IMB 2015/2016

Accounting for Managers

Financial analysis of Apple and Microsoft

Course Coordinators: Prof. Dr. Samo Javornik Students: Blaž Babnik

Prof. Dr. Metka Tekavčič Milica Bogavac

Sanja Končan

Ljubljana, December 2015

Contents

1. Introduction.................................................................................................................................3

2. Description of companies and their business model..................................................................3

2.1 Apple...........................................................................................................................................3

2.2 Microsoft....................................................................................................................................4

2.3 Differences in business models............................................................................................5

3. Analysis and description of the industry....................................................................................6

4. Financial statement analysis.......................................................................................................7

4.1 Trends and structure in Apple Balance Sheet.........................................................................8

4.2 Trends and structure in Microsoft Balance Sheet...................................................................9

4.3 Ratio analysis...........................................................................................................................10

4.3.1 Profitability.......................................................................................................................10

4.3.2 Liquidity............................................................................................................................10

4.3.3 Solvency.............................................................................................................................11

4.3.4 Activity...............................................................................................................................11

5. Scorecard table..........................................................................................................................12

6. Conclusion..................................................................................................................................13

7. References and sources:............................................................................................................14

8. Appendix:...................................................................................................................................15

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1. Introduction

2. Description of companies and their business model

2.1 Apple

Apple is the world's largest information technology company by revenue,[7] the world's

largest technology company by total assets, and the world's third-largest mobile phone

manufacturer. On November 25, 2014, in addition to being the largest publicly traded

corporation in the world by market capitalization, Apple became the first U.S. company to be

valued at over US$700 billion. The company employs 115,000 permanent full-time

employees as of July 2015 and maintains 453 retail stores in sixteen countries as of March

2015; it operates the online Apple Store and iTunes Store, the latter of which is the world's

largest music retailer.

Apple has always been and continues to be a manufacturer of computers and electronics with

a focus on complete hardware and software integration. Prior to 1996, the company focused

almost exclusively on personal computers in the Macintosh line, with the occasional foray

into innovative products like the Newton. When Steve Jobs rejoined the company in 1996,

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that mission evolved beyond personal computing into products like the iPod, iPhone, and

iPad.

Apple's longest running line of business is that of computer hardware and software. The

company has always believed that hardware is only as useful as its software, and the

importance of full software and hardware integration cannot be underestimated. This

dedication to owning the full integrated product has allowed Apple to focus on quality and

usability, at the cost of market share with its Mac line of products.

There are two basic business models in the world. The first is cheap, low-quality, high-

volume products. You don't make much profit per unit, but you sell of a ton of them. The

second is expensive, high-quality (luxury), low-volume products. You don't sell many units,

but you make a lot of profit per unit. It's really hard to split the difference, selling high-

volume, high-quality products. If you spend 1% more on quality, your customers can't tell the

difference (without more research on their part), so you'll lose 10% of your customers who

won't accept the higher price. Or, you are selling to the luxury market, lowering price to sell

more units means lowering quality standards, destroying your brand. Apple is another

company that succeeds at this, selling higher quality products at enormous volumes, at

mainstream prices.

As quoted in Apple's Form 10K, "The Company’s fiscal year is the 52 or 53-week period that

ends on the last Saturday of September". This is mainly because the company wants to end its

year on a Saturday because of higher sales on the weekend.

Apple is positioned well for the future, and it's not a company that's willing to settle for

current success. Unafraid of cannibalization, the company continues to churn out iPhones that

make the iPod look like a hobby, as well as the iPad Mini that unashamedly steals market

share from its big brother. Notoriously secret, the company reveals little about the product

pipeline, but its believed that Steve Jobs left a product roadmap for more than a decade.

2.2 Microsoft

Microsoft Corporation (commonly referred to as Microsoft) is an American multinational

technology company headquartered in Redmond, Washington, that develops, manufactures,

licenses, supports and sells computer software, consumer electronics and personal

computers and services. Its best known software products are the Microsoft Windows line

of operating systems, Microsoft Office office suite, and Internet Explorerand Edge web

browsers. Its flagship hardware products are the Xbox game consoles and the Microsoft

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Surface tablet lineup. It is the world's largest software maker by revenue, and one of

the world's most valuable companies.

