Another key value driver of apple will be that of sales growth rate and market share growth.Creative professionals constitute one of Apple’s most important markets for both hardware and software products .Creative customers utilize the Company’s products for a variety of creative activities including digital video and film production and editing .digital video and film production .In order to accelerate market share throughout the world ,the company manages its business primarily on a geographic basis.Its operating segments consists of the America(North and South),Europe ,Japan and retail .The European segment include European countries as well as Middle East and Africa .The Retail segment operates Apple-owned retail stores in the US .They also do operate in Australia and Asia but on a much lower scale .
Customers are attracted to Macintosh Computers for a variety of reasons ,including the reduced amount of training resulting from the Macintosh computer’s intuitive ease of use ,advanced graphics capabilities ,industrial design features of hardware products and ability of Macintosh computers to network and communicate with other computer systems and environments .The company is confronted by aggressive competition in all areas of the business .The market for the design .manufacture and sale of personal computers is highly competitive .It continues to be characterized by rapid technological advances in both hardware and software development ,which have increased capabilities and applications of these new products .This has resulted in the frequent introduction of new products and significant price feature and performance competition .Apple’s competitors who sell personal computers based on other operating systems have aggressively cut prices and lowered their product margins to gain or maintain market share .Furthermore ,as the personal industry and its customers place more reliance on the internet ,an increasing number of Internet devices that are smaller ,simpler and less expensive than traditional computers may compete for market share with Apple’s existing products .The already success of the Apple in the digital music area has encouraged significant competition from other companies ,many of whom have greater financial ,marketing and manufacturing resources than Apple .In order to remain competitive in that lucrative market ,Apple is heavily dependent upon its ability to ensure a continuing and timely flow of competitive products and technology to the market place .
Now we start analyzing the different trends occurring in the Balance sheet and cash flow statement of Apple .We can observe from the Consolidated statement of operations that there was an increase in the net sales area .In fact during the year 2004 ,net sales increased by 33 % or $2.1 billion compared to 2003 .This can be explained by the fact that these increases in net sales and unit sales were a result of a strong demand for all the Company’s Macintosh systems .Apple diversified products such as Power book or Ibook brought the strongest revenue and unit growth during 2004..The increase of 33 % is a huge one of a particular segment .Unit sales of portable systems accounted for 51 % of all Macintosh systems sold during fiscal year 2004 compared to only 42 % during 2003 .This can be explained by the fact that these results reflect an overall trend in the industry for a greater demand of portable systems .But we must take into account that although sales of Power Macintosh have increased yet sales of this product were constrained in the second half of 2004 as a result of manufacturing problems at IBM .IBM being the sole supplier of the kind of processor Apple uses.
There was also a huge demand for IPods during the year 2004 compared to 2003 .In fact the increase was around 279 % and this was due particularly to the introduction of the mini Ipod ,increased expansion of the Company’s Ipod distribution network and the continued success of the iTunes Music store due largely to making it available to all people using Pc’s .
Let us analyse the Gross Profit Margin encountered by Apple during the years 2002-2004 .This is shown in the table 1below and all the figures are in millions except the Gross margin percentages .It is also called Gross Profit Ratio and it is calculated as shown below :
Gross Profit Margin = 100
Table 1 :Gross Margin
As observed from the table Gross margin declined in year 2004 to 27.3 % of net sales from 27.5 % of net sales in 2003 .Apple’s gross margin declined in 2004 due to an increase in mix towards lower margin Ipod and Ibook sales and also because of certain pricing actions on the different Macintosh Models they were selling .It is also due to the fact that there was a higher warranty costs on certain portable Macintosh products and also higher freight and duty costs in 2004 .These unfavourable factors were partially offset by an increase in direct sales and a 39 % year-over-year increase in higher margin sales of software .From these figures it can be anticipated that Apple’s gross margin in the year 2005 of the overall personal computer and consumer electronic industries will remain under pressure in light of price competition from different competitors who will compete against Apple in the Pc’s and Ipod’s department .It will also incur increasing air freight which will continue affecting gross margin .
Gross margin will continue to be affected by a variety of factors such as industry wide global pricing pressures ,increased competition ,compressed product life cycles ,potential increases in the cost and availability of raw materials and outside manufacturing services and potential charges to the Company’s product mix ,including higher unit sales of consumer products with lower average selling prices and lower gross margins.The lower gross margin in 2004 compared to 2003 could also be explained by Apple’s ability to effectively manage product quality and warranty costs and to stimulate demand for certain of its products .Its margin could also be affected by fluctuations in exchange rates over time .Also,since markets of Pc’s are volatile and subject to rapid technology and price changes there is a risk that Apple will forecast incorrectly and produce or order from third-parties excess or insufficient inventories of particular products or components .It can also be able to respond to short term shifts in customer demand patterns .
I think that one of the great advantages Apple has over their competitors is the fact that they spend a huge amount of their sales on Research and Development which can only benefit them in the short and long term run .In fact no wonder this explain the continued success of the increase in sales of the Ipods throughout the world .The table below summarises the operating expenses for the last three years .All the figures are in millions except the percentages .
