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16 Financial Statement Analysis

Additional discussion appears in the Management’s Discussion and Analysis section of
Colgate’s annual report. These two sources are excellent starting points in constructing a
company’s business plan and in performing a business environment and strategy analysis.
It is important to stress that business planning is not cast in stone and is fraught with
SERIAL ACQUIRERS uncertainty. Can Colgate be certain of the future of consumer and business computing
CEOs who built up their needs? Can Colgate be certain its raw material costs will not increase? Can Colgate be
companies with a blitz of sure how competitors will react? These and other questions add risk to our analysis.
deals include GE’s Jack While all actions involve risk, some actions involve more risk than others. Financial
Welch who did 534 deals,
and AutoNation’s H. Wayne statement analysis helps us estimate the degree of risk, or uncertainty, and yields more
Huizenga with 114 deals. informed and better decisions. While information taken from financial statements does
not provide irrefutable answers, it does help us to gauge the soundness of a company’s
business opportunities and strategies and to better understand its financing, investing,
and operating activities.

Financing Activities
A company requires financing to carry out its business plan. Colgate needs financing for
purchasing raw materials for production, paying its employees, acquiring complemen-
tary companies and technologies, and for research and development. Financing
activities refer to methods that companies use to raise the money to pay for these needs.
Because of their magnitude and their potential for determining the success or failure of a
venture, companies take care in acquiring and managing financial resources.
There are two main sources of external financing—equity investors (also called owners
or shareholders) and creditors (lenders). Decisions concerning the composition of fi-
nancing activities depend on conditions existing in finan-
cial markets. Financial markets are potential sources of fi-
Total Financing
nancing. In looking to financial markets, a company
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considers several issues, including the amount of financ-
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ing necessary, sources of financing (owners or creditors),
30 timing of repayment, and structure of financing agree-
$ Billions 25 ments. Decisions on these issues determine a company’s
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organizational structure, affect its growth, influence its
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10 exposure to risk, and determine the power of outsiders in
business decisions. The chart in the margin shows the
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makeup of total financing for selected companies.
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Albertson’s Target Colgate FedEx Equity investors are a major source of financing. Col-
gate’s balance sheet shows it raised $1.95 billion by issu-
Equity Creditor Total ing stock to equity investors. Investors provide financing
in a desire for a return on their investment, after consid-
ering both expected return and risk. Return is the equity investor’s share of company
earnings in the form of either earnings distribution or earnings reinvestment. Earnings
distribution is the payment of dividends to shareholders. Dividends can be paid di-
rectly in the form of cash or stock dividend, or indirectly through stock repurchase. Div-
idend payout refers to the proportion of earnings distributed. It is often expressed as a
ratio or a percentage of net earnings. Earnings reinvestment (or earnings retention)
refers to retaining earnings within the company for use in its business; this is also called
internal financing. Earnings reinvestment is often measured by a retention ratio. The
earnings retention ratio, reflecting the proportion of earnings retained, is defined as
one less the dividend payout ratio.
Equity financing can be in cash or any asset or service contributed to a company in
exchange for equity shares. Private offerings of shares usually involve selling shares to one