An organization’s overall financial condition is often ascertained through the use of financial ratios by management accountants, managers, creditors, and potential shareholders among other stakeholders. These financial ratios in addition form the basis of decision making and financial analysis in comparing the strength and weakness of the company to its competitors. From financial ratios, an analysis of an organization’s profitability, efficiency, short-term and long-term financial stability can be analyzed. Lately, Google Company has been experiencing stiff completion from other big names in internet technology, specifically from Microsoft’s Bing. This paper analyzes these two companies 2011 annual report, compares and contrasts their business models and explains how their financial performance can influence investing decisions.

Bull (2008) asserts that financial ratios form an integral part of financial statements analysis. This is because they are frequently used in quantifying many aspects of businesses in which case they bring to light the liquidity, profitability, efficiency and financial stability of a firm (Mittak, 2010). Additionally, these ratios allow a comparison to be carried out; between companies, industries, different time periods of companies, and between corporations and their industry average. This paper makes use of these ratios to analyze, compare and contrast the annual financial reports and business model of Google and Microsoft internet technology companies.

Microsoft Corporation is one of America’s leading multinational firms in the software and internet technology industry. This firm manufactures supports and licenses a wide variety of service and products that are predominantly related to computing (Microsoft Corporation, 2011). Presently, this firm is the largest software firm in the world and dominates the office suite market with its Microsoft Office package. This company has strengthened its grip in the internet information searching market segment by launching its Bing search engine in place of the defunct Live Search.

 This grip into the internet information market segment appears to be a threat to Google Inc., which had dominated this market segment. In the accounting period ended 29th June, 2011, Microsoft Corporation had sales revenue amounting to $69,943,000 and a net income of $23,150,000 as compared to their 2010 sales revenue of $62,484,000 and net income of $18,760,000.

Google, on the other hand, is also an American multinational firm majoring in the provision of internet-based services and products. These products and services include: cloud computing, internet information search, advertising and software technologies. Most of the revenues that this company earns come from advertising revenues, which account for a larger portion of its profits (Google Inc., 2011).

The rapid growth that this company has experienced since it was incepted has seen it enter into production, partnerships and acquisitions, which are excess of its main web search engine. Google offers online efficiency software like office suite, social networking and e-mail. In the accounting year ended 30th December, 2011, Google Inc. recorded sales revenue of $37,905,000 and net income of $9,737,000 as compared to their 2010 sales revenue of $29,321,000 and net income of $10,381,000.

Ratio Analysis of Google Inc. and Microsoft Corporation

According to Costales and Szurovy (2011), financial ratios show the relationships between specific components expressed in a firm’s financial statement. When these financial ratios are applied effectively, they act as powerful tools of unraveling the underlying reasons for the trend of business, the condition and the financial structure of firms. Unfortunately, these ratios can also mislead the management, especially when they are taken at face value on a stand-alone basis, rather than being related to other ratios and the existing vast array of available business information (Khan, 2010).

In assessing the financial ratios of Microsoft Corporation and Google Inc., this paper shall look at five key aspects; profitability indicator ratios, liquidity measurement ratios, debt ratios, operating performance ratios, cash flow indicator ratios, and investment valuation ratios.

Profitability Indicator Ratios and Analysis

Profitability ratios make evident various measures of profitability applied by a specific firm, or how well the firm is using its resources to generate profit and how efficiently it is being managed (Gitman & McDaniel, 2009). These ratios also indicate the profit earning capacity of a business venture and the ability of a company to earn a satisfactory return on total assets, sales, and invested capital. The profitability ratios for Microsoft Corporation and Google Inc. are shown in the table below;

Microsoft Corporation

Google Inc.

% Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Return on Assets (ROA)

16.11%

9.54%

12.11%

12.62%

-6.57%

0.51%

Return on Equity (ROE)

9.24%

4.35%

22.91%

21.45%

-4.89%

-1.46%

  1. Return on Assets (ROA)

Return on assets refers to the measure of how effectively a given firm’s assets are being utilized in generating profits. According to Gill and Chatton (2010), this ratio is also the yardstick of assessing the efficiency of operations of a business given that it indicates how the assets that have been employed in the business are utilized to result in net profit. Microsoft Corporation has recorded a decline in its ROA by 6.57%, whereas Google Inc. has recorded an increase of 0.51% from 2010 to 2011. Microsoft’s decline could have been brought about by the decline in asset share that it experienced in 2011. From these ratios, it can be assumed that Google Inc. effectively used its assets to generate profits as compared to Microsoft Corporation.

