Case 2 final input

Case 2
The Financial Cockpit:
Three Levers and One Flight Plan
StudentStudent numberMaria
Epifanova01632800Lesly JeanLouis00826331Junyi
Ouyang 01597944Elaine Cui01248695

Table of Contents
Table of Contents...............................................................................................................2
Introduction.......................................................................................................................3
Case Analysis......................................................................................................................4
Question 1....................................................................................................................................6
Question 2....................................................................................................................................8
Question 3..................................................................................................................................10
Question 4..................................................................................................................................12
Question 5..................................................................................................................................13
Question 6..................................................................................................................................14
Question 7..................................................................................................................................16
Question 8..................................................................................................................................17
Conclusion........................................................................................................................18
2

Introduction
The case presented the situation of a non financial product specialist named Jill Keyes who
wanted to have a quick and insightful view of some companies ' fundamental by looking at
their financial reports. Jill works for Craftsman Furniture, Inc. which is a medium size
manufacturer and distributor of household and office furniture located in the southern
region of the United States. She wanted to conduct some comparative analyses to gauge
CFI's financial health compared to the companies in the region and beyond in case they
need a new partner or a potential corporate acquisition opportunity. Jill wanted to use the
DuPont ratio model in order to have a succinct and provocative insight into the companies.
Her view is based on the fact that the return on equity (ROE) would be determinant in
predicting the level of return that most shareholders would want and would forecast how
well the company used their owners' funds. Jill and her colleagues embark in this endeavor
with the conviction and determination that it would benefit greatly Craftsman Furniture,
Inc. in case the company wanted to increase their market share by partnering with another
company or acquiring one. Is the DuPont ratio model full proof when it comes to the
dilutive effect of an acquisition? Or does the ROE tell the whole story about the provenance
of these predictable returns?
This paper takes a deep look at the nine companies that Jill has selected for her analysis,
these companies are in the list of Fortune and are separated by three industries as
Computers and Office Equipment, Household and Personal Products as well as Internet
Services and Retailing. The analysis of these companies is mainly based on DuPont breaking
down method of ROE. At the end, the case analysis provides some insights for Jill on further
evaluation of CFI using the DuPont analysis.
3

Case Analysis
Since Jill decided to look at several well-known companies, based on the information given
in the below table, it is important to acknowledge the company which uses its assets in the
most productive and efficient way. Those nine companies are divided by the industry
category in which they perform. Thus, Hewlett - Packard, Dell and Apple represent the
computers and office equipment industry, while Procter & Gamble, Kimberly-Clark and
Estee Lauder fit the Household and personal products category and, at the bottom of the
table, the internet services and retailing industry is represented by Google, Yahoo and eBay.
The study is based on the historical data extracted from the companies’ annual reports. This
way, the paper analysis the companies using DuPont ratio breakdown.
4

Company
Yea
r
ROS,
%
Change AT Change
ROA,
%
Change FL Change
ROE,
%
Change
Hewlett-
Packard
Year
5 7
75%
1,00
-20%
7
40%
3,00
67%
21
133%
Year
1 4 1,25 5 1,80 9
Dell
Year
5 4
-33%
2,25
4%
9
-31%
6,44
78%
58
23%
Year
1 6 2,17 13 3,62 47
Apple
Year
5 15
400%
0,80
-20%
12
300%
1,92
15%
23
360%
Year
1 3 1,00 3 1,67 5
Procter &
Gamble
Year
5 14
8%
0,57
-33%
8
-27%
2,13
-38%
17
-55%
Year
1 13 0,85 11 3,45 38
Kimberly-
Clark
Year
5 9
-25%
1,00
9%
9
-18%
4,89
100%
44
63%
Year
1 12 0,92 11 2,45 27
Estee
Lauder
Year
5 6
0%
1,50
0%
9
0%
3,22
45%
29
45%
Year
1 6 1,50 9 2,22 20
Google
Year
5 19
46%
0,68
-26%
13
8%
1,15
-2%
15
7%
Year
1 13 0,92 12 1,17 14
Yahoo!
Year
5 6
-74%
0,50
28%
3
-67%
1,33
0%
4
-67%
Year
1 23 0,39 9 1,33 12
eBay
Year
5 21
-13%
0,52
24%
11
10%
1,45
21%
16
33%
Year
1 24 0,42 10 1,20 12
Table 1: Selected DuPont Ratio Amounts and Changes between them within five-year period
Source: The Financial Cockpit: Three Levers and One Flight Plan, 2010
To make it easier to analyze the change of ratios within five-year time, the fluctuation level
of each ratio was calculated. Hence, these amounts of changes are vastly applied in the
further research.
5

