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Amy Krispow
Shauna Hatfield
Accounting 1120
April 20, 2016
International Business Machines Financial Statement Analysis
The purpose of this paper is to discuss and analyze the company IBM's financial position,
including profitability, risk, stockholder relations, and efficiency. IBM, or International Business
Machines, is a consulting and technology corporation that manufactures and sells computer
hardware, software, and consulting services for technology. Using the ratio analysis tool, I
analyze and compare IBM for the years 2013 and 2014, as well as to the industry average. The
information I discuss was taken from the IBM 2014 and 2013 annual reports, which I located on
their website.
I will first be analyzing IBM's profitability, or a company's ability to earn a profit. The
first tool to analyzing IBM's profitability is profit margin, which is calculated by dividing net
income by revenue. Profit margin measures the amount of profit a company keeps from every
dollar of sales. IBM's profit margin was 13.0% in 2014 and 16.8% in 2013, with an industry
average of 1.0%. Although the profit margin dropped from 2013 to 2014, IBM is well above
industry average, a healthy indicator of profitability.
The gross margin ratio, or gross profit percentage, measures how much profit a company
makes from inventory after paying its cost of goods. The gross margin ratio is calculated by
dividing net sales minus cost of goods sold by net sales. In 2014 the gross margin was 50% and
in 2013 it was 49.5%. Although 50% seems like a high profit, compared to the industry average

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of 80.1%, IBM's is relatively low. This could be an indicator that IBM is underpricing its
products or paying too much for material.
The next profitability ratio is return on assets, which is calculated by net income plus
interest expense divided by average total assets. Return on assets measures a companys
profitability in comparison to its total assets, meaning it shows how efficiently a company is
using assets to produce income. For 2014 and 2013, IBM's return on assets was 10.3% and
13.8%. Although the rate dropped from 2013 to 2014, compared to the industry average of
1.6%, IBM is extremely efficient in using their assets to generate cash.
Return on equity is calculated by net income minus preferred dividends divided by the
average shareholder's equity. Since IBM doesn't have preferred stock, we don't need to worry
about preferred dividends. Return on equity measures the amount of profit a company is
generating from the money invested by shareholders. In 2014, IBM's return on equity was 69.4%
and in 2013 it was 79.1%, with an industry average of 3.94%. Although an indicator of
profitability, IBM relies on its shareholders for a mass amount of income.
The final profitability ratio is earnings per share. Earnings per share is calculated by the
net income divided by the weighted average number of common shares outstanding. The
weighted average is used is because companies issue and sells stock throughout the year, so it's a
more accurate indicator. This ratio measures how much of a company's profit is allocated to each
outstanding share of common stock. IBM's earnings per share dropped from 15.06 in 2013 to
11.97 in 2014. Although there was a small drop, with the industry average of 2.66, this is a
healthy indicator of IBM's profitability.
Taking into consideration all the profitability ratios, IBM overall is extremely profitable.

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The gross margin indicated that IBM may be underpriced or need to look into lowering their cost
of materials. The ratios also showed that IBM is generating a fair amount of profit from both
assets and equity, though it seems they rely heavily on stockholders investments, which can be
an issue. Although IBM is still generating a profit, most of the ratios have dropped from 2013 to
2014. Things like this tend to fluctuate, but if this decline continues, IBM might not be the best
company to invest in.
Next, I'll be analyzing IBM's risk, looking first at short-term liquidity. Liquidity is a
companys ability to meet their finances with their liquid assets. Cash is the most liquid of assets,
since it can most quickly be converted into other assets. To measure IBMs liquidity, I will be
using the current ratio and the acid-test ratio.
The current ratio, which is calculated by current assets divided by current liabilities,
measures the efficiency of a company as well as its short-term financial health. It shows whether
a company has the ability to cover its short-term debt, debt due within the next year, with its
short-term assets. Current assets are used in this ratio because they are more easily converted to
cash. The current ratio for IBM was 1.25 in 2014 and 1.28 in 2013. Compared to the industry
average of 1.86, IBM's current ratio is slightly low. However, IBM still has $1.25 of assets
available to pay for every $1 of debt.
The next indicator of liquidity is the acid-test ratio, which measures if a company has
enough short-term assets to cover instant liabilities. Acid-test ratio, also known as quick ratio, is
calculated by quick assets, assets that can be quickly converted into cash, divided by current
liabilities. In addition to cash, quick assets include short-term accounts receivable and short-term
investments. IBM's acid-test ratio was 1.02 in 2014 and 1.06 in 2013, with an industry average of

