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ACCOUNTING AND FINANCIAL MANAGEMENT


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1.1 Executive summary

This paper focuses on the review of the financial statements of a company called CVS Health. The review of the balance sheet and the income statement has been conducted by computing the financial ratios after which recommendations have also been provided based on these financial ratios. Vertical and horizontal analysis of the income statement and balance sheet has also been conducted as a way of reviewing them.

2.1 Introduction

CVS Health is also one of the largest global leaders in the provision of pharmaceutical products and boitechnology and Walgreen Boots Alliance is among its major competitors. CVS Health had a successful financial year which ended DECEMBER 31, 2015 and this is attributed to the major acquisitions that it had made earlier on. Out of the 810 million prescriptions made in the market over the past 5 years, CVS Health has managed to secure 39% of them. The company is actually growing its market share day in day out. This company has also managed to reduce the competition that it faces through the acquisition of major competitors like Omnicare. Omnicare used to supply 100 million scripts to 2 million patients. Some of the acquisitions that this company also made in 2015 is the purchase of 1670 pharmacies and 80 retail clinics. Detailed information regarding to the financial performance of CVS Health has been provided in the computation and interpretation of its financial ratios.

3.1 Review of balance sheet

3.1.0 Vertical analysis

VERTICAL ANALYSIS
Assets:
Cash and cash equivalents 2,459 2.63%
Short-term investments 88 --
Accounts receivable, net 11,888 12.69%
Inventories 14,001 14.95%
Deferred income taxes 1,220 1.30%
Other current assets 722 0.77%
Total current assets 30,378 32.44%
Property and equipment, net 9,855 10.52%
Goodwill 38,106 40.69%
Intangible assets, net 13,878 14.82%
Other assets 1,440 1.54%
Total assets 93,657 100%

Liabilities:

Accounts payable 7,490 8%
Claims and discounts payable 7,653 8.10%
Accrued expenses 6,829 7.29%
Short-term debt -- --
Current portion of long-term debt 1,197 1.28%
Total current liabilities 23,169 24.74%
Long-term debt 26,267 28.05%
Deferred income taxes 5,437 5.81%
Other long-term liabilities 1,542 1.65%
Commitments and contingencies -- --
Redeemable non-controlling interest 39 --
Shareholders’ equity:
CVS Health shareholders’ equity:
Preferred stock, par value $0.01: 0.1 shares authorized; none issued or outstanding --
Common stock, par value $0.01: 3,200 shares authorized; 1,699 shares issued and 1,101 shares outstanding at December 31, 2015 and 1,691 shares issued and 1,140 Shares outstanding at December 31, 2014 --
Treasury stock, at cost: 597 shares at December 31, 2015 and 550 shares at December 31, 2014 --
Shares held in trust: 1 share at December 31, 2015 and 2014 --
Capital surplus 30,948 33.04%
Retained earnings 35,506 37.91%
Accumulated other comprehensive income (loss) (358) --
Total CVS Health shareholders’ equity 37,196 39.72%
Non-controlling interest 7 --
Total shareholders’ equity 37,203 39.72%
Total liabilities and shareholders’ equity 93,657 100%

3.1.1 Horizontal analysis balance sheet.

Reference year 2015 2014 (%) 2013 (%)
Cash 2,459,000 99.11 60.14
AR 13,108,000 122.83 136.10
Inventory 14,001,000 117.36 126.76
Short term investment 88,000 258.82 100
Other current assets 722,000 83.37 152.97
Total current assets 30,378,000 116.91 119.95
Property plant and equipment 9855000 111.44 114.39
Goodwill 38,106,000 135.41 143.56
Other assets 1440,000 99.65 95.05
Intangible assets 13878000 141.99 145.64
Total assets 93657000 126.24 130.94
Accounts payable 14,319,000 115.82 138.80
Short/ Current longterm debt 8850,000 132.80 173.22
Total current liabilities 23,169,000 121.77 150.20
Long Term Debt 26,267,000 225.86 204.56
Other Liabilities 1,542,000 100.72 108.52
Deferred Long Term Liability Charges 5,437,000 134.71 139.37
Minority Interest 7,000 140 140
Total Liabilities 56,422,000 155.74 167.98
Misc. Stocks Options Warrants 39,000 100 100
Common Stock 17,000 100 100
Retained Earnings 35,506,000 111.48 124.61
Treasury Stock 28,886,000 119.97 143.22
Capital Surplus 30,948,000 101.74 103.93
Other Stockholder Equity 389,000 156.85 216.11
Total Stockholder Equity 37,196,000 0.98 0.98
Net Tangible Assets 14,788,000 3520.9.52 792.07

