At this part of the valuation, it is important to tie together all the previous analysis. This gives a true sense of how the company is operating in the
industry and where it is heading in the future. First we identified the business strategy and the five success factors. This tells us how the company plans to thrive in the discount retail industry. From the accounting analysis, we will be able to determine from past financial statements how the company will fund future growth. To properly forecast the future of Dollar General and assess their development, it is essential to calculate the liquidity, profitability, and capital structure ratios. Liquidity ratios refer to the amount of cash or equivalence on hand for operations. Profitability ratios determine the amount of profits based on operations. Capital structure ratios determine the cost of debt it takes to operate the business. These ratios will help determine how well the company is performing from a business strategy perspective to its competitors.
Trend & Cross Sectional Analysis
The analyses of a firm’s financial statements tell about its liquidity, profitability, and capital structure. Know these things when analyzing a firm is important in order to evaluate the firm and its performance. The liquidity ratios tell us how much of the firm’s assets is cash or cash-equivalents and in turn tell how timely they will be able to meet their current obligations. The profitability ratios tell how profitable a firm is based on its efficiency and rate of return.
Finally, the capital structure ratios tell how the firm is financed and how much of their income is being used to pay interest versus how much is being used to pay the principal.
Financial Ratio Analysis
Several ratios can be performed to evaluate the financial position of a firm. Each ratio illustrates a different aspect of the company’s well being for example how quick assets can be converted in to cash to cover liabilities. The ratios can also tell how efficient the company is in the industry. Each ratio will be computed to reflect a 5 year trend of each company. Three main areas that will be focused on in the following section are liquidity ratios, profitability ratios, and capital structure ratios.
These ratios will be used to asses Dollar Generals position in the discount retail industry. Each ratio will dissect the financial statements of Dollar General and their competitors. From these ratios, the value of the past performance can be determined as well as trends that can help in forecasting the future trends of the company.
Liquidity Ratios
Liquidity ratios apply to the amount of cash equivalent assets on hand for a firm and the ability to convert these into funds for future liabilities. The
liquidity ratio will be broken down into two different types of ratios. The first two line items are current and acid test coverage ratios which display a company’s ability to cover debt with current assets. The next three ratios are operating efficiency ratios which consist of inventory turnover, receivable turnover, and working capital turnover. The operating efficiency ratios are based on the cause and effect using financial data from both the income statement and the balance sheet.
The first sets of ratios we have analyzed are the liquidity ratios and of these the first to discuss is the current ratio. The current ratio is found by
dividing a firm’s current assets by its current liabilities. Current assets are almost all assets besides land, buildings, equipment, and intangibles; and current
liabilities are any liabilities that will be due in the next year. This number tells us
how many dollars of assets we have for every one dollar of liability. The higher the number this ratio is, the more liquid a firm is, or the greater ability it has to pay off its upcoming obligations. However if this number is too high above the industry standard the firm is most likely not using all their assets efficiently. The lower this number is the more debt the firm has in comparison to its assets, and therefore less able to pay them off. Dollar General’s current ratio over the past five years has remained just below the industry average. Although, when looking at the chart you can see that Dollar Tree has had a much higher ratio than the other firms, and in turn has brought the industry average up. Dollar General’s ratio being lower than the industry’s is nothing to be alarmed about, especially since they have constantly had more than one dollar of assets to every one dollar of liabilities.
Current Ratio over the past five years
Below is the cross sectional analysis showing the trends of Dollar General over the past five years in comparison with the trends of its direct competitors and the industry as a whole. Dollar General started out with the lowest current ratio, but more recently has been just below the industry standard. While Family Dollar started out with a higher ratio than Dollar General, their ratio has been declining and they currently have the lowest ratio in the industry. Fred’s and Dollar Tree have ratios that remained higher than the industry in the past five years. This could mean they are inefficiently using their assets. Overall Dollar General has the best ratio because it is closest to the industry standard without
2002 2003 2004 2005 2006
Dollar General 1.37 1.99 2.22 2.1 1.89
Family Dollar 1.99 1.94 1.72 1.51 1.44
Dollar Tree 2.88 2.73 3.29 3.19 2.5
Fred’s 3.27 2.55 2.55 2.76 2.58
being too high. The trend with each competitor in the industry appears to be heading towards convergence within the next couple of years.
Current Ratio
The second liquidity ratio is the quick asset ratio or acid test. This shows how much cash or cash-equivalents there are for every dollar of liability and is found by dividing the quick assets by the current liabilities. Quick assets are cash and any assets that can be easily converted to cash if need be. Dollar General’s quick asset ratio has been pretty low for the past five years with the exception of 2004 where it peaked. This is similar to the current ratio in that too high a number can equate to inefficient use of assets. Recently Dollar General has
remained below the industry average, but has still followed the industry’s trends.
