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Custom Liquidity Measurement Ratio Essay

Current ratio is used to measure the ability of a company to pay its short-term debts, as well as other current liabilities by comparing the company’s current assets to current liabilities (Walsh, 2010). A current asset equivalent to 1 implies that the current assets’ book value is similar to current liabilities’ book value. It is important to note that investors look for companies whose current ratios are 2:1, implying that they have double the current assets as the current liabilities. When the current ratio is less than one, it means that a company may experience problems meeting its temporary obligations. A ratio that is too high implies that a company is not adequately utilizing its current assets (Walsh, 2010). The following are the 2011 current ratios of the two companies according to appendix 1 and 2:

Google- 5.9

Microsoft- 2.9

Profitability Indicator Ratios

Return on assets.

Return on Assets show the after-tax returns that are earned on all assets of a firm irrespective of its financial structure (Kennon, 2011). It measures how efficient a firm is utilizing all the assets of stakeholders to earn returns (Kennon, 2011). The return on assets and equity ratios for Google and Microsoft in 2011 were as follows:

Google- 13.4%

Microsoft- 20.9%

Return on equity.

Return on equity is a measure of the rate of return on capital invested by stock owners and maintained by the company (Kennon, 2011). It shows the ability of a company to create profits from the equity of shareholders i.e. return on equity shows how well a firm utilizes investment funds to promote growth (Kennon, 2011). It is a useful tool for comparing the profitability of various companies in the industry. It is worth noting that investors have interest in companies with high and growing returns on equity. For Google and Microsoft return on equity is:

Google- 18.72%

Microsoft- 36.6%

Debt Ratio

Debt ratio.

Debt ratio is an indicator of the proportion of debt that a company has compared to its assets. It gives an idea to investors about the level of potential risks a company is likely to face, as well as its leverage, thus influencing their investment decisions (Walsh, 2010). A debt ratio of more than one shows that a firm has more debts compared to assets, while a debt ratio of less than one indicates that company’s assets are relatively bigger than its debts (Walsh, 2010). Debt ratios of the two companies are indicated below:

Google- 0.05

Microsoft- 0.19

Operating Performance Ratio

Fixed asset turnover ratio.

This is the ratio of net sales to fixed assets. It measures the ability of a firm to create net sales from fixed-asset investments, particularly plant, property, and equipment. Companies with greater value of fixed asset turnover are very effective in utilizing fixed-asset investments in generating income (Walsh, 2010). According to Appendix 1 and 2 respectively, the following are the fixed asset turnover ratios for the two companies:

Microsoft- 2.07

Google- 1.91

Cash Flow Indicator Ratio

Dividend payout ratio.

Dividend Payout Ratio refers to percentage of income that is paid to shareholders in terms of dividends (Gill, Biger, Tibrewal, & Rajendra, 2010). This ratio gives an idea of the extent to which income supports dividend payments. Companies that are more mature tend to have high dividend payout ratios that (Gill, 2010). The following are the ratios for the two companies:

Google- 18%

Microsoft- 22%

Investment Valuation Ratio

Price / earnings ratio.

This refers to the ratio of the current share price of a company in comparison to its per-share earnings. Companies with high P/E ratio are expected to increase future growth earnings as opposed to those with low P/E ratio (Walsh, 2010). However, it is important to note that the ratio is more useful when it is used to make comparison between companies within the same industry.

Google- 20.5%

Microsoft- 11.2%

A Comparison and Contrast of Google and Microsoft Business Model

Core Business

Google Inc. is a U.S.-based international Internet and software company that specializes in Internet search, advertising, as well as cloud computing. Google’s core business includes Google search, advertising, and apps (Kurtz, 2010). The company generates its profit from the above sources. For instance, its web search engine, Google Search is the most popular search engine throughout the United States, with a market share of 65.6%. The company indexes numerous web pages to enable their clients to search for any information they need via the use of keywords and operators (Kurtz, 2010). Google search has extended its scope to searching images i.e. Google Maps. Though the company launched Google Video in 2006 to enable users search, watch, and upload videos online, it discontinued the service to concentrate on its search aspect (Kurtz, 2010).  Google obtains 99% of its revenues from advertising via its AdWords program. The AdWords program permits advertisers to exhibit their advertisements within the Google content network via two schemes: cost per view or cost per click. There is also the Google AdSense, a sister service to Goole Adwords, which permits website owners to display ads on their websites and make money each time advertisements are clicked (Kurtz, 2010).

Microsoft Corporation on the other hand is a multinational corporation based in the United States that develops and manufactures a variety of computing products and services such as the MS-DOS, MS Windows, MS Office etc (Kurtz, 2010). The company has recently diversified its operations in the video game industry and electronics with products such as the XBOX 360, MSN etc (Kurtz, 2010). In 1995, Microsoft expanded its products to offer computer networking as well as World Wide Web, which was bundled with a web browser, online service MSN, and Internet Explorer. Microsoft recently introduced its search engine - Bing (previously Windows Live Search) in 2009 under the leadership of its CEO Steve Ballmer to enable users have a variety of search engines for accessing information on the Internet (Kurtz, 2010).