3.2 Stockholder equity

2015 2014
Non-Equity Reserves - -
Preferred Stock (Carrying Value) - -
Redeemable Preferred Stock - -
Non-Redeemable Preferred Stock - -
Common Equity (Total) 37.2B 37.96B
Common Stock Par/Carry Value 17M 17M
Retained Earnings 35.51B 31.85B
Cumulative Translation Adjustment/Unrealized For. Exch. Gain (165M) (65M)
Unrealized Gain/Loss Marketable Securities - -
Revaluation Reserves - -
Treasury Stock (28.89B) (24.08B)
Total Shareholders' Equity 37.2B 37.96B
Accumulated Minority Interest 46M 5M
Total Equity 37.24B 37.96B

3.3 Review of income statement

3.3.0 Vertical analysis

Vertical analysis

Net revenues 153,290 100%
Cost of revenues 126,762 82.69%
Gross profit 26,528 17.31%
Operating expenses 17,074 11.14%
Operating profit 9,454 6.17%
Interest expense, net 838 0.55%
Loss on early extinguishment of debt -- --
Income before income tax provision 8,616 5.62%
Income tax provision 3,386 2.21%
Income from continuing operations 5,230 3.41%
Income (loss) from discontinued operations, net of tax 9 --
Net income 5,239 3.42%
Net income attributable to non-controlling interest (2) --
Net income attributable to CVS Health 5,237 3.42%
Basic earnings per share:
Income from continuing operations attributable to CVS Health 4.65 --
Income (loss) from discontinued operations attributable to CVS Health 0.01 --
Net income attributable to CVS Health 4.66 --
Weighted average shares outstanding 1,118 0.73%
Diluted earnings per share:
Income from continuing operations attributable to CVS Health 4.62 --
Income (loss) from discontinued operations attributable to CVS Health 0.01 --
Net income attributable to CVS Health 4.63 --
Weighted average shares outstanding 1,126 0.74%
Dividends declared per share 1.40 --

3.3.1 Horizontal analysis Income statement.

Reference year 2015 2014 (%) 2013 (%)
Sales 153,290,000 109.99 120.92
Cost of goods sold 126,762,000 111.19 123.10
Gross profit 26,528,000 104.58 111.54
Operating expense 17,074,000 103.05 108.43
Operating profit 9454,000 107.44 117.63
Interest expense 838,000 139.67 164.64
EBT 8,616,000 112.22 114.45
Taxes 3,386,000 111.64 115.64
Net income 5,237,000 112.77 114.05

3.3.2 FUNDAMENTAL ANALYSIS: FINANCIAL RATIOS

This section will handle the computation of the financial ratios of CVS Health for the financial years ended 2013, 2014 and 2015. The values obtained from this analysis will later be interpreted so that meaningful information can be derived from them. The information obtained is important in ascertaining the company’s financial strengths and weaknesses during the recent past. This information then provides a basis for the formation of strategic plans used to reinforce the company’s financial performance.

Liquidity Ratios

2013 2014 2015 Industry benchmark
Current ratio 1.38 1.37 1.31 1.16
Current ratio 0.69 0.74 0.71 0.85

Current ratio= Current assets/ Current liabilities

Quick ratio= (Current assets-inventories)/ Current liabilities

Activity Ratios

2013 2014 2015 Industry Benchmark
Inventory turnover 10.12 9.56 9.05 5.75
Total assets turnover 1.53 1.88 1.64 0.48
Fixed assets turnover 2.62 2.89 2.42 3.30
Days sales outstanding 298.57 295.85 286.54 36.81

Inventory turnover = cost of goods sold/ Average inventory

Total assets turnover= Sales/ Net assets

Fixed assets turnover= Sales/ Fixed assets

Days sales outstanding= (Accounts receivable/ Total credit sales) * Number of days in the financial year.