  1. Return on Equity (ROE)

ROE is the ratio of net profit to the total owner’s equity. This ratio measures the return that owners of the company or shareholders receive on their investment in the firm (Bull, 2008). Both Microsoft Corporation and Google Inc. have recorded a decline in ROE of 4.89% and 1.46% respectively from 9.24% in 2010 to 4.35% and from 22.91% in 2010 to 21.45% in 2011. This decline could be attributed to a decline in earnings per share experienced in 2011 by both companies. Microsoft’s earnings per share fell from 34 to 33 cents per share and Google’s also declined from 52.78 to 26.13 cents per share. Microsoft’s  ROE is at a good position of above five-percent for the two years, unlike Google’s, which fell to a dangerously 4.35% in 2011. Microsoft’s ROE could be high due to a number of factors like a reduction of the number of shares in the hands of the public by management through buying them back on the open market among others.

Operating Performance Ratios

Operating performance ratios are typically employed in the analysis of how well a firm utilizes its assets and liabilities and how well it conducts its business internally (Gill & Chatton, 2000). These ratios also provide information about how well a firm uses its assets to generate sales. The operating performance ratios for Microsoft Corporation and Google Inc. are shown in the table below.

Microsoft Corporation

Google Inc.

Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Fixed Asset Turnover (Times)

0.61

0.60

1.72

1.62

(0.01)

(0.10)

  1. Fixed Asset Turnover

This ratio shows how efficiently a firm utilizes its assets in generating sales (Gill & Chaton, 2010). Both Microsoft Corporation and Google Inc. have indicated a decline in asset turnover ratio of 0.01 and 0.1 respectively. Microsoft Corporation had an asset turnover of 0.61 in 2010 and 0.60 respectively, while Google Inc. had an asset turnover of 1.72 and 1.62 in 2010 and 2011 respectively. An asset turnover of less than one, like in the case of Microsoft Corporation, indicates a less-efficient usage of assets in generating sales.

Liquidity Measurement Ratios

Liquidity measurements identify the financial stability of a firm, which is assessed by financial stability ratios that gauge the firm’s ability to meet its long-term obligations with just enough capital remaining to function (Gill & Chaton, 2010). Financial stability can be divided into two; short-term financial stability or liquidity and long-term financial stability or solvency (Gill & Chaton, 2010). Short-term financial stability refers to the liquidity of the firm, while long-term financial stability refers to the solvency position of the firm. Solvency ratios measure the ability of the firm to survive over a long time period. Liquidity ratios for Microsoft Corporation and Google Inc. Ltd are shown in the table below.

Microsoft Corporation  

Google Inc.

Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Current Ratio

4.27

1.74

1.05

1.23

-2.53

0.18

Quick Ratio

3.48

1.40

1.29

1.18

-2.08

-0.11

  1. Current Ratio

This ratio measures the liquidity of the company in meeting its short-term obligations. Microsoft Corporation has declined in its liquidity position from 4.27 in 2010 to 1.74 in 2011. This could be due to the increase in debtors experienced in 2011 as compared to 2010. Google Inc., on the other hand, has increased its liquidity position by 0.18 from 1.05 in 2010 to 2011. This is due to an increase in the number of assets in the year.

  1. Quick Ratio

Quick ratio measures the relationships between the firm’s current liabilities and its monetary current assets. Both Microsoft Corporation and Google Inc. have reduced their debt, holding capacity by 0.11 from 3.48 and 1.29 in 2010 to 1.40 and 1.18 in 2011 respectively. Quick ratio of Google Inc. is lower than Microsoft Corporation’s within the two years, indicating a more stable position in handling debts.

Debt Ratio

Microsoft Corporation

Google Inc.

Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Debt Asset Ratio (Total Debt)

15.96%

18.35%

37.72%

35.33%

2.39%

-2.39%

Debt Equity Ratio (Total Debt)

18.99%

22.47%

60.56%

54.63%

3.48%

-5.93%

  1. Debt Asset Ratio

The debt asset ratio of Microsoft Corporation has increased by 2.39% from 15.96% in 2010 to 18.35% in 2011. This increase is attributed to the increase in the number of debtors experienced in the year 2011. The decrease experienced by Google Inc. is due to the increase in monetary assets in 2011.

  1. Debt Equity Ratio

The debt equity ratio of Microsoft Corporation has also increased by 3.48% probably due to the increase in the number of assets in the year. Google Inc., on the other hand, has recorded a decrease from 60.56% in 2010 to 54.63% in 2011. This decrease signifies a fall in the shareholders equity due to the amount of debts incurred in the year.

Cash flow Indicator Ratio

Cash flow indicator ratios, also known as divided policy ratios, are used to provide insights into the dividend policy the firm uses and the prospects for future expansion. The commonly used ratios are the payout and the dividend yield ratio (Gitman & McDaniel, 2009). The payout ratio considers the prospect for business continuity and future increase of dividends. Payout ratios for Microsoft Corporation and Google Inc. Ltd are shown in the table below

Microsoft Corporation

Google Inc.

Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Payout Ratio

6.96

8.35

7.72

5.33

1.39

-2.39

 Microsoft’s payout ratio has increased by 1.39 from 6.96 in 2010 to 8.35 in 2011, whereas Google’s has declined by 2.39 from 7.72 to 5.33. These changes indicate that Microsoft expects a better business continuity prospects and dividend increases.

Investment Valuation Ratio

Investment valuation is realized through the earning per share ratio. According to Gitman & McDaniel (2009), the earnings per share ratio indicate the earnings per equity share and establish the relationships between available net profit for the equity of shareholders and the number of equity shares. Earnings per share ratios for Microsoft Corporation and Google Inc. Ltd are shown in the table below;

Microsoft Corporation

Google Inc.

Change

KEY RATIOS

2010

2011

2010

2011

Microsoft

Google Inc.

Payout Ratio

1.9

1.3

1.7

3.3

0.6

1.6

Both Microsoft and Google experienced an increase in earnings per share of 0.6 and 1.6 respectively as indicated in the table above.

Comparison of Google and Microsoft

Google Inc.’s core business is the provision of internet-related services and products like cloud computing, internet information search, advertising technologies and software. Of late, Google has diversified into provision of online productivity software like social networking, e-mail and office suite among others (Google Inc., 2011). This company’s products further extend desktop, web browsing, and instant messaging services. Furthermore, this company is the leading developer of Android mobile phone operating systems and the notebook friendly Google Chrome OS. Apart from its innovative products, Google has been known for its informal corporate culture and has been ranked among the best employers in the world.

Microsoft Corporation, on the other hand, dominates the computer operating system and software application market. This company is known for its Microsoft Office computer application program and its Windows, Vista, and Windows 07 operating systems. Furthermore, this company has recently ventured into the wide games industry with the introduction of Xbox 360 and Xbox consoles (Microsoft Corporation, 2011). Unlike Google’s informal corporate culture, this company maintains a corporate perspective.

From the ratio analysis above, Microsoft Corporation, though not as vigorous as Google Inc., is in a better position to withstand recession. This is because it has a larger asset base and liquidity position. This means that it can easily pay off its debts.

Conclusion

In conclusion, the profitability of Microsoft Corporation was high in 2010 as compared to 2011. This shows that the profitability of this company has declined within the span of one year. Google Inc. Ltd, on the other hand, has also experienced a decline in its profitability within the two years. Despite this decline in profitability, Microsoft Corporation Ltd is more profitable to invest in comparison to Google Inc. In terms of efficiency, both companies were efficient in paying their debtors and receiving payments from creditors in 2010 as compared to 2011. For a potential creditor who wants to invest in these two companies; Google Inc. Ltd would be the best option to invest in. In terms of short-term and long-term financial stability, the best company to invest in would be Google Inc. Ltd given that it appears more stable in meeting its liquidity and solvency obligations.

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