Microsoft was founded by Paul Allen and Bill Gates on April 4, 1975, to develop and

sell BASIC interpreters forAltair 8800. It rose to dominate the personal computer operating

system market with MS-DOS in the mid-1980s, followed by Microsoft Windows. For years,

Microsoft dominated the computer industry with its Windows software; Apple was an

afterthought for more than a generation of operating products. Before Google Web browsing

began to dominate the market, Microsoft gave away Internet Explorer for free and drove

Netscape out of business.

The Microsoft revenue model historically relied on just a few key strengths. The first, and

most important, is the licensing fees charged for use of the Windows operating system and

the Microsoft Office suite. After a few years of increasing irrelevance in the race against

Google and Apple, Microsoft unveiled a new vision in April 2014, instantly shifting focus to

make Windows software more compatible with competitor products, such as the iPad.

Microsoft also has a few successful products, highlighted by the Microsoft Surface and

Surface Pro, that battle Apple devices.

Moving forward, however, Microsoft realizes it cannot simply stick with the same old

method and continue to compete with Apple and Google. Paid software is a more difficult

sell in an age of low-cost alternatives. Additionally, tablets and phones are replacing PCs. A

newer Microsoft business model has been telegraphed by CEO Satya Nadella, one that

emphasizes product integration and a "freemium" software package.

2.3 Differences in business models

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3. Analysis and description of the industry

Information technology is broader industry in which both companies, Apple and Microsoft

are operating. More specifically, Apple belongs to Computer Manufacturing industry whereas

Microsoft is classified as Computer Software & Services Industry.

Computer Software & Services Industry includes companies which offer a wide range of

products and services, personal computer operating systems, network security applications to

payroll processing services and information technology consulting and outsourcing services.

Companies operating in Computer manufactoring industry manufacture and assemble

personal computers (PCs), laptops and servers.

Competition is a common theme in information technology, also with rivalries between

Apple and Microsoft. Entry into this industry is common, however it is harder to survive

within. Competitive nature of this industry requires the newcomer to be able to sustain a

technological and product marketing edge over its larger rivals. And if suceeded, at the end

these compenies most likely become acquisition targets to Microsoft, Apple and other high

powers as they cannot compete against them.

Large part of this industry's cost structure represent sales and marketing expenses.

Expenditures on research and development vary across the industry, although they reach

enormously levels especially in a software developer's cost structure. Apple and Microsoft

have global operations, that they expose to inconsistencies of foreign exchange. Nevertheless,

the group's margins are wide; and good returns on invested capital suggest effective use of

funds.

Foundation that was formed with increased data processing, has brought greater efficiency

and productivity to nearly every kind of business. Information technology, of which software

and services is an integral part, and computers and servers as external part, have become

inseparable from a business's daily operations. It plays exceptionally important role for the

customer.

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One would think that information technology will never become fully mature because of its

high tech industry. However, the results show the opposite, while there seems to have been a

shift in the balance of market power from the industry to its end markets. This end markets

are experiencing increasing competition and pressure on profitability. Many systems are not

used to their fullest, therefore this industry’s customers are looking for ways for more

efficient usage of these already developed systems. One of the industry’s responses for

maneuvering has been a concept of virtual servers or virtual computing, which provides more

effective way in using system capacities by allocating computing sources. Another larger

opportunity is to move to cloud computing wherein computing resources are not directly

owned and software and services are purchased-by contract or metered usage-and made

available via Internet technology. (Industry Overview: Computer Software and Services)

Computer manufacturing industry is reporting a decline as there is presented market

saturation with the products. Consumer markets in United States, Japan and Western Europe

are approaching to lower demand.

Recent trend has showing how domestic manufacturing activity of Apple has weakened in

US and Europe, as a result of offshoring. Industry operators have continued to relocate

production activity overseas and take advantage of lower labor and production costs in order

to compete with foreign manufacturers. However, while general demand for computers has

grown in between, intense competition due to product homogeneity has led to falling prices

and smaller profit margins.

In recent years has aggressive competition transformed computer manufacturing into an

increasingly standardized industry with limiting revenue potential. (Computer

Manufacturing: Market Research Report)

4. Financial statement analysis

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We will describe trallalala

4.1 Trends and structure in Apple Balance Sheet

For the last decade investing in Apple appeared to be a good business decision. On 27 th of

Sept, 2014 Balance Sheet of Apple company revealed for 231 billion and 839 million US

worth assets, total liabilities of 120.292 billion and the level of total shareholders was

111.547 billion US$. The main strength of Apple is its liquidity. They dispose with 13.8

billion US cash and cash equivalents and also with 11.23 billion US$ in marketable securities

that can be easily converted into cash. Thus, the company dispose with significant amount of

cash. Most of this money is kept outside the US. The Apple Company would have to pay

additional US taxes if it decides to enter the country. This is the reason why the company

decided rather to borrow money to implement its share buyback1 program.

