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Essay: Understand Apple Inc.’s Annual Report and 10K: Profit, Capital and Cash Flow

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Company Background

Apple Inc. trades its common stock on the NASDAQ Stock Market LLC (“Nasdaq”). The ticker symbol of the company is AAPL.

The principle activities of the organization incorporate structuring, assembling and showcasing versatile correspondence and media gadgets and PCs, and an assortment of related programming, administrations, organizing arrangements and third-party digital content and applications. The Company's items and services comprise iPhone, iPad, Mac, Apple Watch, Apple TV, and an arrangement of consumer and professional software applications, iOS, MacOS, watches' and tvOS working frameworks, iCloud, Apple Pay and an assortment of accessory, service and support offerings.The company offers its items worldwide through its retail locations, online stores and direct sales force, and through outsider cellular network carriers, wholesalers, and retailers. Furthermore, the Company offers an assortment of outsider Apple-compatible items, including application software and different accessories through various stores.

The closing price of the stock on 30 September, 2017 is $154.12 per dollar. The closing price  on 30 September, 2016 was $113.05. Consequently, there is an increase of 36.03% in the stock price from 2016 to 2017.

Understanding the Annual Report and 10K:

Profit, Capital, and Cash Flow

The net income of Apple Inc. for the past 3 years has seen a positive trend, but with varying degrees of growth year over year. From 2014 to 2015, the growth rate was 35.14%, whereas from 2015 to 2016, there was no growth rate. In 2015, Apple Inc., made a net income of $53.394 billion, however, in 2016, the company made a net income of only $45.687 billion. Hence, there was a decline in the growth rate by about (14.434%). Additionally, from the year 2016 to 2017, there was slight growth of 5.83%.There was a significant decline in the growth rate that Apple Inc. has encountered over the past 3 years. In the 2014/2015 fiscal year, the company released an array of new products (that were promised to the consumers in the previous fiscal year); due to this, the expectations of the customers were at an all-time high. The company released products from the iPhone 6 & 6s to the Apple TV 4 to software like the iOS 9.2. However, there was no growth in the 2015/2016 fiscal year because “the customers expected more” from Apple Inc considering the hype it created surrounding the release of new technology and products. The major blow to Apple Inc’s income came from the slump in its iPhone 7 and MacBook sales. The inability of the company to meet the customer’s expectation explains the decline in the sales. The increase in net income in the 2016/2017 fiscal year came with the release of the iPhone 8 in September, right before the end of the fiscal year. Since the earlier quarters of the year had not seen major releases, the release of this iPhone bumped the revenues up. Hence, the major factors that caused this trend is the customer demand. In a time where customer demand is constantly changing, it is crucial that the company not only introduces new products and services but also makes changes to the existing ones to stimulate customer demand. Additionally, external factors like scandals, negative reviews etc., tend to affect a company greatly.

  Apple Inc’s gross margin percentage has decreased in the past 3 years, from 40.06% in 2015, to 39.08% in 2016, and down to 38.47% for the most current year of 2017. Evidently, Apple Inc has been losing sales and thus decreasing profits over the years, and there have been many speculations as to why. Firstly, the company has seen an increase in product cost structures relative to the selling price of their products. The COGS (Cost of Goods Sold) plays an important role in the calculated yearly profits, and many factors are to blame for the increase in such: royalties, input costs, warranty costs, depreciation, and manufacturing/shipping. One possible explanation for the decrease in selling price is that low-end (older generations) and mid-end iPhones have a significantly higher demand than the newest, most expensive iPhone. The quality and performance of these older generation phones satisfy the wants and needs of a typical consumer, thus Apple Inc must decrease the selling price of the newest model to incentivize consumers to purchase the latter rather than the older, less expensive models. Specifically, one of Apple Inc’s largest markets, China, has seen an increased rate for lower selling priced models than for the newest and most expensive models. Secondly, experts believe that this decrease in GMP (gross margin %)  has been negatively affected by the idea that the company has already hit its “peak,” and that those who want and can afford an Apple Inc’s product already have one.

Apple Inc’s stockholders equity increased by $5.798 billion between 2016 and 2017, which indicates a 4.5% increase year over year. Stockholders equity is determined by the difference between total assets and total liabilities. Therefore, one can assert that the change in stockholders equity is a result of a change in total assets and/or total liabilities. Looking at Apple Inc’s balance sheet from the past two years, it is evident that total assets increased at a larger magnitude than total liabilities. Total assets increased by $53.633 billion, whereas total liabilities only increased by $47.835 billion; the difference between the two increases is $5.798 billion, which yields current stockholders equity. Although cash and cash equivalents remained stagnant year over year, Apple Inc’s total asset increases were mainly due to increases in asset accounts such as long-term marketable securities, receivables, fixed assets such as property, plant, and equipment and other current/non-current assets. Moreover, the majority of the liability increases were due to large increases in accounts payable as well as long term debt. Ultimately, the changes in these asset and liability accounts resulted in the 4.5% increase in stockholders equity.

