The Balance Sheet
An overall picture of the assets during the monitored period:
Cash Position
For year 2003 SAP has $2,640 million in cash and short term investments. Comparing this to the company’s short term debts it can be seen that in 2003 the entire value of SAP’s current liabilities is $2,836 million. Even the difference between the two values is not very big, this still means SAP has not enough money to pay off current liabilities, which is not very good for the company as it may face in some moments the danger of going bankrupt.
Working Capital
The SAP working capital can be calculated by taking the current assets ($5,379,548) and subtracting from them the current liabilities ($2,836,031). The answer is $ 2,543,553, which is how much SAP has in working capital. This value can be used to find the working capital per share. For the year 2003 there are 3,628 million shares outstanding. Taking the working capital and dividing it by the shares outstanding gives as a result $7.01, which is the amount of capital per-share. This means that if SAP starts selling stocks at $7.01 per share, the company would be selling all of its fixed assets (real estate, computers, long term investments, etc.) plus its earnings / profit for free. This will be the case in times of serious economic downturns. As a comparison, the current weighted average price for SAP stocks is $113.1 per share.
Debt to Equity Ratio
SAP is debt free. It has no long or short term debt. If $0 is taken (the amount of the company's debt) and is divided by the shareholder equity ($4,672 million), the final result is 0. This means that 0% of the company's equity consists of debt; the shareholders own it all.
- Profitability Ratio Analysis
Before analyzing whether the SAP business is profitable or not, it is good to remember what profit is. Profit is the difference between turnover, or sales, and costs: that is,
profit = turnover - costs
There are several ways of measuring profit: gross profit; net profit before and after taxation; and retained profit are just some of them.
These ratios can enable the evaluation of the SAP’s profits with respect to a given level of sales, a certain level of assets, or the owner’s investment. Without profits, the company could not attract outside capital. Owners, creditors, and management pay close attention to boosting profits because of the great importance placed on earnings in the marketplace.
Gross Profit Margin
This ratio measures the percentage of each sales dollar remaining after the firm has paid for its goods. It is calculated as follows:
Gross Profit Margin = Gross Profit∗ / Turnover
The table below presents how the gross profit margin for SAP varies for the last 5 years (1999 - 2003):
According to the date, the percentage of revenue left after subtracting the cost of goods sold is constantly improving, which means that SAP’s development and distribution efficiency during the production process is also improving. That is, SAP is constantly improving its ability to make a decent profit as long as overhead costs are controlled. This can be of a great importance for potential investors who would be willing to pay more for businesses that have high efficiency ratings.
What also appears to be important from the above comparison through the years is that the gross margin tends to remain stable over time. Significant fluctuations can be a potential sign of fraud or accounting irregularities.
Net Profit Margin
This ratio measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted. It essentially expresses the overall cost/price effectiveness of the operation. The ratio is calculated as follows:
Net Profit Margin = Net Profit∗ / Turnover
The table below presents how the net profit margin for SAP varies for the last 5 years (1999 - 2003):
To get a better understanding of the net profit margin it is good to make a comparison between this ratio and the gross profit ratio. Only in this way a good impression can be gained of the company’s non-production and non-direct costs such as administration, marketing and finance costs. Through some of the monitored years SAP keeps a pretty small difference between the net profit and the gross profit margin values. However there is a tendency for broadening the difference between the two ratios each time the revenues are going up. This can be explained either by problems maintaining its cost structure, or by implementing a new pricing strategy which sometimes results in lower profits. But what is more likely is that with the increase of its revenues SAP has increased its expenses for R&D (Research and Development) thus trying to be more innovative and to keep its leading position on the market. More evidences supporting this theory can be found in the Consolidated Income Statement where it is evident the constant increase of the R&D expenses from $749 million in 1999 to $1,254 million in 2003. If this is the case, this indicates management’s ability to operate the business with sufficient success. Success in this case means not only recovering the cost of the merchandise or services, the expenses of operating the business (including depreciation), the cost of borrowed funds, and leaving a margin of reasonable compensation to the owners for putting their capital at risk, but furthermore, developing innovations that will lead to significant increase in revenues and market presence in the future.
Operating Profit Margin
This ratio measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividends are deducted. It represents the “pure profits” earned on each sales dollar. Operating profits are “pure” because they measure only the profits earned on operating and ignore interests, taxes, and preferred stock dividends. It is calculated as follows:
Operating Profit Margin = Operating Profits / Turnover
The table below presents how the operating profit margin for SAP varies for the last 5 years (1999 - 2003):
There is a positive trend for SAP to constantly increase its operating profit margin, which means that the company generates more money from its own operations (it does not include income from investments in other businesses, for instance) and improves its management efficiency each year. Therefore, it can be stated that the “general health” of the core SAP business is continuously improving.