Accounts receivable reached a value of 17.4 billion US $. This is the amount that other

businesses that cooperate with Apple owe the company: such as mobile phone operators,

retailers, and state and educational institutions, which are also its major customers. The high

level of accounts receivable may pose risk in business as it slows down cash flow cycle.

However, within Apple this should not be the case because the whole amount of accounts

receivable is evenly distributed, meaning, the two biggest debtors account for not more than

10% of total accounts receivable.

Another important element of Apple's assets is the 130.16 billion US$ in the long-term

marketable securities. This amount includes approximately 79 billion US$ in corporate

securities and about $ 22 billion in US treasuries. These investments pose risk of rising

interest rates. However, these investments are taken at fixed interest rates. Company also has

20 billion US$ in properties, plants, and equipment category. This represents the value of

property and equipment that Apple uses for a purpose of their depreciation. Apple’s goodwill

was estimated for 4.6 billion US$, which represents the highest goodwill of any company in

the world.

1 Share Buyback is a program of repurchasing of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market

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Apple’s current liabilities amount for 63 billion US$ and include for 30 billion US$ of

accounts payable (the amount the company owes to its suppliers). Also, it issues more than 6

billion US$ of commercial paper. Commercial paper was used in order to finance activities

such as share buy-backs that are committed, and to pay dividends.

The company has long-term debt that exceeds 28 billion US$. Long –term debt is divided by

fixed-rate debt (debt issued by fixed interest rate) and floating-rate debt (where interest rates

may rise, less secure). Other non-current liabilities of the company, KOJE NECE DOSPETI

JOS NEKO VREME NA NAPLATU, have a value of about 25 billion US$.

Apples shareholder equity position has a value of about 23 billion US$ and represents the

equity base. However, there has been generated 87 billion US$ dollars in earnings. In June

2014, the company conducted the stock split2 in a manner that for each share received seven

new shares, ratio 1-7.

4.2 Trends and structure in Microsoft Balance Sheet

At the end of 2014 Microsoft had 8.7 billion US$ in cash, and this amount isn’t just enough

to cover short-term liabilities during the 4 years, it represents also increasing of 128%

comparing to previous year.

Accounts receivable of Microsoft are 52 days and Apple only 17 days. Both of the companies

has the value of accounts receivable and inventory around 7.5. One more significant element

of Microsoft Balance Sheet is its goodwill (20 billions).

Microsoft has short-term debt around 2 billion US dollar, and Apple 6.4. This debt does not

represent needs for these companies, it is actually consequence because of the fact that they

have opportunity to get loans under really good conditions (low interest rates), and that will

lead to cheap capital and expansion of business. Microsoft has around 21 billion US dollars in

long-term debt, and Apple has a little bit less than 17 billion. This will give long-term-debt to

total assets ratio 12% for Microsoft and 8 % for Apple.

Microsoft is extremely stable company which has high amount of equity (90 billions) and it

represents save long-term investment.

2 A corporate action in which a company divides its existing shares into multiple shares

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Ovdje jos nesto dodati

4.3 Ratio analysis

Napisati nesto o ratio analysis I koje smo koristili ,

4.3.1 Profitability

The value of gross profit margin (38.59%) of Apple is lower comparing to leading

competitors in the industry (55-65%), while values for operating profit and net margin profit

are at the top of the industry. Value of return on equity and return on assets is significantly

higher than in competitor’s case. The value of return on equity of Microsoft is higher

comparing to the most important competitors but still lower comparing to Apple. The value

of gross profit margin is on the top of the industry (64.7%), what tells us about high

profitability of this company.

Gross profitmargin=Revenue−Cost of Goods SoldRevenue

Returnon Equity= Net Income

Shareholde r ' s Equity

4.3.2 Liquidity

Liquidity ratio provides us information of how easily a company can pay off to all creditors if

needed. This ratio is calculated by dividing current assets and current liabilities. In the case of

Apple, this ratio has a value of healthy 1.08, which shows that the company has enough

current assets available to them to cover all current liabilities. For Apple relatively low value

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of current ratio is not the consequence of bad financial situation, it is actually result of

specific way of managing with its equity or capital. The same case is with the value of cash

ratio (0.4) so we for sure can say that the Apple is one of the companies with the biggest

capital reserve.

