Financial Ratio Analysis of Coca-Cola and Pepsi Companies

Financial analysis in the contemporary world plays a major role in gauging the viability of a company, its profitability, and ultimately the stability of a company. It is in the realm of a good accounting practice to ensure that an organization is a going concern. To achieve a competitive edge within an industry, full of companies, with tight competitive spirit, an organization is forced to evaluate its financial statements and determine how its performance is measurable among other competitors. There are several financial statements analysis methods used to test, and forecast a company’s future performance. Some of the methods include comparative statements analysis, common-size statements analysis, Cash-flow statement analysis, fund-flow statement evaluation, and ratio analysis. In this report, ratio analysis method of financial statements evaluation will be employed in the comparison of Coca-Cola, and Pepsi Companies because the other methods mostly assist in forecast of a company’s future performance depending on its past results, and not in relation to external organizations performances (Gregoriou 157-205).

Since financial statements are prepared from the past quantitative data, it beat the logic to use ratio analysis in the comparison of the performances of the two or more companies. Through the use of ratio analysis method, it will be easy to measure the profitability or stability any two or more companies. The different ratios analyzed will help understand how Coca-Cola and Pepsi companies work their ways in meeting current and long-term financial obligations. Leverage ratios, specifically, demonstrates whether the case study companies are operating in debt or equity capital. Activity ratios will as well bring out how the companies apply the correct asset usage in their operations; these will comprise asset sales and receivable collection trends. The profitability ratios derived from income statements will help determine overall effectiveness and performance of Coca-Cola and Pepsi. This paper will use the aggregate financial statement summaries of Coca-Cola and Pepsi Company in the computation of ratio analysis. Liquidity tests are calculated from current assets and liabilities. The major objective of the report is to compare relational performance indicators between Coca-Cola and Pepsi, and derive user’s conclusion based on the results. 

Pepsi Financial Statement Summary used for Ratio Analysis Report

The Pepsi Financial data has been summarized from Yahoo Finance site, with major concentration on specific financial statement data such as balance sheet; current assets and liabilities, total assets and liabilities, inventory, net receivables and cash and equivalents. The Income statement data collected from the site include: Net income before taxation, total sales, and sales costs. The cash flow data used include accounts receivable changes, and inventory receivables. The tables below show a summary of amounts of Pepsi Company financial statement. Therefore, it is prudent to separately perform internal company financial analyses before performing external comparisons with other companies. This analysis process can only be properly achieved using horizontal financial analysis method. To perform horizontal ratio analysis, a company has to compare data that is more than one year, to determine the trend and forecast the internal change. The horizontal analysis report preparation, involves Pepsi Company financial data for year 2015 and 2016 respectively, appendix 1. 2015 amounts are used as the base data, while the 2016 amounts are considered as the current data.

Pepsi Company Balance Sheet Data 

Fig 1: Balance Sheet data used in Ratio analysis in ‘000’

Pepsi Company Income Statement Data

Fig 2: Income Statement data used in Ratio analysis in ‘000’

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Pepsi Company Horizontal Analysis Computations

To determine a company’s balance sheet variance between two financial years, the formulae below is used:

Horizontal Analysis= {Current Amount (2016)-Base Amount (2015)}/ {Base Amount (2015}

CA Horizontal Analysis= (27,089,000-23,031,000)/ (23,031,000) = 0.1762= 17.62%

CL Horizontal Analysis= (21,135,000-17,578,000)/ (17,578,000) = 0.202= 20.2%

TA Horizontal Analysis= (74,129,000-69,667,000)/ (69,667,000) = 0.064= 6.4%

TL Horizontal Analysis= (63,034,000-57,744,000)/ (57,744,000) = 0.0916= 9.16%

Inventory Horizontal Analysis= (2,723,000-2,720,000)/ (2,720,000) = 0.0011= 0.1%

NR Horizontal Analysis= (6,694,000-6,437,000)/ (6,437,000) = 0.0399= 3.99%

NR Horizontal Analysis= (9,158,000-9,096,000)/ (9,096,000) = 0.0068= 0.68%

Income Statement variances for the two years are also calculate using the same formula

Horizontal Analysis= {Current Amount (2016)-Base Amount (2015)}/ {Base Amount (2015}