Question 1
← Which of the nine companies used its assets most productively?
Return on Sales (ROS) = Net Income (NI) ÷ Sales
Asset Turnover (AT) = Sales ÷ Average Total Assets
(TA)
Return on Assets (ROA) =NI ÷ Average TA
Return on Assets (ROA) = Return on Sales (ROS) ×
Asset Turnover (AT)
Return on Asset examines company’s efficiency in managing its assets. Nevertheless, it is
important to understand that there are two main components of this ratio as Return on
Sales and Asset Turnover. Therefore, not only ROA has to be analyzed but also Asset
Turnover and ROS.
At the first glance, to analyze the asset efficiency of these nine companies it is easy to
quickly look at their Asset Turnover amount (AT) as well as their Return on Assets (ROA)
from year 1 to year 5. It is also not difficult to say that Dell had the highest level of AT (2,17)
in year 5 and the highest amount of ROA belonged to Google (13) and Apple (12).
Nevertheless, these numbers are different from industry to industry and it cannot be correct
to say that these companies are the best at using its assets. Thus, the most insightful
analysis should come from the understanding of how these ratios related to asset efficiency
are interpreted. Even though, Google and Apple show relatively low AT in year 5 compared
6

to the rest of the companies on the table, it is fundamentally relevant to point out that
these two companies show the strongest Return on Assets (ROA) across the board. For
every dollar invested in assets in Year 5, Apple had a return of 12 cents on the dollar and
Google had 13 cents on the dollar. Overall, it is safe to say that Apple is the most efficient
and most productive company based on its historical ROA improvement compared to
Google in year 1 to year 5. In year 1, Google earned 12 cents on the dollar for every dollar in
assets while Apple earned a mere 3 cents. Five years later, Google earned 13 cents while
Apple showed a steep jump of 12 cents on a dollar for every dollar in assets and that with a
decrease in AT that same year.
It is also important to mention that the measurement of how profitable a company is to its
assets (ROA) could be highly affected by Return on Sales of companies. Thus, as it was
mentioned, not only AT depicts the leader in asset efficiency, but also the ratio of net sales
to revenue (ROS) does it. This way, Apple has achieved a tremendous change of ROA –
although AT’s change was negative, ROS has increased by 400%, which made ROA boost,
and at the end, made the company use its assets most productively among others. The
same situation goes for Hewlett – Packard (which had the second highest change of ROA for
the period of five years) as well as it applies to Google that had a decline in AT, but
increased in ROS.
To conclude, it is always essential to look deeper when analyzing a ratio, since the ratio’s
components analysis can helpfully illustrate the specific character of the trend.
7

Question 2
← Which of the companies used debt most aggressively in financing its operations?
Financial Leverage = Average TA ÷ Average Owners’
Equity (OE)
Financial leverage illustrates how a company uses its debt and equity. Based on the
equation given above as well as the information presented in the table, it is simple to
identify those companies with the most aggressive debt financing in operations only by
looking at their respective financial leverage. The more a company uses debt to finance its
operations, the higher its financial leverage becomes and consequently the more risk it
incurs.
That way, Dell and Kimberly-Clark undeniably have financial leverage levels of 6.44 percent
and 4.89 percent respectively in year 5. Furthermore, among the companies given, Dell has
the highest historical rise in that ratio, supported by an increase of $2.82 on average for
each dollar invested in equity. Nevertheless, before casting a wide net on these two
companies as being too risky, it is important to take a look at their specific industry and their
competitors in order to make sure that it is not the norm in their sector and try to
understand their business' model. Within the Computers and office equipment industry,
Dell has by far the highest financial leverage in year 5, which does not reflect the industry
average of 3.8%( 1.92+6.44+3.0/3). As far as Kimberly -Clark is concerned, it seems that its
financial leverage is well within range when compared to the other companies within the
same category.
Internet Services and Retailing Industry Category has the lowest ratio when comparing to
other industries. That diversity in level of ratios might mean that the Internet Services and
Retailing Industry is more volatile than others which means it carries more risks.
When looking at the reverse side of asset to debt ratio, Procter & Gamble’s five-year
positive change in equity has decreased its Financial Leverage which also impacted their
8

