Financial Statement Analysis Project
The two companies that I will be comparing in this project are McDonalds and Wendys. Both of these companies are competitors in the same industry. I am using the information from their 2005 Financial Statements.
When comparing the debt-to-assets ratio of McDonalds and Wendys, you have to divide the firms total liabilities by their total assets. Essentially, the debt-to-assets ratio is the primary indicator of the firms debt management. As the ratio increases or decreases, it indicates the firms changing reliance on borrowed resources. The lower the ratio the more efficient the firm will be able to liquidate its assets if operations were discontinued, and debts needed to be collected. In 2005 Wendy's had $2,076,043 worth in total assets and $846,264 in total liabilities. When divided, Wendys has the lower ratio of the two competitors at 40%. This means that they would take losses of 40% if operations were shut down, and the cash received from valuable assets would still be sufficient to pay off the entire debt. It also means that 40% of Wendys assets are made through debt. McDonalds in 2005 had $12,545.3 (in millions) of total liabilities and $22,534.5 (in millions) of total assets. After doing the math, McDonalds ends up with a ratio of 56% which is higher than Wendys by sixteen percent. This means that there is more default on McDonalds liabilities, which can be a costly event from lenders perspective. McDonalds makes 56% of all its assets through debt. In reality, its not good to have a debt-to-assets ratio over 50%. Its also not good to have a debt-to-assets ratio that is too low because that shows that you have money that isn't being used to gain future economic profit. So a stable percentage closest to 50% is wanted. When looking at both of the financial statements, even though McDonalds may have a higher debt-to-assets ratio, it doesn't necessarily mean that McDonalds is in a worse situation than Wendys.
To calculate the current ratio, which is one of the most popular liquidity ratios you divide all of firms current assets by all of its current liabilities. McDonalds has $1,819.3 (*everything is in millions for McDonalds) of current assets and $2,248.3 in current liabilities making the firms current ratio .81. In 2005 Wendys has current assets of $266,353 and current liabilities of $296,687 making their current ratio .90. Current ratios are used to represent good liquidity and financial health. Since current ratios vary from industry to industry, the industry average determines if a firms current ratio is up to par, strength or a weakness. In any event if the current ratio is less than the industry average than an analyst or individual interested in investing might wonder why the firm isn't balancing its current assets and liabilities better. On both McDonalds and Wendys website is says that the industry average for a current ratio is .60. So when comparing both firms, based on the industry average, McDonalds and Wendys are doing well and can both be efficiently liquidated. Liquidity refers to how quickly the firms current assets can be converted to cash. Now as far as being compared to each other by McDonalds having a lower current ratio, that itself doesn't indicate that McDonalds is in a worse financial situation. Lower liquidity may be offset by a variety of other financial indicators, because McDonalds still ranks higher on its overall financial stability and financial health.
To find the quick ratio, which is often called the acid test; only cash & cash equivalents as well as accounts receivable are added and then divided by current liabilities. The purpose of the quick ratio is to indicate the resources that may be available in the short term. Essentially quick ratio is sort of a worse case scenario...