The cash flows of the company from operating activities in 2017 were $63.598 billion and net income was $48.351 billion. This indicates that cash flows were 31.5% greater than net income for the year. The difference between the two metrics is due to cash flows from operating activities including net income as well as other adjustments to net income such as depreciation and amortization, deferred income tax expense, accounts payable, as well as other changes in asset accounts. Ultimately these adjustments account for the additional $15.247 billion in cash flows from operating activity when compared to net income.

The total amount of assets that are financed through liabilities (debt) accounts for 64%, while the total amount of assets that are financed through the owners (stockholders equity) accounts for the remaining 36%. This means that the majority of Apple Inc’s assets are financed by debt rather than by the owners (stockholders).  In addition, Apple Inc has a debt to equity ratio of 1.80, which means that they had $1.80 in debt for every dollar of equity. This debt can allow a company to increase operations and produce a higher income for both the company and its respective stockholders. One cannot compare debt to equity across a variety of industries, thus for this example we will compare Apple Inc’s to Microsoft Inc’s. For Microsoft, they are spending $2.13 in debt for every dollar of equity. Thus, one can safely assume that Apple uses less debt financing than its competitor.  

Apple Inc. has been being audited by Ernst & Young since 2009, prior to being audited by KPMG. Apple Inc made the executive decision to switch from KPMG to Ernst & Young in 2009 because of a competitive bidding by multiple firms to audit the company. Apple Inc has a market cap of almost 800 billion dollars, and Ernst & Young charged Apple to audit their company at a fair price of 13.5 million dollars in audit fees in 2016.

Apple Inc’s 10-K report provided Ernst and Young's auditors opinions on the process of auditing Apple. The auditors prepared their audit to be fit to the standards of the Public Company Accounting Oversight Board (PCAOB). The auditors stated that “Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion”(Apple Inc. Form 10-K). On the 10-K sheet it states “We have audited Apple Inc.’s internal control over financial reporting as of September 29, 2018, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the “COSO criteria”). In our opinion, Apple Inc. maintained, in all material respects, effective internal control over financial reporting as of September 29, 2018, based on the COSO criteria”(Apple Inc. Form 10-K). As you can see the Ernst & Young auditors did a remarkable job auditing Apple Inc. following all the rules and regulations of the PCAOB. The auditors did not face any issues while auditing do to Apple is a very formal and responsible company.

Profitability

Profitability is a relative metric which is used to determine the profit of a company with relation to the size of the company. Essentially, it can be defined as a measure of efficiency i.e. how successful or not a company is. The ratios which best measure the profitability of any company are the profitability ratios. In layman’s terms, the profitability ratios show the comparison between net income and other items on the financial statements of a firm. There are 4 main ratios which make up the profitability ratios. Each one is important to indicate how well a company is doing – return on equity ratio (reflects the relationship of income earned and investment by owners), return on asset ratio (this reflects the income to total assets utilized to generate income), earnings per share ratio (it is the measure of the return on investment which is based on the number of outstanding shares)  and profit margin ratio (shows the net profit as a percentage of sales). Apple Inc. has a higher (36.07%) ROE than its competitor Microsoft Inc (20%). The ROA for Apple Inc is 12.88% whereas that of Microsoft Inc. is 6.41%, which indicates that Apple Inc. is effectively utilizing its assets as compared to Microsoft Inc. Furthermore, the EPS for Apple Inc is 9.427 (calculated EPS is different than the actual EPS due to rounding off) whereas that of Microsoft is 2.159. This indicates the portion of the company’s profit that is allocated to each outstanding share, hence, Apple Inc is allocating more to each outstanding share than Microsoft Inc. Moreover, the profit margin for Apple Inc is 21% whereas that of Microsoft Inc is 15%, this basically indicates that for every dollar sale Apple Inc is subtracting 79 cents in expenses whereas Microsoft subtracts 85 cents. Hence, proving that Apple Inc has more operational efficiency.

