Week 1 Discussion 1. Economics

From the e-Activity, evaluate at least two companies’ financial statements that have received a negative rating from one of the financial rating agencies. Determine which financial ratios most likely impacted the rating decision. Compare and contrast at least two financial ratios that support the rating agency’s claims. Speculate on how the ratios are likely to change considering the economic environment in which it operates. Support your position. The two companies that I choose for this discussion are the American Express, Inc. and the General Electric Company.

Both of them received negative rating from the Thomson Reuters Stockreport + and both of them is under the -2 category. As I research on the ratios that these rating companies might use, I discover that they love to use the leverage ratios as an indicator. Take American Express and the General Electric as an example. Both of them carry more than 400% Debt to Common Equity while the Long Term Debt Percent to Common Equity are both more than 250% which consider very high in comparing to those obtain positive rating like Boeing, whose total Debt percentage to Common Equity is only 201.

05%! Other than these leverage ratios, the assets per employee ratio seem to be another key factor to determine the ranking. Company has positive rating like Boeing has assets per employee ratio at $397,262. 38 per employee while both GE and American Express have over 2 million per employee! If a company’s debt to equity ratio is more than 400%, it means that the company relies heavily on debt than equity. It is true that interest expense is tax deductible and which will help to improve the net income as a result of this benefit.

However, this ratio will tell the investor that the company might get into cash problem if the growth in sales is slow plus the collection rate is low. In addition, when the assets to employee ratio is over million, it tells the investor that the company is inefficient in generate profit. Any changes in the economy, the company is likely to encounter a lot of problems. Change in economic environment would hardly help the American Express as they are well known for high service charge to both merchants and consumers.

It would be difficult for them to improve the ratio unless they stream down and change their policy on charging. As for the General Electric, they have to wait till the economy bounces back in full swing then, the assets turnover rate will be improved immensely. In addition, with the help of the growth in sales, they will be able to pay-off some debts and thus reduce the debt to equity ratio. Imagine that you are a chief financial officer with $150,000 of idle cash that you must invest to increase earnings for your company.

Select at least two companies and the ratios you would use to determine your investment strategy. Based on the companies you choose, speculate on how the ratios are likely to change over the next five years. I would like to make an investment on Apple, Inc. and Boeing Company in a ratio of 6:4. The ratios that I use for the evaluation will be the growth rate in sales, the return on earning assets ratio, cost of goods sold to sales ratio, the debt to common equity ratio, and the dividend payout in the past 5 years. If the economy remains the same, the cost of goods sold to Sales ratio for Apple, Inc.

will drop proportionately as they have the costs under good control while the sales remains growing at 40% rate. In addition, the return on earning assets will grow a little bit due to the increase in sales. Other than that, other ratios will pretty much the same. As for Boeing, unless there is a sudden demand in new jets, the sales will pretty much the same. As they are pretty good at streamlining, I do not expect a dramatic change in its ratios at all. Reference: Financial data retrieved from www. thomsonone. com & www. scottrade. com.