Short Title: A Review of Croatian Operational Research (187-191)

This assignment is based on a case study of A.O. Smith Corporation (AOS) and aims to analyze the company's financial performance using various financial ratios, including profitability, liquidity, efficiency, and solvency ratios. The case study provides financial statements for the years 2014 and 2015, which are used to calculate these ratios. The analysis will help in understanding the company's financial health, identifying areas of strength and weakness, and making informed decisions.

FINANCIAL ANALYSIS OF

FINANCIAL ANALYSIS
CONTENTS
Topic Page No
Introduction 3
Environmental scan an risk analysis 4-6
Analysis of financial statements using ratios 7-9
Analysis of cash flow,MVA and EVA 10-11
Conclusion 12-14
References 15-17
Appendix 18-22
Introduction
2

FINANCIAL ANALYSIS
In year 1874 Charles Jeremiah Smith founded corporation named as A.O. Smith Corporation.
It is considered as ruling producer of inhabited and marketable water heaters and boilers. It’s
headquarter is established in Milwaukee, Wisconsin. The product range of A.O. Smith
Corporation includes domestic gas and electronic water heaters and large-scale marketable
water heating systems. Corporation embraces the two sections i.e. North America and rest of
the world (China, Europe and India).In year 1976 it had proposed its initialy highly-efficient
residential water heater.The top contenders of this company are Paloma Co. Ltd., Bradford-
White Corporation and Aero International.Inc.
The strategic SWOT analysis of the business and operations of A.O. Smith Corporation will
help to evaluate visualization of the position of organization.
STRENGHTS
 Inflated revenue & profitability.
 Providence of monetary reinforcement
 Accessible networks of sales and
distribution
 Market entrance barriers.
WEAKNESS
 Productivity
 Possibility of rise in rate of loan
 Tax Structure
 Brand portfolio
 Rise in candidacy in market
3

FINANCIAL ANALYSIS
OPPORTUNITIES
 Profitability & growth rate
THREATS
 Financial competence
 Rapid increase in price of raw material
 Rising interest rates
 Risk caused by external factors
 Revolutionize in price
REFERENCE:
A.O.SmithCorporation(2015)http://www.aosmith.com/uploadedFiles/Web_Assets/
Documents/Annual%20Report.pdf
A.O.Smith Corporation (2015) About us Retrieved September11,2016,from
http://www.aosmith.com/About/History/
a) An environmental scan and risk analysis of the organization
In today’s scenario the most significant activity among corporations is the
environmental scanning. A research and understanding of the events which influences
the organization like trends, economy, technology, society etc is considered as
environmental scanning.
In A.O.Smith Corporation a resourceful use of resources is done so that impact on
the environment could be reduced. A recognizing programme is developed by the
corporation for encouraging its employees for resource conservation and
4

FINANCIAL ANALYSIS
sustainability while performing job. For this purpose an award is given to the
employee at the end of the annual year who had achieved the maximum amount of
reduction in consumption of electricity, water and natural gas. Leadership in Energy
and Environmental Design (LEED) silver certification was awarded to the
corporation in year 2011.
The basic risks and uncertainties facing by the A.O.Smith are as follows:
1. Economic recession reported globally could cause adverse effect on A.O
Smith Corporation.
2. As it has an important business section in china so any kind of decelerate in
transition in Chinese economy is also risky for A.O Smith Corporation.
3. Growth in sales of products which are Lochinvar-branded may result in
reducing the expected revenue and earnings of A.O Smith Corporation.
4. Any kind of letdown in fulfillment of ambitions of 2015 may negatively affect
the investors of A.O Smith Corporation.
5. An adverse effect may cause by the turn down in new marketable edifice of
A.O Smith Corporation.
6. Any kind of interruption (i.e. cancellation of order, reduction in the quantity
of order) in purchase by the major customers or any kind of material loss may
negatively affect the A.O Smith Corporation.
7. Rapid increase in competition may decline the revenue of A.O Smith
Corporation.
8. Any kind of defects in product may adversely affect the operations of A.O
5