Table 2 :Operating Expenses
Apple recognizes that focused investments in Research and Development is critical to its future growth in the market place and are directly related to timely development of new and enhanced products that are central to its core business strategy .It has historically relied upon innovation to remain competitive .R&D expense amounted to approximately 6% of total sales net during the year 2004 which is a 2% down on the previous two years .This decrease is due to the increase of 33 % in total net sales in the company for the year 2004 .Although R&D expense decreased as a percentage of total net sales in year 2004 ,actual expenditures for R&D in fiscal 2004 increased by 4% from year 2003.This increase is due to support for new product development and impact of employee salary merit increases .
We can also analyse that expenditures for selling ,general and administrative increased by 17 % during 2004 compared to 2003 .These increases were due primarily to the Company’s continued expansion of its retail segment in both domestic and international markets and also higher direct and channel selling expenses resulting from increase in net sales .Selling ,general and administrative as a percentage of total net sales in 2004 were 17 % down from 20 % in 2003 .This is due to the increase of 33 % in total net sales in Apple in 2004 reflecting leverage on the Company’s fixed costs .Total interest and other income ,net decreased $30 million or 36 % to $53 million during year 2004 compared to $83 million in 2003 and $112 million in 2002.These decreases are attributed primarily to declining investment yields on Apple’s cash and short term investments resulting from lower market interest and a shortening of average maturity of its investment portfolio as well as lower gains on sales of short term investments in 2004 .Also the weighted average interest rate earned by Apple on its cash ,cash equivalents and short term investments fell by 1.38 % in 2004 compared to 1.89 % in 2003 .
Now we have a look at the liquidity and capital resources of Apple company .I am summarizing some selected information and statistics taken from the balance sheets.All the figures are in dollars in millions and are displayed in Table 3 .We can observe that the Company had $5.464 billion in cash ,cash equivalents and short-term investments .This represent an increase of nearly $898 million over the same balances at the end of year 2003 .The principal components of this increase were cash generated by operating activities of $934 million and proceeds from the issuance of common stock under stock plans ,partially offset by cash used to repay Apple’s outstanding debt and also purchases of property,plant and equipment .It believes that its existing balances of cash ,cash equivalents and short –term investments will be sufficient to satisfy working capital needs ,capital expenditures or any other outstanding commitments over the next 12 months .
Table 3:Liquidity and Capital resources
The starting point for a systematic analysis of a firm’s performance is its return on equity as we call it .It is defined as shown in the equation below :
Return on Equity =
This is a comprehensive indicator of a firm’s performance as it will gives us a good indication of how well managers are employing the funds invested by the firm’s shareholders to generate returns .Considering the case of Apple we made the following observations:
Return on equity in 2004 = = 0.054
Return on equity in 2003= =0.016
We can see that there has been an increase in the return on equity from 0.016 in 2003 to 0.054 in 2004 .This indicates that Apple’s strategy of focusing on profit improvement is beginning to show a slight positive result .Comparing that to historical trends of return on equity in the economy ,Apple’s performance can be viewed as being below average .
A company’s assets can be affected by two factors namely by how profitably it employs its assets and how big the firm’s asset base is relative to shareholders’s investment .Thus .,the equation for return on equity can be decomposed into return on assets and a measure of financial leverage which is given below in the equation :
Return on Equity =Return on Assets x Financial leverage
=
Return on Assets will tell us how much profit Apple is able to generate for each dollar of assets invested .Thus ,we calculate the return on assets for both 2004 and 2003
Return on Assets in 2004 =
Return on Assets in 2003 =
We can see that the return on assets has increased slightly from 2003 to 2004 indicating an improvement in profit margin .
Now we calculate the Financial leverage of the company in both years to make the analysis .
Financial leverage in 2004 =
Financial leverage in 2003=
Financial leverage tells us how many dollars of assets Apple is able to deploy for each dollar invested by its shareholders .There has been a light increase in Financial leverage during these two years .The return on assets can be decomposed as a product of two factors .This is shown below :
Return on Assets=
The ration of net income to sales is called net profit margin or return on sales while the ration of sales to assets is called asset turnover .The profit margin ratio will give an indication how much Apple will be able to keep as profits for each dollar of sales it makes .Asset turnover will indicate how many sales dollars Apple is able to generate for each dollar of its assets .
Profit Margin in 2004 =
Profit Margin in 2003 =
Asset Turnover in 2004=
Asset Turnover in 2003=
I am going to summarise all the results above in a tabular way which will explain the decomposition of Return on equity .
Table 4 :Decomposition of Return on Equity
The table above displays the three drivers of Return on equity for Apple which is net profit margin ,asset turnover and financial leverage .In 2004 Apple is largely driven by increases in its net profit margin .The return on its equity in 2003 has been affected by a drop in its asset turnover .It also has a superior operating performance as indicated by its higher return on asset in 2004.In 2003 Apple was cushioned by its more aggressive financial management than in 2004 .So far ,we have been performing the Dupont financial analysis and we have been explaining how to link the ratios key drivers to the management of Apple’ resources .