Acid Test for the past five years
2002 2003 2004 2005 2006
Dollar General 0.23 0.18 0.54 0.33 0.22
Family Dollar 0.41 0.35 0.21 0.16 0.22
Dollar Tree 1.13 0.64 1.08 1.15 0.8
Fred’s 0.26 0.09 0.04 0.046 .023
Below is the cross sectional analysis of Dollar General’s quick ratio as well as its direct competitors and the industry’s as a whole. With the exception of Fred’s, the industry has remained within the range of a dollar over the past five years ($0.16-$1.15). Fred’s most likely has far too many assets in comparison to the industry, which shows signs of inefficiency. Dollar Tree, Dollar General, and Fred’s have all followed the industry trend the past five years, while Family Dollar has done just the opposite. Since Fred’s has such a higher ratio it has brought the industry ratio up; therefore there is no need to be alarmed over Dollar General being slightly lower than the industry.
Quick Asset Ratio
Although the next two ratios -inventory turnover and working capital turnover- are classified as liquidity ratios, they tell more about a firm’s operating efficiency than its actual liquidity. The first of these to analyze is the Inventory Turnover. This ratio measures how frequently the inventory in a company’s warehouse is used and replenished. The higher the number is the better because it indicates higher sales. This number is found by dividing the cost of goods sold
by the inventory and it tells us how many times per year the inventory is
replenished. Dollar General, being the industry leader, has consistently had one of the highest inventory turnovers in the industry.
Inventory Turnover for the past 5 years
2002 2003 2004 2005 2006
Dollar General 3.37 3.9 4.19 3.92 4.15
Family Dollar 0.64 0.6 0.59 0.06 0.08
Dollar Tree 0.26 3.4 3.27 3.85 4.32
Fred’s 4.04 4.13 3.9 3.76 3.76
Industry Avg. 2.077 3.01 2.98 2.89 3.078
The cross sectional analysis below shows the industry and its trends over the past five years. Family Dollar is well below the industry standard, showing that they are not selling efficiently enough to keep up with the industry. Dollar Tree experienced a tremendous amount of growth from 2002-2003 and has since been able to remain above the industry average; however if Family Dollar wasn’t so low, bringing the average down, Dollar Tree would probably be just below the industry average up until the past year or so. Fred’s has one of the higher turnovers of the industry showing very efficient sales, with a slight decline just recently. Dollar General’s ratio was rising until 2004 with a decline in 2005 and now is almost back on track.
Dollar General has followed the industry trend more than any of other firms and has remained above the industry every year. Operating efficiency has been consistent with inventory turnover averaging four times a year. This shows that their inventory is fairly liquid with three month intervals out of the year.
Inventory Turnover
The other liquidity ratio that measures operating efficiency is the Working Capital Turnover. This number is found by dividing a company’s sales by its working capital, working capital being the company’s current assets less its current liabilities. Working capital measures how many sales dollars every one dollar of working capital can generate. The higher this number is the better, because it indicates higher sales. Dollar General has set the industry standard for working capital turnover and has had the highest turnover every year for the past five years with the exception of 2004. Since 2004, Dollar General has had a steadily rising turnover.
Working Capital Turnover
Below is the cross sectional analysis of Dollar General’s working capital turnover as well as its direct competitors and the industry as a whole. As you can
2002 2003 2004 2005 2006
Dollar General 12.6 9.25 7.56 8.46 10.35
Family Dollar 0.24 0.25 0.3 0.27 0.08
Dollar Tree 0.32 6.12 4.63 5.24 6.89
Fred’s 6.58 7.97 7.87 7.08 7.43
see Dollar General leads the industry and has had the highest turnover every year for the past five years, with the exception of 2004, where they were just barley behind Fred’s. Since 2003 Dollar General has been setting the trends for the industry. Family Dollar has a very low turnover relative to the other
companies, while Fred’s and Dollar Tree are just a little behind Dollar General.
Working Capital Turnover
The nature of the discount retail industry does not entail the need for accounts receivables. The industry is dependent on the volume of purchases because basic commodities are sold at low prices. As a result, the average customer purchase was $9.36 in 2006. (Dollar General 10-K) Therefore the accounts receivable turnover ratio will not be calculated for Dollar General. If the receivables turnover ratio were to be calculated, it would be performed by taking total sales and dividing it by accounts receivable. This would be a valuable tool for determining the corporations cash to cash cycle. This is the measure of how long it would take to free up cash from accounts receivables and inventory. The faster the cycle is the more amounts of cash is available for operations and reducing debt. The only part of this cycle that Dollar General can monitor is the day supply of inventory. In essence, the cash to cash cycle for the
industry is just the day supply of inventory. This is first half of the cash to cash cycle. This is calculated by taking the number of days in the year and dividing it by the inventory turnover ratio. The smaller the ratio is the better it is for the firm. It states how many days inventory stays in storage instead of being sold on the floor. Below is a chart showing the day supply of inventory for Dollar General and the industry. They have been leading the industry with Fred’s and have remained below the industry average. This is favorable because it shows that inventory is generating revenue instead of sitting in storage.
Day Supply of Inventory
Over the past five years Dollar General has followed the industry liquidity trends quite consistently and has set the trends in inventory and working capital turnover. Dollar General is quite liquid in comparison to the industry which means they are able to quickly convert their cash to assets if necessary to meet current and upcoming obligations. Dollar General has shown great ability to generate sales over the past five years and is the leader in its industry.