Return on Total Assets (ROA)
The ROA, often called the return on investment (ROI), measures the overall effectiveness of management in generating profits with its available assets. The higher the ratio the greater the return on assets. The ROA is calculated as follows:
ROA = Earnings Available for Common Stockholders / Total Assets
The table below presents how the ROA for SAP varies for the last 5 years (1999 - 2003):
These values indicate how much SAP has earned on each dollar of asset investment. That is, in 1999 the company has earned 9 cents on each dollar of asset investment and has almost doubled these values during the years to reach 17 cents per dollar of asset investment in 2003. Each time SAP increases the profit per dollar of asset its business becomes less asset-intensive. This means that the company needs less money to reinvest into its business to continue generating earnings. Therefore, during the period between 1999 and 2002 SAP has spent more money in order to run its business until the year 2003 when it increased its ROA ratio with 7 %.
It can also be stated that in respect to the shareholders the company is doing pretty well through the years providing the shareholders with more and more returns each year. This is because with the ROA ratio are measured the company’s earnings in relation to all of the resources it had at its disposal (the shareholders’ capital plus short and long-term borrowed funds) and as this ratio for SAP grows, also grow the returns.to shareholders and they make more money.
In addition, as the software industry is very dynamic and requires constant innovations, the ROA ratio can be very important. It helps the managers decide whether or not to initiate a new project. The basis of this ratio is that if a company is going to start a project they expect to earn a return on it, ROA is the return they would receive. That is, if SAP has a ROA that is above the rate that the company borrows at then the project should be accepted, if not then it is rejected.
Return on Equity – ROE
This ratio reveals how much profit SAP earned in comparison to the total amount of shareholder equity∗ found on the balance sheet. The ROE is calculated as follows:
ROE = Earnings available for common stockholders / Common Stock Equity
The table below presents how the ROE for SAP varies for the last 5 years (1999 - 2003):
The effect the ROE has on SAP can be determined more easily by comparing it to the ROE ratio of the competitors or the industry as a whole, something which will be done in the next section of this study. However, only on the basis of the above table it can be said that SAP’s ROE ratio is continuously keeping around 20% and demonstrates a rapid increase during the 2003. Following the theory statements, the higher the company’s ROE is, the more likely for it to be able of generating cash internally. That is, with a respectable 20% (on average) ROE ratio during this 5 years it can be stated that SAP is efficiently reinvesting the investors capital.
- Cross-Section Analysis
Even a financial ratio analysis is made for measuring SAP’s profitability, it still cannot be said whether a gross profit margin of about 16% on average for the last 5 years is good or bad, whether the net profit margin of around 12% is good or bad, etc. What is missing in order to tell whether ratio result is good are the ratio values for other businesses in the same industry and of the industry as a whole, a process which is wide-known as a cross-section analysis.
The cross-section analysis first compares the values of the SAP profitability ratios calculated above to the corresponding values for the same period for Oracle and Siebel, one of the main SAP competitors. Then average values of the profitability ratios are calculated for the past 5 years both for SAP and for its competitors and are compared to the average values of the software industry for this period as a whole. This is the best way to determine the current position of SAP, in relation to profitability, among its main competitors and among the whole industry.
Gross Profit Margin
On the basis of this data it can be said that even SAP has a stable and constantly growing gross profit margin, it still cannot manage its effectiveness very well compared to its main competitor Oracle which has almost twice higher gross profit margin. That is, Oracle is nearly two times more efficient in its software development, distribution, training, and consulting processes. The same can be Stated for Siebel, which however experiences some problems in 2003.
Net Profit Margin
Moving on to the net profit margin it becomes evident that Siebel is experiencing severe problems handling its costs, which leads to almost no net profit in 2002 and 2003. SAP, Oracle and Siebel have almost equal net profit margins in 1999, but as the Siebel ratio is going down, the one of Oracle is heading up. In 2000 Oracle has almost 3 times higher net profit margin, which however is not so strange when the company Income statement is checked. It becomes evident that the company has realized almost $7 billion net investment gains related to marketable securities. For the years between 2001 and 2003 Oracle keeps a very high and almost constant net profit margin, which is two times higher than the one of SAP. However, in 2003 SAP has a significant increase in its net profit margin, but the company is still far behind Oracle in managing all its costs and expenses.
Operating Profit Margin
Compared to Oracle and Siebel SAP has a very stable and constantly growing operating profit ratio, that is, SAP improves its efficiency every year, which is not the case with Oracle and Siebel. Siebel is almost making losses and Oracle has a tremendous 22% decrease in 2002 and stays in the same position in 2003. Meanwhile, SAP is continuing to generate more and more money from its own operations.
