Page 56 - Financial Statement Analysis

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Chapter One | Overview of Financial Statement Analysis 33

Colgate’s Common-Size Income Statements Exhibit 1.12

Common size 2006 2005 2004 2003 2002

Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100.0 100.0 100.0 100.0 100.0
Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45.2 45.6 44.9 45.0 45.4
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54.8 54.4 55.1 55.0 54.6
Selling, general, and administrative expenses . . . . . 35.6 34.4 34.2 33.3 32.6
Other (income) expense, net . . . . . . . . . . . . . . . . . . . 1.5 0.6 0.9 (0.2) 0.2
Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . 17.7 19.4 20.0 21.9 21.7
Interest expense, net . . . . . . . . . . . . . . . . . . . . . . . . . 1.3 1.2 1.1 1.3 1.5
Income before income taxes . . . . . . . . . . . . . . . . . 16.4 18.2 18.9 20.6 20.1
Provision for income taxes . . . . . . . . . . . . . . . . . . . . . 5.3 6.4 6.4 6.3 6.3
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11.1 11.9 12.5 14.4 13.9

expenses is attributable to costs related to Colgate’s 2004 restructuring program (see
Appendix A for details), which accounts for about 3% of revenues on a pretax basis. If
we exclude restructuring costs, Colgate’s net income in 2006 is 13% of revenues, which
is only marginally lower than that in 2002.
Common-size analysis of Colgate’s balance sheets is in Exhibit 1.13. Because Colgate
is a manufacturing company, PP&E constitutes almost 30% of its total assets. The share
of PP&E has dropped from around 35% in 2002, partly because of depreciation of aging
assets and because of increasing outsourcing of its manufacturing operations. Intangible
assets and goodwill account for 31.9% of its assets, indicating significant acquisitions in
the past. In comparison, 36% of Colgate’s assets are current, up from 31.4% in 2002.
While receivables are the largest component of current assets, much of the increase in
current assets is explained by increases in cash and in inventory. Current liabilities are
38.4% of assets, which is larger than its current assets. This does not bode well for Col-
gate’s liquidity. Current portion of long-term debt constitutes 8.5% of its current liabili-
ties. Colgate’s operating working capital (operating current assets less operating current
assets) is 3% of its assets, suggesting that Colgate has not tied up much money in its
working capital. A lion’s share of Colgate’s financing is debt: total liabilities are almost
85% of assets, of which more than 38% is long-term debt (including current portion).
Colgate’s shareholder’s equity makes interesting reading. Just 21% of Colgate’s assets
have been financed by equity share capital, retained earnings (net of accumulated com-
prehensive income) are 83% of assets and a whopping 88% of its assets are treasury
stock, which suggests significant stock repurchases. Because of the significant stock re-
purchase activity, Colgate’s share of net equity financing is just 15% of assets. For most
companies, such a small share of equity financing may be cause for concern, but in Col-
gate’s case it just reflects its generous payout to shareholders.

Ratio Analysis
Ratio analysis is among the most popular and widely used tools of financial analysis.
Yet its role is often misunderstood and, consequently, its importance often overrated.
A ratio expresses a mathematical relation between two quantities. A ratio of 200 to 100
is expressed as 2:1, or simply 2. While computation of a ratio is a simple arithmetic