Coverage ratios

2013 2014 2015 Industry benchmark
EBITDA coverage 15.79 14.67 11.28 20.24
Times-interest-earned 1 2 1 12
Total debt to total assets 43 49 60 68

EBITDA coverage ratio= (EBITDA/ Interest payments) X100

Times-interest-earned= (Total interest/ Total debt) X 100

Total debt to total assets= (Total debt/ Total assets) X 100

Profitability ratios

2013 2014 2015 Industry benchmark
Return on common equity 3.12 3.67 4.12 2.32
Return on total assets 1.53 1.88 1.64 0.48
Basic earning power 0.90 1.10 1.40 1.56
Profit margin on sales 3.62 3.33 3.42 2.24

Return on common equity= Total sales/ Common equity

Return on total assets= Total sales/ Total assets

Basic earning power= Total earnings available to shareholders/ Number of ordinary shareholders

Profit margin on sales= (Net profit/ Total sales) X 100

Market Valuation Measures

2013 2014 2015 Industry Benchmark
Market/book 4.62 6.21 6.08 19.99
Price/earnings 45.9 54.6 63.6 73.1
Price/ cash flow 1.74 1.81 1.92 2.67

3.3.3 INTERPRETATION OF THE FINANCIAL RATIOS

It is not easy to ascertain the performance of an organization by basing on 1 0r 2 simple numbers. Nonetheless, in the accounting profession practise some different financial ratios are usually calculated in the process of strategic planning then the ratios are obtained as a whole so that they can provide useful information regarding to the organization’s performance. A detailed analysis of the financial ratios enables a financial analyst to ascertain those firms which will eventually fail due to poor performance and those that are likely to continue their operations. Studies have shown that one can be able to identify firms which are likely to fail and prosper in the next five years using the financial ratios (Hindmarch, 2012).

Financial ratios make a lot of sense when they are used to compare firms in the same industry or when they are used internally to assess the impacts of changes in the organization’s structure over time. More insights on the results of the financial ratios of CVS Health will be given in the paragraphs below.

LIQUIDITY RATIOS

In order for the company to survive, it has to be in a position of meeting its obligations as they fall due. Hence, the firm’s liquidity is a measure of its financial health (Hammonds, 2006). The two common measures of liquidity are the current assets ratio and the quick test ratio. The major difference between the two is that the current assets ratio contains inventories in its calculation while quick test ratio excludes inventories.

The quick test ratio is regarded as a better measure of ascertaining the firm’s liquidity state as compared to the current ratio. When the quick ratio is higher than one then this implies that the firm has enough liquid cash that it use to service its current liabilities when they are due to be paid. A complexity arises in the event that the current ratio is greater than one while the quick ratio is less than one. During such situations, it is important for the inventories to be revalued again using accurate measures. From our scenario, a complexity has arose since the liquidity ratios of the two companies depict the same behaviour.

The current ratio is compromised by a couple of problems in the way inventories are valued. The obvious accounting problem arises from the fact that most organizations value their inventories using either the FIFO or LIFO method. Inventory valuation is done using old costs under the LIFO method while in the FIFO method it is done using the latest costs used to acquire the inventories. This thus implies that the organization might value its inventories are relatively high or low prices compared to those that they were procured with. If the market has become competitive and commodity prices have fallen, inventories will be overvalued if the LIFO method is employed (Hartley, 2010). The discrepancy in the methods of inventory valuation makes it difficult for the analysts to compare the financial strengths of two companies unless the differences are corrected. Luckily, CVS Healthhas adopted the same method of valuation (FIFO) thus making it easier for its financial strengths to be compared.

The other difference of using inventory to calculate the current ratio is the fact that their accounting values may be different from the prevailing economic value (Ross et al, 2005). Take for instance a company which is affected by fluctuations in business cycles. Such types of firms will have their inventories building up during times of economic downturn. The accounting value of the inventory will not fall that much during such times but less sales will however be realised due to the downturn. The inventory is highly valued during economic down turns but there is no way in which the firm can sell them at that price thus reducing its liquidity. It is thus not prudent to include inventories in the calculation of the firm’s liquidity during times of economic downturns since it will depict a false state of the company’s financial position. The good thing is that the two companies under analysis deals with products which are necessities thus making them not be affected by economic downturns.

We might then come to a conclusion that the quick ratio is a preferred measure of liquidity as compared to the current ratio but this is not true. There are organizations which deals with marketable inventories that can be readily converted in to cash hence such firms do not deserve to be penalised by this policy. An example of such companies is the CVS Health.

Low values of the quick and current ratios might indicate that the company is having trouble in meeting current liabilities. However, the low values are not that dangerous. If the company has hood long term plans then it can approach financial institutions and secure credits by show casing their plans to the lenders. This way the firm will get enough cash meant for meeting due obligations and running other long term operations. High liquidity ratios do not also imply that the firm is operating efficiently. This might show that the company is not effective in utilising its resources in income generating investments thus reducing its profitability. Apparently the liquidity ratios of CVS Health are not far from the industry benchmarks thus implying it is operating efficiently.