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1.57. If a company has less than 1, this means they don't have enough liquid assets to pay their
current liabilities.
The second part to analyzing risk is through solvency. Solvency measures a companys
ability to meet long-term financial obligations, and it also measures a company's ability to
achieve long-term growth. The ratios I'll be using to analyze solvency are the debt ratio, the debtto-equity, and times interest earned.
The debt ratio is found by dividing total liabilities by total assets. This ratio shows the
amount of a companys assets that are financed by debt. In 2014, IBM's debt ratio was 89.8%. In
2013, IBM's debt ratio was 81.8%. IBM financed more with debt in 2014 than in 2013, and
especially compared to the industry average of 59.3%, IBM is heavily financed by debt.
The next solvency ratio is debt-to-equity, calculated by total liabilities divided by total
equity. This measures how much debt a company has in relation to the total value of its stock.
IBM's debt-to-equity was 8.78 in 2014 and 4.50 in 2013. Although this looks like a significant
increase, IBM's total liabilities from 2013 and 2014 remained relatively close, the amount of
equity is what changed. Compared to the industry average of 1.46, more of IBM's liabilities are
financed by equity than other companies.
The final solvency ratio is times interest earned, which is calculated by earnings before
interest and taxes divided by interest expense. The times interest earned ratio measures the
amount of income available to cover future interest expenses. This also measures a companys
ability to make interest and debt payments, which is why it's a good solvency indicator. In 2014,
IBM's times interest earned was 34.59, and in 2013 it was 50.37. Though the rate dropped from
2013 to 2014, this is still a very high number compared to the industry average of 2.9. This

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means while other companies only make enough to pay their interest expense about 3 times over,
IBM can pay its interest expense 35 times over.
Reviewing the liquidity and solvency ratios, IBM appears to be a risky investment.
Although IBM has enough to pay off current liabilities, it's barely enough. IBM is financed
heavily by debt, meaning a higher risk investment. However, companies do use debt to grow, so
this is not necessarily a negative. IBM's high times interest earned ratio means the company is
more than able to meet its interest payments, but a high ratio can also mean IBM is paying too
much debt with income that could be used to finance growth or other projects.
Next, I will be analyzing IBM's stockholder/investor relations using the price-earnings,
price to free cash flow, dividend yield, and dividend payout ratios. This will provide potential
investors with an accurate view of IBM, and information, needed to make decisions about
purchasing or selling stock. Earnings per share has already been included in profitability, but it's
also a very important stockholder ratio.
The price-earnings ratio is calculated by market value per share divided by earnings per
share. This ratio is good for a potential investor to review because it measures the dollar amount
an investor would need to invest in a company to receive one dollar of earnings back. For 2014
and 2013, IBM had a price-earnings ratio of 13.40 and 12.45. With an industry average of 19.3,
IBM investors receive $1 of earnings for every $13 invested, while investors in other companies
receive $1 for every $19 invested. While a lower price-earnings can be an indicator that the
company is undervalued, this ratio is a harder one to interpret.
The price to free cash flow is calculated by market capitalization divided by free cash
flow. This compares a company's current share price to per share free cash flow. IBM's price to

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free cash flow increased from 27.60 in 2013 to 28.66 in 2014. Compared to the industry average
of 30.2, IBM is a good choice for investors. Investors look for companies that have improving
price to free cash flow, but they also look for lower ratios because it means shares are
undervalued and will have increasing prices, so IBM may be too close to the average for this.
Dividend yield is a percentage calculated by annual dividends per share divided by
market price per share. Dividend yields measure the productivity of an investment. Usually
dividends are seen in profitable companies, so this is good for investors to review. IBMs
dividend yield was 2.65% in 2014 and 1.97% in 2013, with an industry average of 2.2%. This
increase is a good indicator to invest, but only if the dividend yield has continued to rise from
past years as well.
The final ratio to evaluate stockholders relations is dividend payout. This shows how
much net income a company returns to its stockholders, which also shows how much the
company keeps for things like reinvestment and paying off liabilities. IBM had a dividend
payout of 35.48% in 2014 and 24.62% in 2013. IBM is below the industry average of 42.1%, but
the rise from 2013 to 2014 is a healthy indicator to potential investors.
Overall, only looking at the stockholder relations analysis, IBM is a good investment. The
price earnings ratio increased from 2013 to 2014, which is a good indicator to invest because a
higher price-earnings means higher future earnings growth. The dividend payout is also on the
rise, which means investors can expect more of a return.
Finally, I will be analyzing IBM's overall efficiency, which includes inventory,
receivables, asset management, and cash flow. Efficiency means achieving productivity with
little effort being wasted. Efficiency is one of the most important aspects of a business, because