ROE. Although ROE went down, the company became more attractive since it still had solid
return but at the same time decreasing risks.
In conclusion, although Dell and Kimberly-Clark are the ones that use their debt most
aggressively (as illustrated by the level of FL in year 5 as well as the five-year change), the
use of debt strongly depends on business model. Thus, it is seen that the Internet Services
and Retailing industry has a comparably low financial leverage since the companies operate
in a more volatile market environment which make it more difficult to find long-term
adequate financing.
9

Question 3
← Which company’s ROE would be the most attractive to investors, and how was it
generated?
ROE = ROS × Asset Turnover × Financial Leverage
To determine the company with the most attractive Return on Equity (ROE) to investors, is it
suffice = to pick the highest ROE ratio among these nine companies? Or should any careful
investor look at the underlying components of this DuPont equation of ROE= ROS x AT x FL
and their effects on ROE?
Most companies in the table with a relatively high ROE should be analyzed thoroughly in
order to determine their overall value to the investors. Dell, HP, Apple and Kimberly -Clark
may look attractive to the average investor, but the ROE equation may reveal some
interesting observations. Dell has the highest level of ROE (58%) among all the companies in
year 5, but the fact is that it might well be a ROE “on steroid”. With a low ROS, a slight
increase in AT and the highest Financial Leverage not only in its category but also among
others, it is easy to show an efficient ROE. Bearing that in mind, an informed and cautious
investor will easily pick Apple rather than Dell just by looking at values of all the ROE’s
components and their growth within five years. Thus, in year 5, Apple showed a solid 23%
ROE derived from a significant increase in its ROS, a slight decrease in AT and the lowest
financial leverage in the Computers and office Equipment category. When Apple is
compared to Kimberly-Clark, it is interesting to see how much value its brand can create to
boost their top line, which in turn, can provide a determinant multiplier to the ROE without
the need to incur additional debt.
It is interesting to point out that Estee Lauder shows historical consistency in its ratios and
can be considered as an attractive buy opportunity for the average investor . The lesson
here is to look beyond any significant increase in ROE in order to find out what the
underlying factors influencing that particular in ROE are. Either if it is an increase in ROS, AT
10

or FL, it is also important to do a deep dive to determine the sustainability of such sudden
increase in sale that caused the ROS to quickly rise for that particular year. In this case,
Apple brand and superior quality of products are anything but short lived. Thus, necessary
to understand for an investor that Apple’s ROS could fluctuate in the future due to the fierce
competition with Samsung.
Moreover, eBay has the highest ROE change within five years in their sector that was again
caused by an increase in Financial Leverage as well as an increase in Asset Turnover.
However, Google looks also attractive to investors with lower financial leverage and a
significant improvement of their ROS. Although the negative AT’s change within during
these five years also affected ROE negatively, it is safe to point out that the companies
operating in this industry have a relatively low ROA which can be explained by their business
model.
To sum up, for any investor it is essential to derive the reasons behind ROE, since the ratio is
highly influenced not only by operating activities but also by strategy of using debt and
equity. Besides, needless to add that although the company as Apple might be seemed as
the most attractive of how it has extracted its ROE from the analysis from year 1 to year 5,
investors still have to be aware of its fluctuated and fast-moving business environment as
well as severe competition that might affect the future of its business operations.
11

Question 4
← Which company changed the most in how it generated ROE results for investors
from Year 1 to Year 5?
Based on the table provided by the case, it can be seen that within five-year period Apple’s
ROE has changed the most by improving the ratio from 5% to 23%. That remarkable change
was due to a rise in ROS by 400% as well as in ROA by 300%. Another company presented in
the given table that sharply improved its Return on Equity as well as changed the way of its
generation is Hewlett-Packard. Although HP had a negative change of ROA as well as risen
financial leverage level, the company has grown its Net Income to Sales ratio by 75% for the
five-year time. Furthermore, it is observed that all the companies that represent the
Computers and Office Equipment Industry have increased the Return on Equity, and at the
same time all of these corporations borrowed more debt to equity in comparison to five
years ago. That might be explained by some trends in this particular industry.
As it was mentioned in the question 3, in the sector of Household and Personal Products
Kimberly-Clark has mostly changed its ROE, nevertheless, it was mostly caused byhigher
financial leverage rather than increased sales or other positive factors related to successful
ongoing operations.
When looking at the five-yeardifference betweenROE’s generation of the companies
operating in the Internet Service and Retailing sector, Yahoo! seems to change the way of its
abstracting ROE by declined ROS and ROA, which gave an outstanding decrease in ROE
within five years.
It can be concluded that within five years all the companies had changed its ROE generation
in different ways, but the company that remarkably altered its methodof gathering the ratio
might be Apple Corporation, it has done it by manipulating the components of the level of
net income extractedto shareholder’s equity.
12