COVERAGE RATIOS

Firms are financed either by equity or debt or also both. The correct capital structure solely depends on the tax policies that are in place. For instance, debt is favoured by high rates of corporate taxes while equity financing is favoured by high rates of personal taxes. The two commonly used coverage ratios are the debt to assets ratio and the debt to equity ratio.

Just like the liquidity measures, there are problems in the way in which the coverage ratios are measures and interpreted. The major problem is the fact that equity and assets are usually posted using their carrying amounts in the balance sheet. These values have a great discrepancy with the prevailing market values and the amounts that creditors would receive in the event that the company is liquidated.

Debt to equity ratios vary a lot from industry to industry depending on the nature of the industry and the prevailing environmental conditions. For instance a merchandise company can operate with high debt to equity ratio while a manufacturing company cannot. This thus implies that these ratios are useless in comparing companies in different industries.

The debt to equity ratio show the firm’s ability to generate funds from the available capital markets. The higher the coverage ratios the lower the chances of the firm to acquire finances from lenders. This is because such firms are assumed to have high chances of going bankrupt. Good coverage ratios should be below the industry benchmarks if the firm is to remain attractive to potential investors. Apparently that of CVS Health is below the industry benchmarks thus implying that it is still in a position of acquiring funds to improve its products and services.

PROFITABILITY RATIOS

The most common ratios used in measuring the profitability of the company are the return on assets ratio and the return on equity ratio (Gibson et al, 2012). Equity and assets used in the calculation of these ratios are both recorded using their book values hence if the assets were purchased some years back at a low price then the firm’s current performance will be overstated when denominators which are historically valued are used. This then results to a miscommunication of the firm’s true financial performance and that shown by the financial ratios. Assets and equity should thus be recorded at their market values if the true profitability is to be ascertained. The other problem of using these ratios is the fact that analysts tend to focus on single years rather than considering a range of years so that trends can be established and the true profitability ascertained.

A firm is said to be profitable if its profitability ratios are higher than the provided industry benchmarks. Apparently the profits ratios of CVS Health have been above the industry benchmarks over the past three years which is a good trend. It thus implies that the companyis doing well over most of its competitors.

MARKET VALUATION MEASURES

Most of the financial ratios are calculated from data which is associated with the company performance in the stock market and not from the items in the balance sheet and the income statement. The three most common market valuation measures are the dividend yield ratio, EPS and P/E ratio (Drury, 2012).

The most commonly used statistic is the EPS. It is in fact a requirement that this statistic should be provided in the income statements of companies which are publicly traded. As the name suggests, this ratio tells us how much a shareholder earns from every share that he has invested in the company. Generally this is not a useful statistics as it does not mention how much of the assets the company has utilised in order to generate sales. It does not rather highlight on the firm’s profitability. Inventory treatment is also problematic in the calculation of these ratios.

The other commonly used ratio is the P/E ratio and they are indeed reported in the newspapers on a daily basis. Higher P/E ratios shows the ability of the firm to improve its performance in future than it is doing currently.

From the view of some shareholders, knowing a company’s dividend policy is important as it indicates the amount of earnings that the company sets aside for the payment of dividends to its investors. New start-ups have low dividend yield ratios since most of their earnings are reinvested back to the company rather than being paid as dividends.

The market valuation ratios of CVS Health is below the industry benchmarks. This thus implies that the company directs less of their earnings to dividends and chooses to reinvest them in income generating investments. This strategy is attractive to some shareholders while it is not attractive to others. It is attractive to those investors who perceive the long term benefits that this strategy will accrue while it is less attractive to those who would want to benefit from short term strategies.

3.4 Statement of cashflows

Period Ending 12/31/2014 12/31/2015
Net Income 4,644,000 5,237,000
Cash Flows From Operating Activities
Depreciation 1,931,000 2,092,000
Adjustments To Net Income -414,000 -36,000
Changes In Accounts Receivables 737,000 1,594,000
Changes In Liabilities 2,815,000 3,495,000
Changes In Inventories 770,000 1,141,000
Changes In Other Operating Activities 374,000 -357,000
Total Cash Flow From Operating Activities 8,137,000 8,412,000
Capital Expenditures -2,136,000 -2,367,000
Investments 519,000 387,000
Other Cash flows from Investing Activities -2,428,000 -11,440,000
Total Cash Flows From Investing Activities -4,045,000 -13,420,000
Cash Flows From Financing Activities
Dividends Paid -1,288,000 -1,576,000
Sale Purchase of Stock -3,580,000 -4,702,000
Net Borrowings -932,000 11,218,000
Other Cash Flows from Financing Activities -61,000 -61,000
Total Cash Flows From Financing Activities -5,694,000 5,006,000
Effect Of Exchange Rate Changes -6,000 -20,000
Change In Cash and Cash Equivalents -1,608,000 -22,000

