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Chapter One | Overview of Financial Statement Analysis 39

reflect a remarkable operating performance in the face of a highly competitive environ-
ment. Colgate’s gross profit margin of 54.7% reflects its inherent ability to sell well above
its cost of production, despite the intensely competitive consumer products’ markets. Its
pre-tax operating profit margin of 17.65% and net profit margin of 11.01% is well above
average for U.S. companies. In sum, Colgate’s pricing power and superior control of
production costs make it a very profitable company.
Asset utilization analysis is closely linked with profitability analysis. Asset utilization
ratios, which relate sales to different asset categories, are important determinants of re-
turn on investment. These ratios for Colgate indicate above average performance. For
example, Colgate’s total asset turnover of 1.39 is higher than the average for all publicly
traded companies in the United States. Also Colgate’s working capital turnover is neg-
ative, because its current assets are below its current liabilities. This indicates that Col-
gate has not invested in working capital.

Valuation. Exhibit 1.14 also includes five valuation measures. Colgate’s price-to-earnings
ratio of 25.39 and price-to-book of 23.22 are high and reflect the market’s favorable per-
ception of Colgate as a solid performer. Colgate’s dividend payout rate of 48.64% is high,
indicating that Colgate chooses to pay out a large proportion of its profits.

Ratio analysis yields many valuable insights as is apparent from our preliminary analy-
sis of Colgate. We must, however, keep in mind that these computations are based on
numbers reported in Colgate’s financial statements. We stress in this book that our abil-
ity to draw useful insights and make valid intercompany comparisons is enhanced by
our adjustments to reported numbers prior to their inclusion in these analyses. We also
must keep in mind that ratio analysis is only one part of financial analysis. An analyst
must dig deeper to understand the underlying factors driving ratios and to effectively in-
tegrate different ratios to evaluate a company’s financial position and performance.

Cash Flow Analysis
Cash flow analysis is primarily used as a tool to evaluate the sources and uses of funds.
Cash flow analysis provides insights into how a company is obtaining its financing and
deploying its resources. It also is used in cash flow forecasting and as part of liquidity
analysis.
Colgate’s statement of cash flows reproduced in Exhibit 1.8 is a useful starting point
for cash flow analysis. Colgate generated $1.822 billion from operating activities. It then
used $620 million for investing activities, primarily for capital expenditure and payment
for acquisitions. Colgate also paid $1.332 million for debt retirement, which it financed
by issuing fresh debt to the tune of $1.471 billion. The remaining cash flow was primar-
ily returned to its shareholders, in the form of common dividends ($0.678 billion) and
repurchase of common stock ($0.885 billion). Overall, Colgate’s financing activities re-
sulted in a net cash outflow to the tune of $1.059 million. After accounting for foreign
currency exchange rate fluctuations, Colgate’s cash flow increased by $148 million dur-
ing 2006.
This preliminary analysis shows that Colgate generated copious cash flows from its
operations. After using some of it for capital expenditure and acquisitions, the rest of the
generated cash was paid back to shareholders through dividends and stock repurchases.
While this simple analysis of the statement of cash flows conveys much information
about the sources and uses of funds at Colgate, it is important to analyze cash flows in
more detail for a more thorough investigation of Colgate’s business and financial activ-
ities. We return to cash flow analysis in Chapters 7 and 9.