FINANCIAL ANALYSIS
Smith Corporation.
9. The future growth of the A.O Smith Corporation may get affected if it will not
be able to fulfill the future acquirement.
10. Decline in number of customers may be faced by the A.O Smith Corporation
if they will not do any kind of innovation in their product as well as in
technology of the product.
11. Product with new technology and more advancement may lead A.O Smith
Corporation towards success.
12. Failure in implementing innovative and novel resource planning system for an
enterprise could interrupt the performance of A.O Smith Corporation.
13. Maintenance of key recruits plays a vital role for A.O Smith Corporation.
14. Additional risk faced by A.O Smith Corporation as it also deals in places other
than US.
15. International operations cause risk related to foreign currencies.
16. Material worth instability and trader attentiveness may adversely affect the
operations of A.O Smith Corporation.
17. New rules and regulations made for the stock or materials used by A.O Smith
Corporation in manufacturing of its product may cause negative impact on it.
REFERENCE
A.O.SmithCorporation(2015)http://www.aosmith.com/uploadedFiles/Web_Assets/
Documents/Annual%20Report.pdf
6

FINANCIAL ANALYSIS
b) A financial statement analysis of the organization utilizing ratios
The tool used for the estimation of ratios with the help of financial statements for deriving
the imminent of companies’ data. For estimation purpose P & L A/c and Balance Sheets are
used. It provides detailed knowledge about the business organization.
Liquidity Ratios
Ratio which measures the ability of an organization for recompensing the debts and its
margin of safety is considered as liquidity ratio.
a) Current Ratio – The first and foremost ratio of liquidity is the current ratio. It
estimates the ability of the corporation to pay out the short-term liabilities. Current
ratio is considered as ideal when it is more than 1.In case of A.O. Smith Corporation
this ratio was 2.18 in year 2014, which was slightly increased in year 2015 i.e. 2.23. It
shows the rise in trend as it is higher than the standard rate. The reason behind this is
firm is efficiently utilizing its resources; it has high-quality of short-term liquidity.
b) Quick Ratio- In this ratio organization shows its ability to pay out its current
liabilities. The current assets which are convertible into cash within 90 days of
duration are considered as quick assets. Standard quick asset ratio is 1:1. As per the
A.O. Smith Corporation it was 1.68 in 2014, which slightly increased to 1.76 in 2015.
This result to rise in trend. It shows idle level of cash balance.
Solvency Ratios
7

FINANCIAL ANALYSIS
Ratio which estimates the ability of an organization to convene its long term debts is
considered as solvency ratio.
a) Debt Equity Ratio- It is an important solvency ratio. In this ratio borrowed funds and
proprietors’ fund is used for the estimation. Standard debt equity ratio is 2:1. In case
of A.O. Smith Corporation it was 0.15 in year 2014 which reported a slight increase
to 0.16 in year 2015. This shows that company has week capability to pay, it will get
less payment of interest and lenders have elevated rate of safety margin.
b) Interest Coverage - Another Solvency ratio is interest coverage ratio which shows an
efficient and effective way to pay interest on outstanding debt. In case of A.O. Smith
Corporation it was 51.30 in 2014, which reported an increase of 55.39 in 2015.It
shows there is good scope of taking loan at the lowest interest rate.
Profitability Ratios
Profitability Ratios attempt to measure the firm's success in generating income.
a) Return on Assets Ratio- It is an important profitability ratio. It estimates the net
income produced by the total assets in a given period of time. It estimates a return on
investment made by the company in Assets (Maricica & Georgeta, 2012). High
rate of ratio is considered as better in nature. In case of A.O. Smith Corporation it was
8.47 in year 2014, which increase to 10.96 in year 2015. Its impact shows on profit
i.e. more amount profit is recorded in year 2015. Net worth is increased. Rise in scope
of attracting the money lenders for lending funds.
8

FINANCIAL ANALYSIS
b) Return on Equity Ratio- Another profitability ratio is return on equity. It estimates
the ability of an organization to generation of profit from proprietor’s fund. High rate
of ratio shows efficient utilization of resources. In case of A.O. Smith Corporation it
was 15.34 in year 2014, it raised to 20.04 in year 2015. This result to increase in
scope of fund raising and large quantity of appropriations.
REFERENCE:
A.O.SmithCorporation(2015)http://www.aosmith.com/uploadedFiles/Web_Assets/
Documents/Annual%20Report.pdf
Guest, J. (2012, August). How credit analysts view and use the financial statements.
Retrieved August 25, 2016, from Financial Reporting Council: https://www.frc.org.uk/Our
Work/Publications/ASB/How-credit-analysts-view-and-use-the-financial-sta.pdf
Niresh, J. A. (2012). Capital structure and profitability in Sirilankan Banks. Global Journal of
management and business research, 12(13), 82-90.
Onwumere, J. U. J. (2009). Business and Economic Research methods (2nd ed.). Enugu:
Vougasen Limited.
Pervan, I., & Kuvek, T. (2013). THE RELATIVE IMPORTANCE OF FINANCIAL
RATIOS AND NONFINANCIAL VARIABLES IN PREDICTING OF INSOLVENCY.
Croatian Operational Research Review , 187-198.
c) A financial statement analysis of the organization utilizing free cash
flow, market value added and economic value added
9