Sales Horizontal Analysis= (62,799,000-9, 63,056,000)/ (63,056,000) = (0.00408) = (0.408) %

CoS Horizontal Analysis= (28,209,000-28,731,000)/ (28,731,000) = (0.0182) = (1.82) % 

NIBT Horizontal Analysis= (8,553,000-7,422,000)/ (7,422,000) = 0,152 = 1.52%

Horizontal Financial Analysis of Pepsi and interpretation

From the computations above, it is less complex to determine whether the financial statements of Pepsi Company show stability in their operation in the current year, 2016. There is a positive percentage variance in all the financial items tested. For instance, current assets showed a percentage increase of 17.62, meaning that the company is still able to handle its daily financial activities. Current liabilities also has a marginal percentage increase of 20.1, indicating that most of the Pepsi short-term operations are credit dominated, therefore, indicating that the company prefers credit purchases of its commodities to cash engagements.  Total Assets and liabilities on the other hand, showed a small percentage increase from 2015 to 2016; this was noted to be 6.4% and 9.16% respectively, indicating that the company lacks enough capital, and depends on corporate borrowing to fund their entire operations. There is a small margin in inventory held at the company warehouses, which is a sign that the 0.1% increase is resulting from the implementation of contemporary inventory management systems, and tools such as Just-In-Time (JIT), and computer based Inventory Enterprise Resource Planning (ERP). The smaller percentage of net receivable and cash receivables is a warning of poor management of working capital. The volatility of working capital of Pepsi maybe as a result of frequent trades of massive drinks produced. The lower percentage income received, 1.52%, could be fueled by negative percentage sales, (0.408) %, made during the current period. Within this period, it emerges that the cost of sales reduced by (1.82) %, which was still relatively greater than the total sales reduction, thus reducing the company’s profit margin (Friedlob and Ralph 66-167).

Computation of Pepsi Financial Ratios

Based on the horizontal Analysis calculated above, ratio analysis will use the current percentage variance as the primary data, fed in different financial ratio formulas.

Fig 3: Pepsi Horizontal Analysis Data

Current Ratio

This financial ratio helps to determine Pepsi’s ability to settle short term debt obligations using current assets. The negative result is an indication of poor working capital management, and it signifies that the company is in financial struggle and may resort to long-term debt to settle its current financial obligations, which may eventually lead to dissolution of the company.

Current Ratio= (Current Assets/Current Liabilities)=17.62%/20.2%= 0.87.

The above result shows that whether Pepsi resorts to offsetting all its current liabilities through liquidation of all its assets, it will not be able to covers all the liabilities. It falls short of 13% in short-term debt. Pepsi may be forced to go for long-term borrowing or sell some of its fixed assets to settle all the short-term debts (Clayman et al. 217-310).

Debt Ratio

A company’s solvency is dependent on how their assets are leveraged. Debt ratio indicates the amount of total debt of a company settled through leveraging. A higher debt ratio is an sign that the company is overleveraging, putting the company at risk of dissolution, in the event the loan interest rates surpasses company expectation. 

Debt Ratio= (total liabilities/ total assets) = 9.16% /6.4%= 1.42.

This is an indication that operation assets in Pepsi are majorly funded by external loans from financial institutions like banks. This poses numerous risks, and may make the company fail in cases where they are unable to service their loans, or pay back the principle amount due to economic downturn, or poor corporate governance. Being over 100 percent in debt shows poor financial management by Pepsi management board (Bodie et al. 173-320).

Profit Margin 

This is a ratio that helps Pepsi evaluate whether its operations are making positive or negative profits, and to revise factors that reduce its sales if they are internal controllable factors. 

Profit Margin ratio= Net Income (Before Tax)/Net sales=1.52 %/( 0.408) %=( 3.17) %.

This negative profit margin is an indication that the sales of the Pepsi Company have gone under, and the production costs are rising. Therefore, Pepsis should relook at their financial systems and other internal factors that may be reducing sales level. 

Average days for inventory sales (DIS)

This is a tool employed by investors of a given company to determine how long inventories are liquidated by the company. Since Pepsi is a soft drink company. Investors will expect its inventory to take the shortest time possible during sales and when dispatched to consumers.

