Due to the complexity of corporate financial statements, the prospect of deciphering meaningful insight can be a daunting task. Furthermore, the ratios deployed by professional analysts are numerous, effectively creating a thousand piece jigsaw puzzle whose composition perpetually and frequently fluctuates. Luckily, for those of you who lack either the time or mental stamina to perform calculations such as the disaggregation of the components of return on net operating assets (RNOA), a relatively effective process exists known as Vertical Analysis. The premise of Vertical Analysis is to create common-size financial statements, where all balance sheet and income statement items are converted into percentage terms for purposes of comparison.Using vertical analysis, comparisons can be made between firms regardless of size. This approach is especially useful when determining the relative financial health of competing firms within the same industry. Financial metrics display a large degree of variability across industries; however, within a given industry, competitors should be fairly aligned in terms of funding sources (debt v equity), liquidity, asset turnovers etc. Below is a vertical analysis I prepared using the FY '08 balance sheets from Pepsico (PEP) and Coca-Cola (KO).
Vertical Analysis of Financial Statements - Pepsi v Coke
From here, it's fairly easy to scan through Coke and Pepsi's relative balance sheet percentages(page 2 of pdf) , making some fairly useful generalizations. The first thing I noticed from this comparison is that Pepsi and Coca-Cola have a nearly identical composition of current v long term assets (30/70). However, Cash/Cash Equivalents represents 11.7% of Coke's assets, but only 5.7% of Pepsi's. It appears that Pepsi makes up the difference in it's proportion of (net) receivables to assets (13% v 7.6%); this could just be a timing issue, but it could also mean that Pepsi has become more aggressive in terms of the conditions by which it will offer credit to customers. The next observation I'd make has to do with differences between the two company's capital structures. Pepsi's debt/equity split percentage is 66.2/33.8, whereas Coca-Cola's capital structure is comprised of 49.5% debt and 50.5% equity. Interestingly though, Pepsi's short term debt only represents 1% of the right side of the balance sheet, whereas Coca-Cola comes in at 16.1%. This could just be an indication that Coke relies more heavily on commercial paper to fund it's short term operations; it could also mean that Coke has a significant amount of long term debt coming due in the months ahead. Coca-Cola's 2008 10-K should contain footnote disclosures describing the nature of these short term obligations. In this sense, the vertical analysis above serves as an informative starting point from which to diagnose any potential issues the firm might have down the road. Additionally, vertical analysis can expedite the analysis process by narrowing down which footnotes you, as an investor, should be concerned with.
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