FINANCIAL ANALYSIS
Cash Flow Ratio 2014 2015
Operating Cash Flow Growth % YOY -5.62 30.50
Free Cash Flow Growth % YOY -2.25 52.81
Cap Ex as a % of Sales 3.65 2.87
Free Cash Flow/Sales % 7.55 10.71
Free Cash Flow/Net Income 0.86 0.96
Market value added is the estimation of variation among the investors contribution in
capital and companies market value. Market value added is estimated by two
segments
(i) for shareholder’s equity
MVA= Market Capitalization − Total Common Shareholders' Equity
(ii) for all investors i.e. shareholders + debt holders
MVA = Market value of the company – (Book value of equity + Book value
of debt)
MVA = 82.2 – 1442.3 = -1360.1
Economic Value Added is the estimation of economic profit of an organization. It
is the management of internal performance of an organization which compares net operating
profit to total cost of capital.
EVA = Net operating profit after tax – (capital invested x WACC)
= 229.2 – (72.7 x 12.92) = - 710.08
10

FINANCIAL ANALYSIS
REFERENCE
Monika Bolek, Marta Kacprzyk, Rafal Wolski, (2012), “The relationship between economic
value added and cash conversion cycle in companies listed on the WSE”, Financial Internet
Quarterly, e-Finanse, Vol.8, nr2.
Zamia, J. K., Turetsky, H.F. & Cochran, B. (2005). The MVA-EVA Relationship: Separation
of Market Driven Versus Firm Driven Effects. Review of Accounting and Finance, 4(1), 32-
49.
Pervan, I., & Kuvek, T. (2013). THE RELATIVE IMPORTANCE OF FINANCIAL
RATIOS AND NONFINANCIAL VARIABLES IN PREDICTING OF INSOLVENCY.
Croatian Operational Research Review , 187-198.
d) A calculation of the weighted average cost of capital.
The rate on which an organization is probable to pay an average after tax cost of
various capital sources of an organization is considered as weighted average cost of
capital. In simple term it is an average cost for raising money. For evaluating the
weighted average cost of capital it is necessary to comprise marginal costs of all
sources of capital.
FORMULA:
Where,
11

FINANCIAL ANALYSIS
Re = cost of equity
D = Market value of firms debt
V = E+D
Tc = Corporate Tax
Rd = cost of debt
E = market value of the firm’s equity
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
As per the income statement the weighted average cost of capital (WAAC) of A.O
Smith Corporation is 12.92%. Higher returns on investment reported by the
A.O.Smith Corporations. This will encourage company to raise its capital which may
be required for the investment purpose.
REFERENCE
A.O.Smith Corporation (2015) http://investor.aosmith.com/stockquote.cfm.
Boundless. (2014). Financial statements are used to understand key facts about the
performance and disposition of a business and may influence decisions. Retrieved August 25,
2016, from Boundless: https://www.boundless.com/finance/textbooks/boundless-finance-
textbook/financial-statements-taxes-and-cash-flow-2/introducing-financial-statements-31/
uses-of-the-financial-statement-177-1000/
CONCLUSION
12

FINANCIAL ANALYSIS
A.O. Smith Corporation is leading residential and commercial water heater
manufacturer as well as marketer. As per the detailed study of financial statements of
A.O. Smith Corporation it is evaluated that companies’ condition is good and it’s
earning profit. The asset turnover ratio of the company was 0.96 in 2014 which
increased to 0.98 in 2015. It shows that company is efficient in generating sales. The
sales of the company was 572 in 2014 and 611 in 2015, it shows increase in it. For
edifying the business a good number of effectual obsessions which an organization
can do is borrowing. For this purpose an important ratio is used which is known as
interest coverage ratio. It shows the ability of an organization to pay debt. Interest
coverage ratio of the corporation was 51.30 in 2014 which increased to 55.39 in year
2015. The operating income of the company increased from 287 (2014) to 399
(2015). Net income availability to common shareholder also reported rapid increase
i.e. from 208 to 283. For knowing the exact position of an organization Return on
Equity ratio is required to get estimated. Return on equity ratio of A.O. Smith
Corporation was 15.34 in year 2014, which increased to 20.04 in year 2015. This
shows that profit generated by the business organization per dollar equity. These
details show that company is earning profit. Continuous growth in residential as well
as commercial water heating boilers is reported. The working capital of the firm has
risen from 713 (2014) to 802 in 2015. Cash dividend on companies’ common stock
was declared by A.O. Smith Corporation of $2.4 on regular quarterly basis. Strong
growth rate in net earnings is documented in year 2015 on sales.
13