Profitability Ratios
The basis of profitability ratios is to determine the rate at which a company can turn a profit off of operations. Four main factors determining profits are operating efficiency, asset productivity, rate of return on assets, and rate of return on equity. The overall goal of any company is to make sales at the lowest cost feasible to achieve profits. This operating efficiency is measured by the gross profit, operating profit, and net profit margin. Asset productivity is the efficiency rates a company can turnover investments of assets into revenue.
This is calculated by the ratio of return on assets. Lastly, the rate of return on equity measures the effectiveness a company can produce earnings growth from investments.
The gross profit margin ratio measures the gross profits of the company to the amount of sales. We can determine how well a company has minimized cost of good sold. According to the graph, Dollar General has maintained about a 25 to 30% ranges on it gross profit margin for the past five years. Fred’s Inc has
remained about the same as Dollar General, but Dollar Tree has minimized more cost of good sold and created more profit. Dollar Tree has done average on its profit margin, but as Dollar Tree’s ratios prove, Dollar General can improve on its efficiency whether it is improving inventory costs or finding cheaper suppliers.
Operating Profit Margin
Operating profit ratio measures the same thing the gross profit ratio measures, but it includes selling and administrating expenses. Once again, Dollar General has maintained an average percentage of the past five years of around 7
%. Compared to Fred’s Inc, Dollar General has done well to keep costs at a minimum. As before, Dollar Tree has maintained greater efficiency of the past five years on average, but we should expect this because their gross profit margin was higher. Once again we did not include Family Dollar in our valuation of Dollar General though we did consider that Family Dollar did have a higher operating profit ratio in 2006. We have concluded from the above data that Dollar General is only doing average to the rest of the market. The trend of the overall industry seems to be converging on Dollar General’s position, but we believe that Dollar General can improve its position in the industry by getting rid of excess cost.
Net Profit Margin
-0.08 -0.06 -0.04 -0.02 0 0.02 0.04 0.06 0.08
2002 2003 2004 2005 2006
Dollar General Dollar Tree Family Dollar Freds
Industry average
The net profit margin considers the overall effect of expenses compared to sales and other income. We see that Dollar General has flat lined over the past five years. They have no trends of growing or shrinking and have
maintained about a 4% net profit. The slightly higher margin for Dollar General is because of an interest income. Dollar General’s competitors Family Dollar and Dollar Tree have done a slightly better job over the past five years except for 2006 where Family Dollar has incurred more costs. Fred’s Inc. has done the worst in the industry with a ratio of only 2% in the past two years. Dollar General has a good job of maintaining a near average ratio margin, but competitors are doing better which means Dollar General is not as efficient as they could be.
Asset Turnover
The asset turnover ratios were used earlier as an expense diagnostic. We have now used average assets instead of total assets. The asset turnover ratios show that for every dollar of assets the company has a certain number of sales will be made. In the past five years, Dollar General has improved their revenue profitability. In 2002, they were getting two dollars worth of sales for every asset. They have steadily increased this number over the past five years and in 2006 they are up to about 3.2-3.3 dollars per asset. Compared to the
competitors only Fred’s Inc has done a better job of asset turnover then Dollar General. Fred’s inc. high asset turnover can be explained by size. They have far less inventory and are a much smaller company then the other three companies.
Family Dollar has maintained a 2.5 asset turnover which is only slightly up from past years. Dollar Tree has been lagging behind at 2.2 asset turnovers which have been slightly better then past years. We can conclude from this information that Dollar General is doing a good job of using assets to support sales volume.
Return on Assets
The return on asset is the overall measure of profitability. It uses the net income and the average total assets which include parts of other ratios mainly net profit margin and asset turnover ratio. By dividing net income by assets we can determine the return on the assets. We hope to see a greater percentage from year to year. As the graph displays, Dollar General over the past five years has increased its ROA except for the last year. It is now at a 12 % ROA down from 13% the year before, but the company has improved its ROA from 2002 where it was at a 9% ROA. Dollar General has done relatively well against its competitors. Dollar Tree has maintained a 10 % ROA in the past three years while Family Dollar and Fred’s Inc are down to 5% ROA. We can conclude from this information that Dollar General is doing overall better on its profitability from asset productivity and operating efficiency compared to the other companies in the industry. However, the recent decline, which is slightly unfavorable, in ROA may be signaling a downward trend which could bring it further down to the industry average.
Return on Equity
The Return on equity is the net income of the company divided by the past years owners equity. The ROE measures the amount of the owner’s interest in total assets (class notes). We expect to this ratio much larger then the ROA because equity is only a part of assets and would only equal ROA if the company had no debt. As you can see from the chart, Dollar General finances its operation with great debt then the other companies. Overall, Dollar general has maintained about the same mount of return for the past 5 years. The others companies have lower ROE this could be due to the fact that they finance there companies
operations with less debt. The more profit a company gets each year we should
operations with less debt. The more profit a company gets each year we should