year 2008. A higher repurchase of common stock, a higher accumulated other comprehensive loss and lower retained earnings in FY 2008 were the reasons for a lower equity and therefore a higher Return on Equity ratio in the year 2008.
Current Ratio
The current ratio of PEPSICO for the FY 2008 was 1.23, but it increased to 1.44 in FY 2009. The ideal Current Ratio is 2:1 which means that company's current ratio is below the ideal figure. The reason that Current Ratio fell in FY 2008 was that there was an increase in accounts payable in the year, but the position was better in FY 2009 when the current assets were increased and the accounts payable were reduced by a small amount as compared to FY 2008.
Quick Ratio
The quick ratio for the company in FY 2008 was 0.94 and 1.14 in FY 2009. The ideal Quick Ratio is 1:1 and PEPSICO has maintained its ratio at ideal. The ratio indicates the fact that the inventory of the company is a very liquid item.
Receivable Turnover Ratio
The ratio for the company in FY 2008 was 9.54 and in FY 2009 it fell to 9.29. It can be noted that the ratio is deteriorating slightly over the two years and PEPSICO needs to improve in this area to get better in its debt collection.
Payable Turnover Period
The Payable Turnover Ratio for PEPSICO for the FY 2008 at 2.56 but the ratio fell slightly in FY 2009 to 2.45. PEPSICO is taking much longer to pay its payable and the company needs to improve its payable policy to maintain sound and confident relation with its payables.
Debt to Equity Ratio
The Debt to Equity Ratio for PEPSICO was 1.92 in FY 2008. The ratio fell in FY 2009 to 1.33 due to a fall in total liabilities by $1006 m and an increase in total equity by $4705 m. Although it is not an alarming situation for PEPSICO yet keeping in view the usual trend of this ratio among large companies but still the company's ratio is higher than its competitor. PEPSICO should know that its competitor COCA COLA has an ideal Debt/Equity ratio.
Earnings per Share
The ratio of PEPSICO in FY 2008 was 3.26 but increased in FY 2009 to 3.81. The improvement indicates the fact that PEPSICO is determined to improve its per share earning potential The ratio increased due to increased net profit and constant share capital.
Price to Earnings Ratio
The ratio for PEPSICO in FY 2008 was 16.74 and reduced to 16.00 in FY 2009. This reduction was due to the decrease in market value per share in FY 2009 as compared to the market value per share in FY 2008.
LO1.4
Q.4.1
Both internal and external auditors ideally use a similar technique and approach to analyze the financial information. However the difference arises in the scope of work performed. External auditors perform procedures to examine information as an independent body while internal auditors work for the company without being independent. (K. H. Spencer Pickett, Jennifer M. 'CON' Pickett 2010). The overall approach used by both types of auditors follow the "H,4Ws" approach as follows;
How!
What!
Who!
When!
Why!
Using the above approach an audit starts by obtaining an understanding of an entity and its control environment. Based on this understanding an audit approach is devised. Depending on the control environment of a company, auditors devise a plan. The plan includes the decision on the direction of audit. Auditors perform test of controls to determine the control procedures in different areas of company's operations. They carry out analytical procedures by comparing a set of information with the prior years or a relevant set of another data to ensure the figures are reasonable. Detail substantive procedures are performed on sample basis if test of controls are weak in any particular area or if the nature of an item is crucial. Transactions with the directors of a company are an example of crucial natured item. If information is not making sense, auditors ask the relevant persons in the company about it, who then have to satisfy the auditors about the matter.
LO 2.1
Q.5.1
Budgeting is a process of setting goals and targets based on an organization's capability and capacity. Budgeting is an effective tool to provide a direction of movement and enables the company to make comparison between the actual results and the budgeted figures to obtain an understanding of the organization's efficiency during the period.
The process of budgeting starts by setting a sale target. Sales are the principal income driving factor for any company. A target sales budget should be devised in both units and revenue. This budget will drive the making of other budgets but will depend itself on the others too. After a sales budget a production budget is created with the following general format;
Units
Budgeted sale XXXX
requisite closing inventory XXXX
--------
Total units needed XXXX
Less: opening inventory (XXX)
---------
Required level of production XXXX
After making a production budget, a company needs to identify its Expenditure budget so that its total expenses during the year are pre-known and under control. Based on these budgets the company will conclude on a profit figure targeted for the year. Another necessary budget is the Cash Flow budget which determines the planned utilization and movement of cash during the year.