Average DIS= (Ending Inventory* 365)/(CoS)= (0.1%*365)/ (1.82) %=20 days

According normal investors requirements, 20 days is relatively a good lead-time for sales of Pepsi drinks. 

Days Sales Collection (DSC)

This is a measurement tool in financial analysis aimed at determining the duration customers take to make payments for the goods delivered to them. A company dealing in fast moving commodities like Pepsi would vouch for a lower DSC.

DSC=Avg. Account Receivables/ (Annual Sales*365) = 3.99/ (0.408) %*365=0.027

This is equivalent to 27 days, in a year, which is relatively good for collection of debts from credit buyers.

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Coca-Cola Financial Statement Summary used for Ratio Analysis Report

The summary financial data analyzed for Coca-Cola is also collected from Yahoo financials website, appendix 2. The data openly portrays the company to be having poor returns as compared to Pepsi, which is its major competitor. Almost all the financial related analyses are lower than those of Pepsi Inc., indicating poor competitive grip in the soft drink industry. Below is the selected financial data for the study.

Coca-Cola Company Balance Sheet Data

Fig 4: Balance Sheet data used in Ratio analysis in ‘000’

Coca-Cola Company Income Statement Data

Fig 5: Income Statement data used in Ratio analysis in ‘000’

Coca-Cola Horizontal Analysis Data

These analyses are computed the same way as the ones for Pepsi. The formula is as shown below:

Horizontal Analysis = {Current Amount (2016)-Base Amount (2015)}/ {Base Amount (2015}

Fig 6: Coca-Cola Horizontal Analysis Data

From the Coca-Cola horizontal analysis above, it can be concluded that the company has had a negative operation trend in 2016. Every financial indicator is negative except cash receivables and current assets. The analysis indicates that current assets of the company have fallen by 1.84% which is a warning that the company is not working towards any stability, because it is not in a position to meet its short term debts. Reduction in the current liability is good for the company because irrespective of negative cash flow, the small debts are reducing, however, at a minimal rate. Total liabilities look smaller than the total Assets which is good for the company operation, however, the negative trend of the total asset base is an indication that the company is liquidating some of its operation branches; this may ultimately result in the company stop being a going concern. Negative inventory may also indicate that inventory management systems are efficient, however, the reduction in sales, and a lower profit recorded shows that the company is losing ground to its competitors. The negative costs expended on sales illustrates that the company’s internal controls are in place and minimizes the use of funds on unnecessary undertakings such as salaries and bonuses increase.

Computation of Coca-Cola Financial Ratios

Liquidity of Coca-Cola Company is determined through the use of acid test ratio and current ratio. For this case study, current ratio will be employed in the working capital analysis. 

• Current ratio

CR=1.84 %/( 1.47) %= 1.25

This is an indication that Coca-Cola has more than enough current assets to manage daily financial obligation from their customers. It is a good financial planning to keep current ratio to a certain optimum level. Any amounts more, indicate that the company is losing ground, and may not survive in the foreseeable future.

• Debt ratio 

DR= ((0.36) %/ (3.03) %) = 0.12

The debt ratio of 0.12 is good for Coca-Cola; this is because the company does not heavily depend on external financing. The external financings normally have intrinsic risks that can make a company close, if not able to repay loans or in case of default on loan payments because of poor sales. From the computed result, Coca-Cola does its financing through equity funding and reinvestment of profits.

• Profit Margin ratio (PMR)

PMR= Net Income (Before Tax)/Net sales= (15.3) %/ (5.5)%= 2.78

Coca-Cola’s profit margin is higher; this shows that even if the total profits have gone down in 2016, the cost of production has also gone down making the company to still enjoy an increased amount of profits.

• Average Days for inventory Sales

Average DIS= (Ending Inventory* 365)/(CoS)= ((0.82)%*365)/ (5.82)%=51 days.

This is an indication of poor management of the Coca-Cola company inventories. It takes long for payments to be made on distributions that have already occurred. 51day lead-time could be a major contributing factor in Coca-Cola’s downward profit margins.

• Days Sales Collection (DSC)

Avg. Account Receivables/ (Annual Sales*365) = 22.5%/ (5.5)%*365=1.12

This is a very short time to collect cash from the company creditors. It helps the company to increase its current assets, therefore, improving its ability to take care of any current financial obligations. Sales collection of approximately one day may be because of well-organized global distributor network channels.

