In corporate finance, determining financial ratios is one of the most important and effective techniques for measuring the performance of an organization. It is difficult to measure how a company has been performing over a given financial time without involving financial ratios. In accounting, financial ratios express the relationship between the activities of a company over a given period of trade (Houston & Brigham, 2009). They seek to present the relationship between the items on the company’s financial statements in a given period of trade (Weston, 1990). Although these ratios present historical data, they are important in providing an important technique for identifying a company’s internal strengths, weaknesses and opportunities for improvement on its performance. In addition, financial ratios provide investors and regulators with an effective way of determining the performance of a company in comparison with others in the same industry (Houston & Brigham, 2009). Although financial ratios are not effective when used alone, they create meaningful information when comparing the performance of a company with those of other companies in the same or related industries. In accounting, four major types of financial ratios are used to measure corporate performance based on liquidity, profitability, solvency and efficiency.
In this paper, the four types of ratios will be used to determine the performance of AT&T Company Inc., one of the major providers of mobile and internet services in the US. The analysis will determine the performance of the company in the 2012 fiscal year and predict the financial health of the organization in the future.
Financial performance of AT&T Corporation in 2012 FY
Liquidity ratios
Liquidity ratios are financial metrics that determine the ability of an organization to meet its short-term debts over a given trading period. High values of the ratio imply that the company has a large margin of safety, which enables it to meet its short-term debts.
Current ratio
Current ratio is the first financial ratio that examines a company’s ability to pay its short-term debts using its current assets. Current assets are those assets that can be easily liquidated. The current ratio measures the company’s strength of current assets against current liabilities. The conventional formula for current ratio is given by:
Current ratio= current assets ÷ current liabilities
As of September 30 2012, AT&T Company had current assets worth $18,435 million and current liabilities worth $36,183 million as shown in the table below. The table also determines the current ratio, which stands at 0.51 (AT&T annual report, 2012).
The above table indicates that the company has a relatively higher capacity to meet its current liabilities using its current assets. The performance of the company in this area is commendable because it has achieved tremendous improvement since 2010, given that the current ratio grew from 0.59 in 2011 to 0.71 in 2012 (AT&T annual report, 2012).
Quick ratio
Also known as the acid-test ratio, quick ratio is a conservative, refined and stringent technique for measuring the performance of an organization in terms of ability to meet its current debts (Houston & Brigham, 2009). It considers the value of cash equivalents, short-term investments and accounts receivable over current liabilities. The following formula is used to express quick ratio:
Quick Ratio = (Cash & Equivalents + Short-Term Investments + Accounts Receivable) ÷ Current Liabilities
In the table below, AT&T’s quick ratio is determined using the above formulae as follows;
The above table shows that the company’s acid-test ratio stood at 0.55 for the two fiscal years (AT&T annual report, 2012). It is an indication that the company’s ability to meet the current liabilities using its quick cash is relatively strong, although this capacity is not growing.
Profitability ratios
Gross profit margin
Gross profit margin (GM) is used to indicate the company’s percentage of revenue that is available to cover its operating and other expenses. The margin is calculated using the formula ‘Gross profit margin = 100 × Gross profit ÷ Operating revenues’. The formula considers GPM is gross profit expressed as a percentage of the operating revenues at the end of the financial year (Houston & Brigham, 2009). At AT&T, the company’s performance for the two fiscal years 2010, 2011 and 2012 indicates that the company gross profit margin was deteriorating as shown in the table below (AT&T annual report, 2012)..
Operating profit margin
Operating profit margin is the profitability ratio calculated as a ratio of operating income and revenue. The following formulae is used to express operating profit margin: Operating profit margin = 100 × Operating income ÷ Operating revenues (Houston & Brigham, 2009).
At AT&T Company, financial statements for the three consecutive years indicate that the operating profit margin deteriorated between 2010 and 2011, but registered an improved growth between 2011 and 2012, which is an indication of the company’s improvement in profitability (AT&T annual report, 2012). The table below provides the calculated operating profit margins for the three consecutive years.
As indicated, the company’s profit margin decreased significantly from 19.625 to 7.27%, which amounts to a decrease of about 12% per annum (AT&T annual report, 2012).. Nevertheless, the company was able to register an increase of about 3% per annum in its profit margin, which stood at 10.2% in 2012 (AT&T annual report, 2012). This is an indication that the company was gaining momentum in its overall profit. It is worth noting that the company reporting the first growth in its profits in the 2012 financial year, ending its decrease in performance that was caused by the financial crisis of 2008-2010 (AT&T annual report, 2012). Therefore, this ratio is important in indicating the trend of the company’s performance in terms of profitability. In addition, it provides a quick way of elucidating information for investor when attempting to describe the worthiness of investing in the company’s securities and bonds (Weston, 1990).
Solvency ratios
Solvency ratios are used to determine the stability of an organization based in debt relative to the assets and equity (Weston, 1990). For instance, an organization with too much debt loses its capacity to manage its cash flow when the interest rates rise or the business environment in the industry or the economy deteriorates (Weston, 1990). Debt-t-equity and debt-to-asset ratio are the main solvency ratios used to determine the solvency of an organization.
Debt-to-equity ratio
This is the ratio of total debt and total shareholders’ equity. It provides an indication of the company’s strength of shareholders equity against its debt. In fact, it is one of the most ratios of interest to investors as it indicates the worthiness of investing in the company. The formula “Debt to equity = Total debt ÷ Stockholders’ equity attributable to parent” is used to calculate equity-to-debt ratio. At AT&T, it is evident that the company’s debt to equity ratio deteriorated for the three years 2010, 2011 and 2012 as shown in the table below.
References
AT&T annual report (2012). The annual report 2012. New York: AT&T inc.
Houston, J. F., & Brigham, E.F. (2009). Fundamentals of Financial Management. Cincinnati, OH: South-Western College Pub.
Weston, J. (1990). Essentials of Managerial Finance. Hinsdale: Dryden Press.