LO 2.2
Q.5.2
The next important phase of a budgeting process after its preparation and implementation throughout a period is the comparison of actual results with it. The comparison is an activity where the actual results during the period are compared with the amount that was set in the budget. This process is more commonly known as Variance Analysis. There are two types of variances, either Favorable or Adverse. Following variances should be found in order to establish the performance;
Sales Variance
Variable Production Overhead Variance(Direct material + Direct Labour)
Fixed Production Overheads
Expenditure Variance
After determining the variances of actual results with the budgeted results, an investigation should be made to identify the reasons of variances found. Both favorable and adverse variances should be investigated and anomalies, if found any, should be taken care of.
LO 3.1
Q.5.3
Investment proposals are part and parcel of everyday decision making of every company especially the big corporations like PEPSICO. The management of the company is required to assess the viability of every proposal and proceed with the best option. Following are different criteria for assessing a proposal;
Profitability:
Since every organization's common goal is to make profit, this is always the first decision impacting point. The more the return on a proposal, the better is for the company.
Increased Production:
Companies often have to consider different proposals with the perspective of expanding their production capacity or widening their scope of business. Businesses with the aim of making expansion always prefer the proposals offering more expansion with the same amount of investment.
Market Leadership:
This can also be a deciding factor for many companies. Proposals which allow a company to capture a greater market share are always preferred if market leadership is what a company is seeking.
Cash flows
The most important of all the deciding factors! The better the return cash flow of an investment, the better for a company, as cash is always the soul for survival.
LO 3.2
Q.6.1
Break even analysis
Every proposal offer greater revenue and determining the level of revenue required to match the cost of proposal is called Break even analysis. This management tool can be applied to match the level of sale required to match the cost of an investment proposal. The major weaknesses of this method include the ignorance of risk factor associated with the cash flows. It only considers the quantitative factors like increase in revenue and ignores qualitative factors like market share and business expansion.
Formula:
BEP= {Total Cost of investment/ (Selling Price-Variable cost)}
Payback period method
This proposal analysis tool defines the amount of time incurred to earn a return that matches the cost of investment. This is actually the time taken for an investment to break even with its return. Therefore payback period determines the length of time to repay the amount of investment. Obviously the shorter the time, the better are the cash flows of a proposal. Weaknesses of this technique are that it only focuses on the time period and ignores the value that a particular proposal offers. It also ignores the risk associated with future cash flows as well the time value of money.
Formula:
Payback Period= Total investment/Cash flow each year
Net present value method
Net Present Value is simply the present value of future cash flows from a proposal. This is an investment appraisal technique with respect to the net discounted value of future cash flows likely to arise from a proposal. This method allows the company to determine the extent of value that a particular proposal can provide in future. If NPV of a proposal is positive it means the proposal will provide more cash inflows in comparison with the out flows and vice versa. An NPV equal to zero means outflows are equal to inflows. Therefore a proposal should always have a positive NPV. The major weaknesses of this technique are that it ignores the level of risk during the investment period, it depends on the discount rate factor and it is difficult to understand for a layman. (Belverd E. Needles, Marian Powers, Susan V. Crosson 2008)
Formula:
NPV= Rt / (1 + i)t
Where;
Rt = Net cash flows (Inflows - Outflows) at time t (the time period e.g no. of years)
i= the rate of discount
t= the time period e.g no. of years
LO 3.3
Q.6.2
Break even analysis
This method provides usual information about the level of return that matches the cost of investment and therefore allows the management to understand their cash flows movement with regard to a particular proposal. Companies with cash flow constraints will definitely consider this technique.
Payback period method
This technique focuses on the time period taken by an investment to at least return the outflow of cash. Therefore this technique focuses on the period of return only, ignoring other considerations as discussed above.
Net present value method
NPV analysis takes into account the time value of money as well as the complete cash flows of a proposal. The information given by this method is more useful as compared to the above methods but it has its own limitations as discussed above.
LO 3.4
Q.6.3
Strategic objectives are the long term plans to achieve long term goals of a company. Strategic objectives focus on long term prospects of a company and derive the direction of its overall activities in order to achieve a particular goal. For example a strategic objective of PEPSICO can be to invade the Dairy industry in the near future!
A financial proposal allows a company to consider the options available to it in order to spread out its scope of operations. The major aim of every organization is to make money and different proposals allow it to consider the opportunities available to earn it. For example if PEPSICO is offered a proposal that allows it to place its first step into the Dairy market, then this proposal can make the management think about the earning potentials in a Dairy market and therefore devise their strategic plans to invade it in future.