The Gross profit ratio as we have seen measures how much profit Apple can earn in relation to the amount of sales it made.As we have seen previously ,the Gross profit margin for Apple in 2004 was given as 27.3 % compared to 27.5 % in 2003 and 27.9 5 in 2002 .This indicates that the profit margin is relatively the same among those years and it means that the amount of sales received during those three years have been nearly identical .
The Mark-up ratio is calculated as follows:
Mark-up ratio =100
In 2004 the mark-up ratio for Apple was = x 100 =37.5 %
In 2003 the mark-up ratio for Apple was = x 100 =37.8 %
We can deduce from these figures that Apple tried to reduce the mark-up ratio resulting in the effect increasing Gross Profit in 2004 with more goods being sold .There was a huge increase in cost of goods sold in 2004 as compared to 2003 .This there has been a greater volume of sales
Another set of ratio which can be analysed will be that of Net Profit ratio .Sometimes owners like to compare their net profit with the sales revenue .This can be expressed in the form of the ratio given below as :
Net Profit Ratio = X 100
So In 2004 Apple’s Net profit ratio was = x 100 =4.62
And in 2003 it was given as = x 100 =1.48
This all indicates that there was bigger increase in net profit ratio as total sales revenue was much stronger in 2004 as compared to 2003 .
We will take a look at Liquidity ratios as they measure the extent to which assets can be quickly turned into cash .In other words they try to assess how much cash the entity has available in the short term .
The Current asset ratio is calculated as follows:
Current Asset Ratio =Current Assets /Current Liabilities
In 2004 Current Asset Ratio = = 2.7
In 2003 Current Asset Ratio = = 2.63
This indicate that Apple s in healthy financial state and it is a generally good trend that the current asset ratio is more than 2 .
It may not be easy to dispose of stocks in the short term as they cannot always be quickly turned into cash .It will be sensible to see what will happen to current ratio if stocks were not included .Thus we perform an acid test ratio as it is called :
Acid test ratio =
In 2004 Acid Test Ratio = 8050-2514/2974=1.86
In 2003 Acid Test Ratio = 6815-1926/2592=1.89
Since the acid ratio test is more than 1 this indicates that Apple’s debtors have paid all their debts in time ensuring the stock turned into cash in a very short period of time .
Another ratio which we can calculate is the Fixed Assets Turnover ratio .This can be compiled by using the formula :
Fixed Assets Turnover Ratio =
In 2004 the Fixed Assets Turnover ratio was = 8279/1298=6.38
In 2003 Fixed Asset Turnover ratio = 6207/1174=5.3
The Fixed Asset Turnover tell us that Apple is a very efficient company as it has a high level of fixed assets which contribute to generate more sales .The more times that the fixed assets are covered by the sales revenue ,the greater the recovery of the investment in fixed assets .
Return on Capital employed can be calculated as given by the formula below :
Return on capital employed =Profit /Capital x 100
In 2004 Apple Return on capital employed was given as =2259/3396 x 100 =66.5 %
In 2003 it was found to be = 1708/2252 x 100 = 75.8%
These two obtained figures above differ since Apple had a larger working capital in 2004 compared to 2003 and also its profits were much larger in 2004 as well ,thus reducing the return on capital employed in 2004 .
Earnings per common share was computed by dividing income available to common shareholders by the weighted-average number of shares of common stock outstanding during the same period .Thus we obtain the following concerning Earnings per share :
Earnings per common share in 2004 = $0.74
Earnings per common share in 2003 =$0.71
Another common investment ratio is the Price/Earnings ratio .It is calculated as :
Price /Earnings Ratio =
Market Price per share in 2004 =$38.01
Market Price per share in 2003 =$23.10
Hence ,Price Earnings Ratio in 2004 =38.01/0.74=51.36
Price Earnings ratio in 2003 = 23.10/0.71 =32.53
The Price /Earnings ratio enables a comparison to be made between the earnings per share and the market price .Consider the case of the result obtained in 2004 ,we can find that the market price is about 51 times the earnings .This means that it would take 51 years before we recovered the market price paid for the shares out of the earnings ,assuming that they remained at that level and they were evenly distributed .This high ratio in 2004 compared to 2003 indicates that the market thinks that Apple future is looking very good .The shares are in demand and hence the price of the shares will be high compared to 2003 .But it will take a long time to get your earnings back so the shares are not a good prospect from that point of view .
Summary
Apple is still committed to bringing the best personal computing and music experience to students ,education ,creative professionals,businesses and consumers throughout the world through its innovative hardware ,software and peripherals as well as internet offerings .As we have seen ,there are many factors that contribute to the good functioning of such a renowned company .Through its continuous research and development programme it will always head the market compared with its rivals who are all trying to close the gaps in terms of techonology and market share .Having analysed some key ratios we have found that the business is looking very healthy indeed and that investors are always going to invest their money in a company who is making huge profits every year .I expect Apple to grow from strength to strength in the future and it will also continue to innovate and as a result increase its market share .The popularity of Apple will be too powerful to ignore throughout the world /
ULMS 701
Managing Resources
Assignment
Module Leader:
Dr D Brookfield
Chatham Building
Presented by
KRIS HEERASING
Submission date: 15th Dec 2005