From the above information, it is evident that the two companies above have certain similarities and differences. For instance, both Google and Microsoft have their headquarters in the United States, and they both offer Internet search services. However, it is worth noting that while Google makes most of its income from advertising, Microsoft on the other hand, earns its profit from developing and manufacturing computing products and services (Lemke, 1990).

Leading Products and/ or Services

Google’s leading products/services are advertising and search engine. As mentioned above, Google makes 99% of its incomes from advertising programs. For instance, in 2006 the company made revenue worth $10.492 billion from advertising, as opposed to just $112 million from other sources such as licensing (Moyer, McGuigan, & Kretlow, 2008). Google ads can be put on the websites of third parties using a two-part program Google’s AdWords and Google AdSense. The AdWords program permits advertisers to exhibit their advertisements within the Google content network via two schemes: cost per view or cost per click (Moyer et al, 2008). There is also the Google AdSense, a sister service to Google Adwords, which permits website owners to display ads on their websites and make money each time advertisements are clicked. In an effort to advertise its products Google launched Demo Slam, a website developed to display technology demonstrations of Google products (Moyer et al, 2008). Demo Slam offers opportunity for creative people to showcase the greatest and newest technology to the world.

Another Google’s leading product is Google Search, which enables users to search information on the Internet. By indexing numerous web pages, Google makes it possible for their clients to search for any information they need via the use of keywords. It is worth noting that the scope of Google search has been extended to searching images via Google Maps (Moyer et al, 2008). The company also launched Google Video in 2006 to enable users search, watch, and upload videos online, but it discontinued the service to enable it concentrate on its key aspect: search.

Microsoft also has several products and services including online services such as Windows Live, Live Search etc, Windows operating system, Microsoft SQL Server, Windows Vista, as well as entertainment products like the Xbox Live, Xbox 360 games and consoles (Moyer et al, 2008). It is worth noting that Microsoft’s leading product is its operating system, Windows, while that of Google is its search engine. Microsoft makes money by selling software i.e. operating system, while Google makes money via advertising. This makes a majority of Microsoft’s products and services to be sold for a fee, while those of Google, such as Gmail and cloud computing are availed to users for free (Moyer et al, 2008).

Management/Leadership Style

This section compares management styles of Eric Schmidt (CEO, Google) and Bill Gates (CEO, Microsoft). Schmidt is a peoples’ person who knows his employees well, including their strengths and weaknesses. This is a quality, which has contributed to his success as a leader, because he interacts with everybody in the company (Moyer et al, 2008). In addition, he adopted the style of allowing workers to operate outside the hierarchy of the company, thus encouraging them to be creative and more productive. Gates on the other hand, employed an autocratic leadership style (Moyer et al, 2008). It is reported that Gates is obsessed with paying attention to details, and he detests complaints. His autocracy was the reason behind his legal problems with the Justice Department, when he attempted to control the World Wide Web.

Innovation Track Record

While Google has had numerous innovation records, Microsoft on the other hand has been criticized for being un-innovative (Moyer et al, 2008). Critics have argued that instead of inventing new products and services, Gates merely reformed existing ones to satisfy customers’ needs.  Its vast market share has been blamed for the company’s lack of innovation. Google however came up with the DoubleClick, which enables the company to find out the interests of the users, as well as target advertisements (Moyer et al, 2008). This enables Google to stay sensitive to their customers’ needs. Another innovation, Google Analytics, has been very helpful to website owners in tracking where and how people utilize their website.

Financial Ratio Analysis and Explanation which Company is Better Able to Withstand a Major Recession

From the financial ratios above, Google is more likely to withstand a major recession in comparison to Microsoft. In comparing Google’s 2011 current ratio of 5.9 to Microsoft’s 2.9 (Appendix1 and 2 respectively), it can be said that Google has a strong asset base compared to Microsoft, hence is more likely to withstand a major recession.

Profitability Ratios, Performance and Investing Decisions

Return on equity shows how well a firm utilizes investment funds to promote growth. Google’s return on equity in 2011 was 18.72%, while Microsoft’s return on equity was 36.6%. According to Lemke (1990), the higher the return on equity, the higher the rate of growth of a company. It implies that Microsoft is performing better than Google. Google’s 2011 return on assets was 13.4%, while Microsoft was 20.9% (Appendix 1 and 2 respectively). This also confirms Microsoft better performance compared to Google, considering that returns on assets measure how efficient a firm is in utilizing all the assets of stakeholders to earn returns.

Three Primary Financial-Based Guidelines in Selecting Companies to Invest

Three primary guidelines include the computation of current ratio, return on equity ratio, and price/earnings ratio. According to Lemke (1990), a company with a higher current ratio is in a better position to pay its current liabilities, making it a good choice for investment. Google’s 2011 current ratio was 5.9, while Microsoft’s was 2.9. Therefore, Google is better company to invest in because of its higher asset base. Profitability ratios, such as the return on equity, also give a measure of what shareholders have earned from their investment. The higher the ROE, the better it is for investment. Google’s ROE in 2011 was 18.72%, while Microsoft was 36.6% (Appendix 1 and 2 respectively). In addition, companies with high price/ earnings ratio are expected to increase future earnings as opposed to those with low P/E. Since Google’s P/E was 20.5%, and Microsoft, 11.2%, Google is the company of choice for investment.

Code: Sample20

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