Question 5
← Did any of the companies change for the worse in how it generated ROE results for
investors from Year 1 to Year 5?
There are two companies that experienced a decline in their Return on Equity from Year 1 to
Year 5. These enterprises are Procter & Gamble (-55%) and Yahoo! (-67%). Nevertheless,
when looking at the way of all the companies generated the ratio, it can be concluded that
six out of nine companies had their Financial Leverage grown which made ROE to go up and
made it riskier for creditors to finance the operations. Procter & Gamble is one of the few
companies that decided to decrease its level of debt to equity, which has significantly
affected its ROE measurement.
Although Procter & Gamble decided to get more attractive for potential investors in the
long-run by dropping its level of financial leverage down, Yahoo!’s negative five-year change
in Return on Equity was mostly influenced by reduced ROS and ROA levels. If looking more
closely to the numbers, for the first year Yahoo! generated 23 cents for every dollar in sales,
however in the fifth year, the company made only 6 cents for every dollar in revenue,
resulting in a negative change of Return on Sales by 74%. It can be concluded that with the
merge of Google, ROS for Yahoo decreased tremendously. The company also has the lowest
ROA in comparison to the players in its industry. Additionally, within 5 years it has extremely
decreased ROA, whereas Google and eBay succeeded to improve it. When looking at the
information given in the table, Yahoo! seems to struggle which might be a result of Google’s
expansion of market share related to advertising revenue.
To bring to an end, the negative ROE does not always mean a fail, an accurate analyst
should look beyond one number since by decreasing Financial Leverage, a company such as
Procter & Gamble is decreasing its debt, becoming less uncertain. However, by doing so in
year 5, the company pushed its ROE to go down. Nevertheless, Yahoo! is a good illustration
of how a decline in ROS ratio, which is straightly related to business operations, might lead
to changing ROE and the way of its generation for the worse.
13

Question 6
← What were the ratio amounts, for the same nine companies in years subsequent to
Year 5, and what insights did those additional data offer?
The table below was extracted and after calculated using the information of Net Income,
Revenue, Average Asset and Equity provided by annual financial statements of 2010 (Year
6). As it can be seen 2010 was a turnover year since the companies started recovering after
financial crisis, and thus, strengthening their business performance.
Compa
ny
Year
ROS,
%
Chan
ge
AT Change
ROA,
%
Change FL Change
ROE,
%
Change
Hewlett
-
Packard
Year 6 7
0%
1,05
5%
7
0%
2,93
-2%
21
0%
Year 5 7 1,00 7 3,00 21
Dell
Year 6 3
-25%
1,76
-22%
5
-44%
6,07
-6%
29
-50%
Year 5 4 2,25 9 6,44 58
Apple
Year 6 21
40%
1,06
33%
23
92%
1,54
-20%
35
52%
Year 5 15 0,80 12 1,92 23
Procter
&
Gamble
Year 6 16
14%
0,60
5%
10
25%
2,12
0%
21
24%
Year 5 14 0,57 8 2,13 17
Kimberl
y- Clark
Year 6 9
0%
1,01
1%
9
0%
3,45
-29%
33
-25%
Year 5 9 1,00 9 4,89 44
Estee
Lauder
Year 6 6
0%
1,48
-1%
9
0%
2,93
-9%
27
-7%
Year 5 6 1,50 9 3,22 29
Google
Year 6 29
53%
0,60
-12%
17
31%
1,20
4%
21
40%
Year 5 19 0,68 13 1,15 15
Yahoo!
Year 6 17
183%
0,42
-16%
7
133%
1,19
-11%
8
100%
Year 5 6 0,50 3 1,33 4
eBay
Year 6 20
-5%
0,45
-13%
9
-18%
1,39
-4%
12
-25%
Year 5 21 0,52 11 1,45 16
Table 2: Selected DuPont Ratio Amounts and Changes between them within one-year period from 2009 to 2010
Source: Ycharts.com, Annual reports of the selected companies of 2010
The first thing that come into attention is that none of the companies decreased Financial
Leverage, meaning that they proffered improved shareholder’s equity to liabilities.
14