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if a business can't run efficiently, it can't survive long-term.
Beginning with inventory, inventory turnover measures how many times a company is
selling or replacing inventory over a period, in this case one year. This is calculated by the cost
of goods sold divided by the average inventory. IBM's inventory turnover in 2014 and 2013 was
21.02 and 21.62. With an industry average of 17.56, IBM is more efficient in their inventory
management and has strong sales.
Another measurement of inventory efficiency is through days sales in inventory,
calculated by finding the cost of goods sold divided by 365, then dividing the average inventory
by that number. This shows investors how long a company takes to turn its inventory into sales.
With an industry average of 20.79, IBM's days sales in inventory are more favorable at 17.36 in
2014 and 16.89 in 2013. While other industries hold onto their inventory for 21 days before
selling, IBM holds onto its inventory for 17 days.
Next we'll evaluate the efficiency of IBM's receivables. Receivables turnover is used to
evaluate a company's efficiency in issuing credit and then collecting its debt on that credit. It also
measures if a company is efficiently using its assets. This is calculated by total revenue divided
by average net receivables. Total revenues are used since IBM is a service, sales, and financing
revenue company. IBM ratios of 2.11 in 2014 and 2.23 in 2013 are low compared to the industry
average of 5.89. This may suggest that IBM needs to review its credit policies and collect on
older accounts.
The second way to evaluate receivables efficiency is by days sales in receivables. This is
calculated by multiplying the average accounts receivables divided by net sales by 365. This
ratio measures the average number of days it takes the company to collect revenue from a sale

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that has been made. Since IBM is a services, sales, and financing company, I used the accounts
receivables in relation to all of those to calculate this ratio. IBM has an extremely high days sales
in receivables, with 173.03 days in 2014 and 163.40 days in 2013. The industry average is 62,
which indicates IBM does not collect its receivables nearly as fast as it should.
Another way to measure IBM's efficiency is through asset management. We use the asset
turnover ratio, calculated by revenue divided by average total assets. This ratio measures
indicates how efficiently a company is using its assets to generate revenue. IBM's asset turnover
was .76 in 2014 and .80 in 2014. With an industry average of 1.6, IBM's asset turnover is low.
This means IBM isn't generating as much revenue with their assets as they could be.
The last measure of IBM's efficiency is through analyzing cash flow. The first ratio is
cash flow to total assets, calculated by cash from operations divided by average total assets. It
measures when and how much cash will be available in the future for operations. This is also
used by investors to measure how efficiently a company is at using assets to collect cash. IBM's
cash flow to total assets was .14 in both 2014 and 2013, which shows low efficiency. This ratio
does not indicate or relate to low profitability, only low efficiency.
The final measure of cash flow efficiency is through cash flow per share, calculated by
operating cash flow divided by the number of common shares outstanding. IBM's cash flow was
7.62 in 2014 and 7.92 in 2013. Generating a higher cash flow per share shows IBM has cash
flow efficiency.
Overall, IBM doesn't appear to be an efficient company. IBM shows sufficient efficiency
in inventory management, but that's about it. Although IBM doesn't hold onto their inventory as
long as other companies, the time it takes for IBM to collect on its sales is extremely high. Along

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with that, IBM needs to work on generating more cash with their assets.
In conclusion, after analyzing IBM's profitability, risk, stockholder relations, and
efficiency, I would not recommend IBM as an investment. IBM shines strong in the profitability
area, but needs to make proper changes in other areas. IBM needs to increase it's overall
efficiency, because without doing so, the company will decline in the long-term. Most of IBM's
ratios decline from 2013 to 2014, which may just indicate a bad year. If this decline continues,
it's an indicator that IBM may be in trouble and is not a good investment.