Direct Comparison of Coca-Cola and Pepsi Financial Analyses

Fig 7: Combined Horizontal Analysis Data

From fig 6 above, it is easy to ascertain that Pepsi is more competitive than Coca-Cola; this is based on the numerous negative results posted by the Coca-Cola. It can also be noted that there are major differences between financial figures posted by the two companies. Pepsi having higher figures shows that they are using modern competitive policies that make their company outshine Coca-Cola. 

Graph 1 above illustrates that Pepsi has a downward trend in its horizontal analysis data. It, therefore, depicts that however much the company makes higher profits, in comparison to Coca-Cola; it might still lose its competitive advantage to Coca-Cola. This is portrayed by its diminishing financial trend. Coca-Cola, however, has negative returns but indicates an direction of increased cash receivables, making it easy to regain its market dominance, and increase its profit margins. Pepsi graph, also confirms that the company receives less cash, and therefore, operates mostly in debt capital, which is risky for the company in the long run.  The lower percentages depicted by both companies also confirms that the soft drinks industry is performing poorly, and not rewarding its participants well enough to expand their operations.

Comparison of Coca-Cola and Pepsi Financial Information based on Ratio Analysis

Fig 8: Combined financial ratios

A direct observation of the comparison table can convince one that Pepsi has financial difficulty because of the negative profit margin. However, other indicators confirm that Coca-Cola is struggling financially, and may opt out of other markets to stabilize their global presence. Below is a graphical representation of the above data.

From the above graph 2, it is straight to conclude that the soft drinks industry as a whole did not perform well in the year 2006. The average market performance is below 5 percent, meaning there were serious external factors such as inflation or consumers tastes and preferences that did not conform to normal industrial operations.  However, the performance of Pepsi is averagely higher than that of Coca-Cola in numerous aspects except in profit margin and current ratio. This is a sign that the performance of Coca-Cola is based on high liquidity operation. The Coca-Cola Company, seemingly, has more liquid cash than assets, or long-term debt obligation. Since financial ratios are published for potential investors, the financial analysis report would scare away investors from the whole industry because the performance of the two major companies is deepening downwards. A Pepsi bar in the graph indicates a negative profit margin; this is a fact that Pepsi lacks contemporary distribution lines to sell their drinks. From the two measurements methods, ratio analysis is the best, because it gives a clear and conclusive distinction between financial performances of different companies. Horizontal analysis, on the other hand, does not factor in all financial parameters, and relies on direct forecast from previous data that may be prone to errors. If the previous data comprises computation faults, it means the final results of Horizontal analysis will comprise a higher level of inaccurate information (Massari eta al.). 

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Benefits of Ratio Analysis

It is healthy to adopt the use ratio analysis in financial performance appraisal because it has several benefits to both internal and external parties. Ratio analysis is used majorly to simplify complex financial statements. Financial statements are always complex in nature, and not easily understood by novice investors. The financial data used in this report is collected from Yahoo financials; comprehending the raw financial statements such as income statements, Cash-flow statements and balance sheets, in addition, coming up with a conclusion about the financial performance of a company is not easy for an easy task for a common investor, therefore, adoption of ratio analysis has enabled simplification of Coca-Cola and Pepsi financial data, and lessened the process of comparing the performance of the two companies. For comparison reasons, ratio analysis disintegrates financial information for large sized organization using analysis formulas. Pepsi and Coca-Cola are the major soft drink companies in the world; however, their comparison in this report is made easy courtesy of financial ratios.  Trend analysis within a given company can only take place with the help of financial ratios. Therefore, financial ratio analysis makes forecasts easy and simple for any person. Important information in a complex financial statement can only be highlighted and identified by financial ratios. For the two companies, it is easy to determine the infinite difference in the profit margins by preparing a relational ratio analysis of their profit margin. Ratio analysis can also act as a monitoring tool because any slight changes in financial statements are identified at a glance, and compared with the set baselines. Consequently, it is healthy to use financial ratios in assessing competitive advantage of a company in any industry since interpreting ratios is not time consuming (McLaney and Peter).