Second, Yahoo! that had relatively bad financial results from Year 1 to Year 5, regained its
control of business operation in Year 6 by improving net income to revenue by 188% and
net income to average asset turnover by 133%. Thanks to these actions, Yahoo! improved its
ROE, which has doubled in comparison to the previous year. Procter & Gamble, which had a
downturn in ROE from Year 1 to Year 5 has also coped to rise its Net Income to Equity by
refiningits Return on Sales as well as Asset Turnover.
Furthermore, it is not surprisingly, but Apple still remained a very stable company with
consistent improvements of its ratios. In contrast to Apple success, Dell, which plays in the
same industry, is still (comparably with Year 1 to Year 5) pulling negative one-year change of
ROS, Asset Turnover, that caused its ROE to sharply decline.
If analyzing the industries separately, based on the one-year difference between the shown
ratios, it can be considered that the most stable industry was Household and Personal
products, that is due to the fact that the ratios of the presented companies have not
changed significantly in comparison with other business categories.
15

Question 7
← Were there other companies that should be reviewed to help evaluate CFI more
fully and to help grasp the varied way(s) other companies generated ROE results
for their investors?
Looking at CFI 's business model, their size and their industry, it would help tremendously to
look at similar companies that are operating either in their vicinity and in other areas in the
United States. Thus, Bob's furniture and Jordan's furniture could have been ideal to look at
because they offer different business strategies and market segmentation that could help
boost CFI's top line. Bob 's furniture, although privately owned, is an interesting example in
terms of their strategy to penetrate new markets and expand their brand by building strong
customers ' loyalty. Besides, Bob 's furniture could have been a window for CFI in the
Northeast and the Mid-Atlantic region. That could solidify CFI 's market position either
through a joint venture or partnership without significant adverse effect in their ROE. At the
same time, Jordan would offer a different business model and a more avant-garde way to
boost the top line. Based on their business model, it seems that they are selling more than
furniture. They are selling an experience, more specifically, a family experience. It is a
combination of skillful promotions as well as some great attractions for the kids. These
companies financial as well as DuPont ratio amounts would have provided deep insights and
would have Jill new perspectives for CFI. In fact, these two companies offered so much value
that they were acquired by two big firms. This way, Bain Capital bought out Bob's furniture
and Berkshire Hathaway scooped Jordan's furniture.
To sum up, it is essential for CFI to concentrate on the companies operating in the same
industries. By making a category analysis, an industry average could be found as well as a
decision on further actions might be discovered. By looking at the financial ratios and key
statistics, Jill might also get some insights and information to compare its company with
others that deal with the similar product in the same market.
16

Question 8
← What other data and sources of information would be important to tap into in
order to more fully flesh out the story depicted by these DuPont ratio amounts and
trends?
It would be absolutely helpful if certain data and information were given in order to
understand and decipher the true story behind these ratios. While the DuPont ratio shows a
simplistic view on the financial health of these companies, it would have been preferable to
know that ROA computed represents only the return on net operating assets, same thing
goes for the Asset Turnover. The five ratios provided in the case do not paint the whole
financial picture of the companies. It would be more beneficial to have a RNOA rather than
a ROA because it would have put more emphasis on the return on net operating activities. A
net operating margin would make a lot more sense because it would address the
profitability component of RNOA. Overall, NOPM and NOAT would assess better
management uses of the company 's operating assets. Besides, the average assets used in
DuPont does not give an indication on whether these assets are solely from operations.
Furthermore, not only quantitative information should be taken into account, but also the
qualitative one. Hence, when analyzing the DuPont ratio amount and trends, it is essential
to understand a company’s specific business model, financial footnotes, its competition,
main industry leaders, their business strategy, industry averages, historical stock prices,
stock prices fluctuations and other. Undoubtedly, there is a big pile of data should be
researched before fully understanding the outcomes of DuPont metric. This additional
information might be discovered using annual reports of the companies, internal and
external news about the company, as well as websites specialized on providing financial
data such as Morningstar, Yahoo! Finance or YCharts.
17

Conclusion
Analyzing the DuPont trends and ratio amounts is helpful for studying a company’s business
performance, though it does not give the full picture. Hence, it is essential to understand
what kind of business model the company applies, who the main competitors are, how the
company uses its assets and finances its debt, how volatile its cash flows are and etc.
Moreover, it is necessary to understand that one ratio is computed using at least two
numbers, which gives us more variables to analyze and to improve in order to increase the
ratio amount.
18

Case 2 final input

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