Return on Total Assets (ROA)
Comparing the above data SAP realizes a growth in its ROA ratio and is currently very close to the Oracle’s ROA ratio. Oracle from the other side is demonstrating a very high effectiveness in making profits from its available assets. It can be stated that Oracle is less asset-intensive, and as SAP is approaching the Oracle’s values it can be suggested that SAP is also quite less asset-intensive.
Return on Equity – ROE
Again Oracle is the absolute leader between the 3 companies, but it can be seen that it has a very fluctuating trend which is constantly decreasing the last several years. SAP on the contrary has quite a stable trend of its ROE ratio and is constantly increasing it to reach to an 11% difference between its value and Oracle. However, 11% is still a very big difference which shows that Oracle is more profitable than SAP in comparison to the total amount of shareholder equity.
Software Industry Comparison
The comparison is done on the basis of the average values of the ratios during the monitored period:
On the basis of the above data it can be said that SAP has a strong position in the global software industry and is constantly improving its financial parameters. What waits still to be done is for the company to exercise a stronger control on its expenses in order to increase the value of its net profit ratio, which is still far behind the average ratio for the industry. However, compared to Oracle, SAP has still a lot to do all over its financial landscape in order to reach the Oracle’s profitability.
After a closer look to the above data it can be stated that Oracle is one of the software industry leaders in terms of profitability. Its average operating margin ratio is higher than the industry’s average, which means the company tends to have lower fixed costs and a better gross margin, which gives its management more flexibility in determining prices. This pricing flexibility provides an added measure of safety during tough economic times.
Comparing this with the ratios SAP has, it can be said that SAP is close behind Oracle in terms of price flexibility.
- Conclusion
During the last 5 years the business priorities for companies worldwide included pressures for better corporate governance; focus on core business, primarily cost controls, lean operations, and efficiency. Following this trend SAP sought to increase profitability by running its businesses more effectively. And as its financial results showed the company demonstrates a strong and gradually increasing profitability results for the last 5 years. The results also showed that the business is being managed in a systematic and very stable way, which is extremely important for the software industry in which SAP operates. This industry is changing and growing so quickly, that only companies with wise financial management can survive and generate profits. What SAP has still to improve is not to pay so much attention to increasing its revenue, but to decreasing its costs thus generating a higher profit. Only with such financial stability and increased profitability SAP can remain among the world most powerful software vendors.
References
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Lawrence J.Gitman, (2003) Principles of Managerial Finance 10nd edition, Pearson Education, Inc. Boston, MA 02116
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Belverd E.Needles, Jr., Marian Powers, Susan V. Crosson,(2002) Principles of Accounting, Houghton Mifflin Company, Boston, MA 02116
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Taylor, Ch. (2003) The Software Industry’s New New Man. TIME, 162 (21), 83
Annual Reports (available on the company web pages – www.sap.com, www.oracle.com, www.siebel.com)
SAP AG (1999) SAP Annual Report. Walldorf, Germany
SAP AG (2000) SAP Annual Report. Walldorf, Germany
SAP AG (2001) SAP Annual Report. Walldorf, Germany
SAP AG (2002) SAP Annual Report. Walldorf, Germany
SAP AG (2003) SAP Annual Report. Walldorf, Germany
Oracle Corporation (1999) Oracle Annual Report. Redwood Shores, California
Oracle Corporation (2000) Oracle Annual Report. Redwood Shores, California
Oracle Corporation (2001) Oracle Annual Report. Redwood Shores, California
Oracle Corporation (2002) Oracle Annual Report. Redwood Shores, California
Oracle Corporation (2003) Oracle Annual Report. Redwood Shores, California
Siebel Systems, Inc. (1999) Siebel Annual Report. San Mateo, California
Siebel Systems, Inc. (2000) Siebel Annual Report. San Mateo, California
Siebel Systems, Inc. (2001) Siebel Annual Report. San Mateo, California
Siebel Systems, Inc. (2002) Siebel Annual Report. San Mateo, California
Siebel Systems, Inc. (2003) Siebel Annual Report. San Mateo, California
Taylor, Ch. (2003) The Software Industry’s New New Man. TIME, 162 (21), 83
Gitman J. Lawrence, (2003) Principles of Managerial Finance. 10th edition, Pearson Education, Inc. Boston, MA 02116
∗ Gross Profit = Turnover - Cost of Sales
Gross profit is the profit the company earns before taking off any administration costs, selling costs and so on.
∗ Net Profit = Gross Profit – Expenses
That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the net profit is the profit that is left, out of which the company will pay interest, tax, dividends and so on.
∗ Shareholder Equity is equal to total assets minus total liabilities. It is what the shareholders “own”. Shareholder equity is a creation of accounting that represents the assets created by the retained earnings of the business and the paid-in capital of the owners.