FINANCIAL ANALYSIS
Inventory turnover ratio shows the moderate quantity of inventory investment in
association to its sales intensity. The inventory turnover ratio of A.O. Smith
Corporation was 7.45 in 2014 and 7.08 in 2015. It indicates that company sales
through its inventory in each quarter. It shows that company may opt to be at neutral
position.
14

FINANCIAL ANALYSIS
References
A.O.SmithCorporation(2015)http://www.aosmith.com/uploadedFiles/Web_Assets/
Documents/Annual%20Report.pdf
A.O.Smith Corporation (2015) About us Retrieved September11,2016,from
http://www.aosmith.com/About/History/
A.O.Smith Corporation (2015) http://investor.aosmith.com/stockquote.cfm
N Zafiris, R Bayldon, (1999) "Economic value added and market value added: A simple
version and application ", Journal of Applied Accounting Research, Vol. 5 Iss: 2, pp.84 – 105
Boundless. (2014). Financial statements are used to understand key facts about the
performance and disposition of a business and may influence decisions. Retrieved August 25,
2016, from Boundless: https://www.boundless.com/finance/textbooks/boundless-finance-
textbook/financial-statements-taxes-and-cash-flow-2/introducing-financial-statements-31/
uses-of-the-financial-statement-177-1000/
Monika Bolek, Marta Kacprzyk, Rafal Wolski, (2012), “The relationship between economic
value added and cash conversion cycle in companies listed on the WSE”, Financial Internet
Quarterly, e-Finanse, Vol.8, nr2.
Guest, J. (2012, August). How credit analysts view and use the financial statements.
Retrieved August 25, 2016, from Financial Reporting Council: https://www.frc.org.uk/Our
Work/Publications/ASB/How-credit-analysts-view-and-use-the-financial-sta.pdf
15

FINANCIAL ANALYSIS
Pervan, I., & Kuvek, T. (2013). THE RELATIVE IMPORTANCE OF FINANCIAL
RATIOS AND NONFINANCIAL VARIABLES IN PREDICTING OF INSOLVENCY.
Croatian Operational Research Review , 187-198.
John R. Brick , and Howard E. Thompson . “The Economic Life of an Investment and the
Appropriate Discount Rate.” Journal of Financial and Quantitative Analysis,
Vol. 13 (121978), pp. 831–846.
Niresh, J. A. (2012). Capital structure and profitability in Sirilankan Banks. Global Journal of
management and business research, 12(13), 82-90.
Onwumere, J. U. J. (2009). Business and Economic Research methods (2nd ed.). Enugu:
Vougasen Limited.
Zamia, J. K., Turetsky, H.F. & Cochran, B. (2005). The MVA-EVA Relationship: Separation
of Market Driven Versus Firm Driven Effects. Review of Accounting and Finance, 4(1), 32-
49.
Austin, M.L. (2005). Benchmarking to economic value added: The case of Airways
Corporation of New Zealand Limited. Benchmarking: an International Journal, 12(2), 138-
150
Frase, L., & Ormiston, A. (2004). Understanding Financial Statements. New Jersey: Pearson
Prentice Hall.
16

FINANCIAL ANALYSIS
Yvonne, J. A. (2001). A Comparative Analysis of Value-Added and Traditional Measures of
Performance: An efficiency score approach. [Online] Available:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=259200.
17

FINANCIAL ANALYSIS
APPENDIX
(I) A.O. SMITH CORPORATION (AOS) INCOME STATEMENT
YEAR 2015 2014
Fiscal year ends in December. USD in millions except per share
data.
Revenue
Cost of revenue
Gross profit
Operating expenses
Sales, General and administrative
Restructuring, merger and acquisition
Total operating expenses
Operating income
Interest Expense
Other income (expense)
Income before taxes
Provision for income taxes
Net income from continuing operations
Net income from discontinuing ops
Net income
Net income available to common shareholders
Earnings per share
Basic
Diluted
Weighted average shares outstanding
Basic
Diluted
EBITDA
2536
1527
1010
611
61
1
399
7
11
402
120
283
283
283
3.19
3.16
89
90
473
2356
1497
859
572
572
287
6
5
287
79
208
208
208
2.3
2.28
90
91
352
18