T

If we look at the current ratio Microsoft has advantage comparing to Apple, because it’s

average value is 2,5, while in the case of Apple is 1,1. At big and powerful companies like

this two, the best indicator is net working capital which amounts 5 billion in Apple, and 68

billion US dollar in Microsoft. The value of current ratio (2.5) is on the same level of the

leaders in this industry and it shows the fact that Microsoft is in really good position because

of liquidity. Cash ratio is also really high which confirmation of this extremely liquid

company is (1.88).

Current Ratio= Current AssetsCurrent Liabilities

Cash Ratio=Cash Equivalents+CashCurrent Liabilities

4.3.3 Solvency

The value of debt to equity ratio is on the lower level comparing to competitions for

Microsoft is 0.25 and for Apple 0.32. Because of that it allows them more space for

borrowing if trallala

Interest coverage is on really good level so we can conclude that companies are not

opterecenja costs of paying interest rate.

Debt ¿ Equity Ratio= Total Liabilities

Shareholde r ' s Equity

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Interest Coverage Ratio= EBITInterest Expense

4.3.4 Activity

The value of inventory turnover (57.94) is convincingly really high, which indicates that

Apple manages their inventories really good comparing to Microsoft which inventory

turnover amounts 11.72.

Asset turnover is 0.83 comparing to Microsoft 0.55.

Inventory Turnover= SalesAverage Inventory

Asset Turnover= SalesTotal Assets

5. Scorecard table

  Grade from 1 (bad) to 5 (good)

   Apple MicrosoftIncome Statement 5 5Balance Sheet 5 5Cash Flow Statement 5 4Total 15 14  ProfitabilityGross profit margin 4 5Return on equity 5 4Total 9 9

LiquidityCurrent ratio 3 4Cash ratio 3 4Total 6 8  SolvencyDebt to equity 4 5Interest coverage 5 3

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Total 9 8  ActivityInventory turnover 5 3Asset turnover 5 4     Total 49 46Maximum 55 55Average 4,45 4,18

6. Conclusion

There are few reasons for buying Apple stocks like Recent Revenue Growth (14,3% on

average annual during previous 3 years), Recent Net Margins ( the average value during pass

3 years -21,8%), long term stability and profitability, attractive ROIC, ROE (Apple has

Return on Invested Capital of 31, 8% and ROE of 43, 8%). On the other hand there are

reasons for not buying: risky PS, relatively low Dividend Yield of 1,7 % ( Apple didn’t give

dividends from 1995until 2012).

During the analyzing Apple we can conclude that beside the fact that is one of the biggest

innovators on the market, it is extremely good for buying tech stocks, like one of the biggest

companies because of market capitalization.

Reasons for buying Microsoft are recent Operating Margin ( really stable, on the level of 28-

28,5 %), strong Operating Cash Flows ( 8,6 billion US dollars, which is 1,9 times higher than

Net Income), attractive ROIC, ROE and FCF ( ROIC=33,9%, ROE=14,3% , FCF( Free Cash

Flow Margin)=35,5%. Reasons for not buying are: recent Revenue Growth (7,8 % on average

annual during pass 3 year, but it was decreased for 12,2 % in last quartile this year), risky

PE,PS, purchasing of Nokia.

Based on presented data and research we can conclude that both of the companies are in

extremely good financial condition and in the future we cannot expect some events which

will have such a bad influence. Still we give a slightly advantage to Apple, first of all because

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of the way they manage money and assets and because financial position of Microsoft is

shaken because of purchase of Nokia.

7. References and sources:

http://www.investopedia.com/articles/markets/111015/apple-vs-microsoft-vs-google-how-

their-business-models-compare.asp

http://www.digitalbusinessmodelguru.com/2013/02/analysis-of-apple-inc-business-

model.html

https://en.wikipedia.org/wiki/Microsoft

https://en.wikipedia.org/wiki/Apple

http://www.ibisworld.com/industry/default.aspx?indid=740

https://www.microsoft.com/investor/reports/ar13/financial-review/discussion-analysis/

index.html

http://marketrealist.com/2014/07/must-know-enterprise-resource-planning/

http://www.valueline.com/Stocks/Industries/

Industry_Overview__Computer_Software_and_Services.aspx#.VmNxtdLqiko

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8. Appendix:

8.1 Apple financial statement

8.2 Microsoft financial statement

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