Financial Analysis of Google Incorporated
Background of Company
Google Incorporated was begun as a pet project in 1996 by Sergey Brin and Larry Page. Their initial project involved developing a search engine that could rank websites on the Internet based on the number of pages linked to a website. The main areas of business that Google is interested in include providing search engine services, third-party advertising, hardware products, enterprise, and operating systems and platforms. The company’s mission statement is to systematize the world’s information making it useful and accessible to everyone across the entire globe.
The company generates revenue by delivering online advertising through the use of the Ad Words program. Businesses use this program to promote their products and services to consumers throughout the world. Third parties use Google’s AdSense program to deliver relevant advertisements to consumers online thus enhancing the user experience and generating significant revenues for the company. The company also generates revenue by selling hardware products on behalf of Motorola.
Financial Overview/Analysis of Google Incorporated
In this paper, we will conduct a ratio analysis to determine the financial performance of the company. The analysis will help in making comparisons of the financial performance of the company from one period to another, the financial flexibility of the firm, and projecting the future earnings of the company. The analysis will be based on financial reporting provided by the firm for the years 2005, 2006, and 2007.
The ratios under this section are meant to illustrate the company’s ability to generate income compared to the expenses and other associated costs during a specific period. Analyzing the company’s financial statements for the three years, one realizes that the company is constantly displaying healthy profit margins with revenues exceeding the total costs. The company’s gross profit margin was at 58%, 60.2%, and 59.9% for 2005, 2006, and 2007 respectively compared to 60.1%, 58.4%, and 59.3% for the same years for Yahoo, one of Google’s fiercest rivals.
The operating profit margin was at 32.9%, 33.5%, and 30.6% throughout the same years while the numbers for Yahoo came in as 21.1%, 14.6%, and 10% during the same time. Google’s net profit margin was at 23.9% in 2005, 29.0% in 2006, and 25.3% in 2007 compared to Yahoo’s 36.1%, 11.7% and 9.5% respectively. The reduction in profit margins does not necessarily indicate a fall in revenues as it shows that the company is more focused on investing in long-term growth and development.
According to Google, the decrease in margins throughout the years is because of increased investment in the research and development department. Estimates indicated that the investment in the research and development department significantly increased by 105% in 2006 and 73% the following year.
Google’s return on equity and return on investment during the three years grew slightly. The slight but steady growth can be attributed to the company’s financial advantage. For instance, in 2006, the company was financed using 92% of equity funds, while in 2007; this amount was at 88%. The ROE is derived by multiplying the net profit margin by the asset turnover and multiplying that result by the equity multiplier. Although the firm’s use of equity funds makes it less vulnerable to external pressures including a fluctuating interest rate, the ROE provides an inaccurate measure of the company’s profitability.
Based on Google’s financial reports for the years 2005 through to 2007, the company was able to meet its short-term liabilities. The current ratio in 2005 was at 12.8%, 10% in the following year, and 8.49% in 2007. The quick ratio was at 11.7% in 2005, 9.63% in 2006, and 8.05% in 2007. The company’s cash ratio was at 10.78% in 2005, 8.62% in 2006, and 6.98% in 2007. The ability to meet its short-term liabilities quicker than most is not always a sound financial position because it might mean that the company is not effectively reallocating its cash balances or that it is holding dead resources. The company should focus on re-investing these cash balances on long-term investments.
In addition, the risk-averse cash ratio portfolio indicates that the company is holding many of its assets in liquid form. The slight decrease in the cash ratios experienced during the years indicates that the company’s short-term liabilities were growing slightly faster than the company’s liquid assets i.e. cash and account receivables. Through this analysis, a supplier might favor Google to other customers because its liquidity ratios show that the company is credit worthy i.e. it is able to convert its assets into cash easily in order to pay off its short-term debts. The suppliers are also assured that their debts with Google will be paid within the stipulated time. However, from an investor’s point of view, Google is not exploiting its assets, as it should as indicated by the high liquidity ratios. Therefore, the company is missing potential income by not re-investing the cash balances.
When analyzing the solvency ratios of Google between 2005 and 2007, one cannot help but get concerned over the stark imbalances in the company’s choice of financing. The company was able to meet its long-term debt obligations because of the minimal use of long-term debt over equity. For instance, in 2006, the debt against the total capital was only at 8% increasing slightly to 10% in 2007.
The solvency ratios for the financial year 2006 include: debt to asset ratio- 8%, debt to equity ratio-0.08, debt to capital ratio-0.08, interest coverage-2731 and the advantage was 8%. In 2007, the debt to assets ratio was 10%, the debt to equity ratio was 0.12, the debt to capital ratio was 0.10, the interest coverage was 19555 while the leverage was 12%.
In 2007, the company was able to cover its interest payments by 19555 times. This indicates that the company is not using the close alternatives to equity that are at its disposal. Despite the fact that such a situation protects the company from fluctuations in the market, it does demonstrate that the company is not as keen when it comes to looking for and maintaining other sources of funds apart from equity. This can be disastrous for the company when problems arise with the equity. The imbalance also shows that the raising of funds through equity is a cheaper option for the firm because it does not have to worry about making dividend payments to shareholders.
d. Financial Activity
Activity ratios are intended to calculate the efficiency of the company’s daily activities including managing the inventory and collecting receivables. There will be no need to calculate the company’s inventory turnover because it does not deal with tangible inventories. The most interesting activity ratio for Google between 2006 and 2007 is the fixed assets turnover. This ratio increased from 1.95 in 2006 to 2.06 in 2007. Based on the company’s balance sheet, the increase was due to a 76% rise in the company’s revenues. This indicates that the company was more efficient at generating income from its fixed assets.
The high liquidity ratios also had an impact on the company’s turnover ratios during the period. The company experienced lower working capital turnovers as well as lower total asset turnovers because of the company’s relatively high volume of current assets. During this time period, the company also saw an increase of its payables turnover from 20.01 in 2006 to 23.57 in 2007. This indicates that the company was not making full use of the credit options available to the company at that time.