FINANCIAL ANALYSIS
(II) A.O. SMITH CORPORATION (AOS) BALANCE SHEET
YEAR 2015 2014
ASSETS
CURRENT ASSETS
Cash and cash equivalents
Marketable securities
Receivables
Inventories
Deferred income taxes
Other current assets
Total Current Assets
Net property, plant and equipment
Goodwill
Other intangibles
Other assets
Total Assets
LIABILITIES
CURRENT LIABILITIES
Trade payables
Accrued payroll and benefits
Accrued liabilities
Product warranties
Long-term debt due within one year
Total Current Liabilities
Long-term debt
Deferred income taxes
Product warranties
Post-retirement benefit obligation
Pension liabilities
Other liabilities
Total Liabilities
323.6
321.6
501.4
222.9
39.9
45.9
1,455.3
442.7
420.9
291.0
36.6
2,646.5
424.9
81.5
90.2
43.7
12.9
653.2
236.1
21.3
95.6
6.2
134.2
57.6
1,204.2
319.4
222.5
475.4
208.3
40.5
52.9
1319.0
427.7
428.8
308.5
31.3
2515.3
393.8
70.3
85.1
42.3
13.7
605.2
210.1
21.4
93.9
9.6
133.1
60.7
1,134.0
(III) A.O. SMITH CORPORATION(AOS) CASH FLOW STATEMENT
2015 2014
Operating Activities
Net earnings
Adjustments to reconcile earnings from continuing operations to cash
provided by operating activities:
Depreciation and amortization
Pension expense
282.9
63.0
0.1
207.8
59.8
28.6
10.8
19

FINANCIAL ANALYSIS
Stock based compensation expense
Loss on disposal of assets
Net changes in operating assets and liabilities, net of acquisitions:
Current assets and liabilities
Noncurrent assets and liabilities
Cash Provided by Operating Activities – continuing operations
Cash Used in Operating Activities – discontinued operations
Cash Provided by Operating Activities
Investing Activities
Acquisition of business
Investments in marketable securities
Proceeds from sale of marketable securities
Capital expenditures
Cash Used in Investing Activities
Financing Activities
Long-term term debt incurred (repaid)
Long-term debt (repaid) incurred
Common stock repurchases
Net proceeds from stock option activity
Dividends paid
Cash Used in Financing Activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents-beginning of year
Cash and Cash Equivalents-End of Year
8.8
0.6
10.1
(19.9)
345.6
(1.2)
344.4
-
(428.8)
315.4
(72.7)
(186.1)
61.7
(33.6)
(128.1)
13.7
(67.8)
(154.1)
4.2
319.4
323.6
0.1
(38.1)
(3.3)
265.7
(1.8)
263.9
-
(321.9)
202.0
(86.1)
(206.0)
(13.9)
48.1
(103.8)
4.8
(54.4)
(119.2)
(61.3)
380.7
319.4
(IV) Ratio Analysis
2014 2015
1. Profitability ratios
Gross margin Gross Profit / Net
Sales
8.82 11.15
Operating Margin Operating Income /
Net Sales
-5.62 30.50
Return on equity Net Income / 15.34 20.04
20

FINANCIAL ANALYSIS
Shareholder equity
Return on assets Net income / assets 8.47 10.96
Return on capital EBIT(1-Tax) /
Invested capital
13.56 17.48
2. Liquidity Ratios
Current Ratio Current Assets /
Current Liabilities
2.18 2.23
Quick Ratio Quick Assets /
Current Liabilities
1.68 1.76
3. Efficiency Ratios
Avg Payment Period creditors*365 / Total
credit Purchase
95.21 97.87
Inventory Conversion Period Inventory*365 /
COGS
48.98 51.55
Receivables Turnover Ratio Credit Sale / Net
Receivables
5.04 5.19
Inventory Turnover COGS / Average
Inventory
7.45 7.08
4. Solvency Ratio
Debt Equity Ratio Debt / Equity 0.15 0.16
Interest Coverage EBIT/Interest
Expenses
51.30 55.39
21