RISK

ANALYSIS
GROUP 5
 I. Financial Ratio

1.Financial flexibility
2.Short-term liquidity risk
3.Long-term solvency risk

Table of II. Interpretation

Content 1.Financial flexibility

2.Short-term liquidity risk
3.Long-term liquidity risk

III. APPLE, INC - A CASE STUDY

I. Financial Ratio
1. Financial flexibility
• Financial flexibility refers to a company's ability to
adapt and respond to changing financial
circumstances and opportunities without being
constrained by its existing financial structure.

ROE = [BEP + D/E (BEP - rd)] x (1 - t)

2. Short-term Short-term liquidity is the firm’s ability to satisfy near-term
payment obligations to suppliers, employees, and creditors

liquidity for short-term borrowings, the current portion of long term

debt, and other short-term liabilities.

2.1 Liquidity Ratio

CURRENT RATIO Current assets
Current liabilities
The current ratio, calculated by dividing current assets by current liabilities,
signifies the level of available cash as of the balance sheet date.

QUICK RATIO Cash + marketable securities + receivables

Current liabilities
It provides a more stringent measure of liquidity than the current ratio because it
excludes inventory, which may not be easily convertible to cash in the short term.
2. Short-term Short-term liquidity is the firm’s ability to satisfy near-term
payment obligations to suppliers, employees, and creditors

liquidity for short-term borrowings, the current portion of long term

debt, and other short-term liabilities.

2.1 Liquidity Ratio

CASH RATIO
Cash + marketable securities
Current liabilities
It provides an even stricter measure of liquidity than the quick ratio because it excludes both
inventory and accounts receivable, focusing solely on the most readily available assets.

Days sales outstanding (DOS) + Days of inventory on

CASH CONVERSION CYCLE hand (DOH) - Number of days payables

It evaluates the efficiency and effectiveness of a company's working capital management by

analyzing the duration between when cash is paid out for inventory purchases and when cash
is received from the sales of products or services.
2.2 Working capital activity ratio

Operating Cash Flow to Current Working Capital Turnover Ratios

Liabilities Ratio

Cash Flow from Operations Net Revenue

Average working capital (= Average Current Assets
Average Current Liabilities
- Average Current liabilities)
This ratio reflects the cash generated over a specific It measures how effectively a company is able to
period in comparison to the magnitude of liabilities generate revenue relative to the amount of working
expected to be settled within one year. capital invested in its operations.
2.2 Working capital activity ratio

Inventory turnover Receivables turnover

Cost of goods sold Net Revenue

Average Inventory Average Receivable

Inventory turnover is a financial metric used to evaluate how Receivables turnover is a financial metric used to assess how
efficiently a company manages its inventory by measuring the effectively a company manages its accounts receivable by
number of times inventory is sold or used up within a specific measuring the number of times receivables are collected or
converted into cash within a specific period, typically a year. It
period, typically a year. It assesses how quickly a company
evaluates the efficiency of a company's credit and collection
replenishes its inventory or converts it into sales.
policies and its ability to promptly convert credit sales into cash.
2.2 Working capital activity ratio

Payables turnover

Purchase (= Ending Inventory + COGS - Beginning Inventory)

Average trade Payables

Payables turnover is a financial metric used to assess how efficiently a company

manages its accounts payable by measuring the number of times accounts payable
are paid or settled within a specific period, typically a year. It evaluates the
effectiveness of a company's payment policies and its ability to manage its trade
credit obligations.
3. Long-term solvency risk
3.1 Debt ratios
• Debt ratios measure the relative amount of liabilities, particularly long-term
debt, in a firm’s capital structure. The higher a debt ratio, the greater is long-
term solvency risk.
3. Long-term solvency risk
3.2 Interest coverage ratio
• Interest coverage ratios indicate the number of times a firm’s income or cash
flows could cover interest charges.
3. Long-term solvency risk
3.3 Operating cash flow to total liabilities ratio
• Balance-sheet-based debt ratios such as the liabilities to assets ratio ignore the
firm’s ability to generate cash flow from operations to service debt. The ratio
of cash flow from operations to average total liabilities overcomes this
deficiency.
 II. Interpretation
1. Financial flexibility - ROE
Greater financial risk
the costs of borrowings

Higher leverage Better financial flexibility

attracts investors and provides opportunities

Overcome financial challenges

building profit reserves.

 2. Short-term Liquidity Risk
Current ratio

• Both current assets and current liabilities increase,

Current ratio was <1.0 before the transaction or vice versa
• Cash flows from operations is slow or volatile

Poor business conditions

Struggle to sell inventories and collect receivables -> increase in the current ratio due
to the growth of receivables and inventory.