4. CONCLUSION

The management of CVS Health should continue implementing their management strategies and adopt new strategies which will help them in dealing with the weaknesses which have been exposed by financial ratio analysis. This way the company will gain more competitive advantage and increase its profitability

5. ANALYST RECOMMENDATION

From the results and interpretation of the financial ratios of CVS Health, I think it would be prudent for one to buy its stocks since they have proofed to be profitable, liquid, highly valued and can also manage their debts well. Investing in this company has a guarantee that one would be able to realise more earnings compared to the initially invested capital.

6. References

Developing Control Concepts in the Twentieth Century (RLE Accounting). (2013).

Drury, C. (2012). Management and cost accounting (3rd Ed.). London: Chapman & Hall.

Hammonds, H. (2006). Budgeting. North Mankato, MN: Smart Apple.

Rational Accounting Concepts (RLE Accounting). (2013).

Relevant Accounting Concepts and Applications (RLE Accounting). (2013).

Gibson, C. J., Meredith, G. G., & Peterson, R. (2012). Accounting concepts: Readings. North Melbourne: Cassell Australia.

Hartley, W. (2007). Accounting Concepts and Accounting Standards. An Introduction to Business Accounting for Managers, 28-39.

Hartley, W. (2010). Accounting Concepts and Accounting Standards. An Introduction to Business Accounting for Managers, 29-41.

Hindmarch, A., & Simpson, M. (2012). Accounting Concepts. Financial Accounting: An Introduction, 79-93.

Ross, S., & Westfield, R. (2005). Corporate finance (7th Ed.). Boston: McGraw-Hill/Irwin.

7. Appendices

7.1 CONSOLIDATED BALANCESHEET FOR THE YEAR ENDED DEMBER 31, 2015

Assets:

Cash and cash equivalents 2,459
Short-term investments 88
Accounts receivable, net 11,888
Inventories 14,001
Deferred income taxes 1220
Other current assets 722
Total current assets 30,378
Property and equipment, net 9,855
Goodwill 38,106
Intangible assets, net 13,878
Other assets 1,440
Total assets 93,657
Liabilities:
Accounts payable 7,490
Claims and discounts payable 7,653
Accrued expenses 6,829
Short-term debt --
Current portion of long-term debt 1,197
Total current liabilities 23,169
Long-term debt 26,267
Deferred income taxes 5,437
Other long-term liabilities 1,542
Commitments and contingencies --
Redeemable non-controlling interest 39
Shareholders’ equity:
CVS Health shareholders’ equity:
Preferred stock, par value $0.01: 0.1 shares authorized; none issued or outstanding --
Common stock, par value $0.01: 3,200 shares authorized; 1,699 shares issued and 1,101 shares outstanding at December 31, 2015 and 1,691 shares issued and 1,140 Shares outstanding at December 31, 2014 17
Treasury stock, at cost: 597 shares at December 31, 2015 and 550 shares at December 31, 2014 (28,886)
Shares held in trust: 1 share at December 31, 2015 and 2014 (31)
Capital surplus 30,948
Retained earnings 35,506
Accumulated other comprehensive income (loss) (358)
Total CVS Health shareholders’ equity 37,196
Non-controlling interest 7
Total shareholders’ equity 37,203
Total liabilities and shareholders’ equity 93,657

7.2 CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED DEMBER 31, 2015

2015
Net revenues 153,290
Cost of revenues 126,762
Gross profit 26,528
Operating expenses 17,074
Operating profit 9,454
Interest expense, net 838
Loss on early extinguishment of debt --
Income before income tax provision 8,616
Income tax provision 3,386
Income from continuing operations 5,230
Income (loss) from discontinued operations, net of tax 9
Net income 5,239
Net income attributable to non-controlling interest (2)
Net income attributable to CVS Health 5,237
Basic earnings per share:
Income from continuing operations attributable to CVS Health 4.65
Income (loss) from discontinued operations attributable to CVS Health 0.01
Net income attributable to CVS Health 4.66
Weighted average shares outstanding 1,118
Diluted earnings per share:
Income from continuing operations attributable to CVS Health 4.62
Income (loss) from discontinued operations attributable to CVS Health 0.01
Net income attributable to CVS Health 4.63
Weighted average shares outstanding 1,126
Dividends declared per share 1.40