Turnover

A company’s activity turnover rate indicates their ability to turn different accounts on the balance sheet into sales or cash. The crucial question that needs to be answered is if the company is generating enough revenue per year. There are two turnover ratios that effectively indicate a company’s ability to generate revenue. Firstly, there is the accounts receivable ratio. This measures a company’s ability to collect cash from its customers. A low ratio indicates that the company is not efficient in collecting cash from customers, and the opposite is true for a high ratio. Apple Inc’s accounts receivable ratio is 12.83, meaning that customers pay for their products roughly 28 days after purchase (365/12.83). Comparatively, Apple Inc’s competitor Microsoft Inc has an accounts receivable ratio of 3.75, indicating that customers pay off their debts every 97 days. Clearly, Apple Inc has a much higher ratio than its competitor, thus showing that Apple Inc has a higher quality customer base than does Microsoft Inc. In addition, the company’s high ratio could indicate that they have implemented a strict credit policy for customers, such as a 30-day policy. The next common turnover ratio is the merchandise (inventory) turnover ratio. This shows how many times a company’s inventory is sold for cash during an accounting period. A high ratio indicates that inventory is quickly turned into cash or sales, and a low ratio indicated that inventory is slowly or never turned into cash or sales, thus introducing the risk of a stockout. In this case, Apple Inc’s inventory turnover ratio is 29.05, or rather they turn their inventory into cash every 13 days. Microsoft Inc, on the other hand, has an inventory turnover ratio of 14.41, or rather they turn their inventory into cash every 25 days. Thus, Apple Inc has a much higher rate at which they turn their inventory into sales (cash), meaning that the demand for Apple Inc’s products is higher than that for Microsoft Inc. All in all, throughout these two ratios as stated about, Apple Inc outperforms Microsoft Inc, resulting in a general idea that Apple Inc has achieved more success in this past year than has Microsoft Inc.

Liquidity

Liquidity is a company's liquid assets; cash, cash equivalents, and other assets that can become liquidated(turned into cash). There are two ratios that define liquidity and those are current ratio and quick ratio. The current ratio equation is current assets divided by current liabilities.  Dividing a company's current assets by current liabilities helps creditors measure a company's liquidity and short-term debts. After analyzing the 10k report of the company, we found that Apple Inc's current ratio was 1.276 compared to one of their competitors Microsoft Inc whose current ratio was 2.901. Apple's current ratio is greater than 1.0, which is a great indicator that Apple is well positioned to cover its debts . Quick ratio is a company's ability to meet their financial liabilities. Quick ratio can be calculated through subtracting current assets by inventory, then dividing that number by current liabilities. We found that Apple's quick ratio is 1.228 compared to their competitor Microsoft whose quick ratio was 2.855. A company with a lower or decreasing quick ratio could mean that a company could be is having difficulties with sales or paying bills to quickly. A company with a high or increasing quick ratio means they are experiencing a revenue growth, turning its accounts receivable into cash quickly and turning over their inventory quickly.   

Solvency

Solvency indicates a company’s ability to pay off both short and long term liabilities. It is sometimes confused with liquidity, however the difference is that solvency accounts for long term liabilities as well, whereas liquidity only accounts for short term liabilities. Ratios such as times interest earned and debt to equity help indicate a company’s solvency. The times interest earned ratio compute a company’s ability to pay back interest, specifically how many times over it could pay back its interest expenses whereas the debt to equity ratio indicates whether a company is underleveraged, overleveraged, or appropriately leveraged. Apple Inc’s times interest earned was 23.382; this indicates that the company’s earnings in 2017 were 23.382 times its debt obligations. This is 70% greater than Microsoft Inc’s times interest earned ratio, which puts Apple Inc in a better position in regard to solvency. Moreover, Apple Inc’s debt to equity ratio was 1.8. This indicates that creditors account for a larger portion of the company’s assets than shareholders by 80%.  This indicates that Apple Inc is appropriately using leverage to generate profits while as being able to pay off its debt, which is indicated by its high times interest earned ratio. Microsoft Inc, on the other hand, has a debt to equity ratio of 2.129. This indicates that creditors, when compared to shareholders, account for doubly Microsoft Inc’s assets. This indicates that Microsoft Inc is taking on greater risk than Apple Inc, but it may be using the leverage properly in order to generate greater returns.

Recommendations

Creditors should loan money to Apple in the short-term (liquidity). A company with current ratio above 1.0 indicates that the company is in a good position to cover its debts. Apple's current ratio is 1.276. This shows that Apple is a company that will repay their debts. Apple's current ratio is a great indicator that creditors will receive their money back from giving them a loan.

We advise that creditors should loan money to Apple Inc in the long run . We recommend this because they have a high solvency, which in turn means that they can pay off their debt obligations in the short run, as well as the long run. Hence, creditors can loan money to them with the expectation that they will be paid back the money during the stated time.

Currently Apple Inc. (AAPL) has a share value of $186.80. As of now,  we recommend that investors hold AAPL. Apple Inc saw a very large drop in price due to their Q3 earnings report for 2018. Although we believe that, due to Apple Inc’s influence in the technology sector and its dominant market share in the smartphone market, it will rebound eventually, we do not recommend purchasing at the current price because we do not believe that it has found it’s bottom yet. With the market continuing to suffer since October, we believe that technology stocks will continue to gradually fall in the coming months; however, we believe that they will eventually rebound, especially Apple Inc due to its strong financials. Overall, we recommend investors hold AAPL.

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