Susceptible to window dressing, a practice where management takes actions to

manipulate financial statements to present a better financial position
 2. Short-term Liquidity Risk

Quick ratio Operating Cash Flow to Current Liabilities Ratio

Some businesses can convert their

0.40
inventory into cash more quickly
relative to other businesses • Healthy manufacturing or retailing
• High cash flows relative to current liabilities ->
low short-term liquidity risk in terms of
operating cash flows relative to current
liabilities.
 2. Short-term Liquidity Risk
Accounts Receivable Turnover
Inventory Turnover
Accounts Payable Turnover

Relatively little need to finance accounts receivable and

inventories
Small number of net days

Aggressive use of credit from suppliers to finance these

current assets
 2. Short-term Liquidity Risk
Working Capital Turnover Ratios

The shorter the net cash operating cycle, the large cash flows from operation to current liabilities

The smaller indicates little needs for financing Inventory and AR

The short cash operating cycle means firms are independent on short-term
sources, lower current ratio

Firms with a shorter number of days of financing required from other sources are less
dependent on short-term borrowing and reduce this ratio
 3. Long-term Liquidity Risk

Debt ratio
Higher debt ratio
Greater proportion of debt in the company's capital structure
increases the long-term solvency risk.
face challenges in meeting its long-term debt obligations and may be
more vulnerable to financial distress.

A liabilities to shareholders’ equity ratio greater than 1.0 is not unusual, but a
liability to assets ratio or a long-term debt to long-term capital ratio greater than
1.0 is highly unusual
 3. Long-term Liquidity Risk

A ratio of 0.20 or
more is common for a
Interest Coverage ratio
financially healthy
company

• Zero-coupon or otherwise deeply discounted bonds and

notes but do not pay periodic cash interest.

• Negotiate deferral of cash interest payment Operating Cash Flow to Total

arrangements with lenders Liabilities ratio
 Apple Microsoft

Categories 2021 2022 2023 change 2022 change 2023 2023

Financial
flexibility
ROE 150.1% 175.5% 171.9% 17% -2% 38.8%
Short-term
liquidity
risk
Current ratio 1.07 0.88 0.99 -18% 12% 1.77
Quick ratio 1.02 0.85 0.94 -17% 11% 1.75
Cash ratio 1.52 1.10 1.12 -28% 2% 1.07

Operating CF to
current 0.83 0.79 0.76 -4% -4% 0.84
liability

Working capital
39.10 -21.23 -220.03 -154% 937% -2.65
turnover
Inventory
40.03 38.79 37.98 -3% -2% 21.10
turnover

Receivable
17.26 14.48 13.29 -16% -8% 4.56
turnover

Payables turnover 4.44 3.73 3.40 -16% -9% 3.48

Long-term
solvency risk

Long-term debt to
2.57 2.92 2.34 14% -20% 0.20
equity

Interest coverage 29.92 41.64 42.29 39% 2% 44.98

Operating CF to
total 0.31 0.35 0.31 13% -10% 0.43
liabilities
 1. Financial flexibility
• Apple’s financial structure heavily relies on debt, which means Apple can
keep a high ROE. The consistent high levels of ROE for Apple from 2021
to 2023 signify strong financial flexibility.
• Microsoft's ROE is 38.8%, much lower than Apple’s, but it still represents a
fairly stable return on equity, showing that the company is using shareholder
equity effectively to generate profit and both Apple and Microsoft exhibit
financial flexibility.
 2. Short-term liquidity risk

2.1 Current ratio 2.2 Quick ratio: Same trend as current 2.3 Cash ratio
ratio
• In the instance of Microsoft, with a
high current ratio, it signifies that • Microsoft's quick ratio of 1.75 • Apple has a higher cash ratio
the corporation possesses an indicates a stronger ability to meet than Microsoft, indicating
abundance of short-term assets to current liability with readily that the company has larger
sufficiently meet its immediate available liquid assets, while amounts of cash and cash
financial obligations. This elevated Apple's lower quick ratio of 0.94 equivalents than Microsoft.
current ratio effectively mitigates suggests a relatively tighter However, both companies
short-term liquidity risk. liquidity position have fairly high cash ratios.
 2. Short-term liquidity risk

2.6 Inventory turnover,

2.4 Operating CF to current liability 2.5 Working capital turnover
Receivable turnover, Payable
• Both companies have a negative turnover
• Apple (0.76): This implies that Apple "Working Capital Turnover" index,
• Apple has a higher inventory turnover ratio
generates insufficient cash flow from however, Apple has a negative compared to Microsoft, suggesting that Apple
operations to completely pay off its current "Working Capital Turnover" index manages its inventory more efficiently in
liability. with a much larger value than converting inventory into revenue.
• Microsoft (0.84): Microsoft has a higher Microsoft. This may indicate that • Apple has a higher receivables turnover ratio,
almost three times higher than Microsoft,
ratio, implying that the company is better Apple is having more serious problems
showing that the company collects payments
able to pay off its current liability with cash using working capital to generate from customers efficiently while maintaining
flow from its operations. revenue than Microsoft. good customer reliability.
• Both companies have similar payables turnover
ratios, indicating that they can manage payments
to suppliers relatively efficiently.
3. Long- Apple has a much higher "Long Term Debt to

term
Equity" ratio than Microsoft. This shows that
Apple uses more long-term debt relative to its
3.1 Long-term deb to equity equity than Microsoft. Microsoft is less
dependent on the use of debt to finance its

solvency business operations.

risk
Interest Coverage Ratio" of Apple and Microsoft
is almost equally high, 42.29 and 44.98
3.2 Interest coverage respectively, which means that both companies
have a stable financial situation and strong ability
to pay interest.

Microsoft's higher ratio of 0.43 compared to

3.3 Operating Cash Flow to total Apple's ratio of 0.31 suggests that Microsoft
liabilities has a stronger ability to generate operating cash
flow relative to its total liabilities.
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