How to analyze an income statement?
Let me show you how I would get started with reviewing
the income statement of a company,
the same way I would do it with participants
in one of my finance for non-financial manager courses.
Here is Walmart's income statement, or profit and loss
statement (P&L) for the fiscal years
ended January 31st, 2017, 2016 and 2015.
2017 is on the left, 2015 on the right.
The income statement can be found in the
annual report.
There is a lot of information here, we need to set
priorities on which items we are going
to dive into, to get the most valuable use
of our analysis time.
My proposal would be to first dive into the
revenue performance, which seems to have dropped
from 2015 to 2016, and then has come back up in 2017.
What are the main drivers for revenue?
Next I would look into the margin performance.
How have gross margin, operating margin, and
net income developed in relation to the
fluctuations in revenue?
As retail is traditionally a fairly low margin industry,
every penny counts.
Net Income is almost 9 billion dollars lower than
Operating Income, let's review what is
going on in the interest and tax lines.
That sounds like a good "To Do List" to me,
let's get started at the top.
Out of the $486 billion in total revenue,
$481 billion was in the net sales line, so
let's review that one first.
How is the net sales revenue split between
Walmart's reporting segments?
By far the largest segment is Walmart US,
in 2017 making up 64% of total net sales.
Second is Walmart International, 24% of the total
in 2017, and third Sam's Club at 12%.
For overall net sales, there was a decline in 2016
versus 2015, and an increase in 2017 versus 2016.
One of the three segments immediately jumps out
at me, can you guess which one?
Walmart International, with a decline
in 2016 of 9% and 2017 of 6%.
I think it is important to analyze what is
going on here first, as these declines are
impacting the overall growth number significantly.
Numbers for Walmart International on the left,
narrative on the right.
The "management discussion and analysis"
or MD&A section in the annual report contains
many valuable comments for an analysis
like we are doing.
I have highlighted the key parts of the narrative that
help us to get an insight to the drivers
of the revenue decline in the
Walmart International segment.
Walmart International operates in many countries,
including Mexico, Brazil and many other countries
in Latin America, Canada, the United Kingdom,
China, Japan and Africa.
In each of these countries, transactions
(selling, buying, paying salaries, operating stores)
happen in local currency.
For reporting purposes, all those amounts are converted
to US dollars, as that is the currency that
Walmart reports in to the stock market.
In 2017, there was a $11 billion negative impact on
revenue versus prior year from fluctuations
in currency exchange rates, and in 2016 even
a negative impact of $17 billion.
Currency exchange rates are an external factor,
out of control by the company, and should
therefore be adjusted for if you want to calculate
the underlying growth.
By the way, if currency exchange rates made
revenue shrink when converting it to US dollars,
then it also helped shrink costs when converting from
local currency to US dollars, so only
the net income is truly exposed.
That paints a very different picture!
Currency effects more than explain the declines
in revenue in Walmart International, and if
you analyze the revenue in this segment on a
constant currency basis, then you will find
that net sales grew 3%!
Next up is Walmart US, at 64% of total revenue
it is the largest segment for Walmart.
Growth of more than 3% two years in a row,
what is driving that?
Part of Walmart's net sales growth in 2017 was driven
by physical expansion: a 1.3% year-over-year
growth in retail square feet.
So what should we look at as the underlying
growth metric that excludes that effect?
Walmart offers the term "comparable sales",
which is shown here quarter-by-quarter versus
the prior year period: sales from stores and clubs
open for the previous 12 months, including
remodels, relocations and expansions,
as well as e-commerce sales.
To finish off the revenue analysis, let's take a quick look
at the "membership and other income" line.
There is a huge increase from $3.5 billion in 2016
to $4.6 billion in 2017.
Where is that coming from?
Well, the increase is fully in the "other income" part
of that line item, and is non-recurring:
a gain on sales of operations in China and Chile.
So if you are planning to make any forecasts
for Walmart FY18 revenue, remember not to
count on those again!
We now have a clearer picture of what is driving
revenue, which is the top line in the income statement.
Next, let's look at the margin performance,
which we can analyze at three levels: gross margin %
(gross margin as % of revenue), operating margin %
(operating income as % of revenue),
and return on sales % (net income as % of revenue).
Let's review the percentages that Walmart provides us
in the annual report: a gross profit rate of 24.9% in 2017,
and operating income as a percentage of sales of
4.7% in 2017.
The gross profit amount that was used to calculate
the gross profit percentage, is strangely
enough not mentioned in the annual report.
I would assume Walmart took revenue and deducted
cost of sales, like I am showing here, but
my calculation gets to a slightly higher percentage.
Let's use the percentages that Walmart has provided,
and look at the trend.
What do you see?
Gross profit rate is rising, from 24.3% in 2015
to 24.6% in 2016 to 24.9% in 2017, an
increase of 30 basispoints, or 0.3%-point per year.
There are many factors that contribute to
these improvements, Walmart lists them in the MD&A.
In 2017 versus 2016, the main driver
for the improvement was improved margin
in food and consumables.
While gross profit is rising, operating income
as a percentage of net sales has declined.
The "management discussion and analysis" clarifies
that the operating expenses have gone up primarily
due to an increase in wage expense at the
Walmart US and Sam's Club segments.
The third and last ratio to calculate is Return On Sales,
which is Net Income divided by Revenue.
3.5% in 2015, 3.1% in 2016 and 2.9% in 2017, a decline
following a similar pattern as operating income.
Those are low net profit margins,
inherent in the retail industry.
And that's not what makes a retailer
like Walmart successful.
If you want to know how Walmart, despite the
low profit margin, gets to a
Return On Assets percentage that is higher than that of
a major telecom company, then watch my video
walking through an example of how to calculate
and compare Return On Assets.
Right, that's the revenue analysis
and the margin analysis done.
Net Income is almost 9 billion dollars lower than
Operating Income, let's review what is
going on in the interest and tax lines.
First off, interest, a charge in total of $2.3 billion,
most of which is interest on debt.
If we turn to the liabilities side of the balance sheet,
we see three sections of debt:
short-term borrowings, long term debt due
within one year, and long-term debt.
The sum of these three line items was $39.4 billion at
year end 2017, down significantly from the $43.7 billion
at year end 2016, due to strong cash flows from
operations that helped fund pay-downs of debt.
Watch my video on Walmart's cash flow statement
to learn how that works.
Let's take the average debt of these two balance sheet
points for our calculation: $41.5 billion.
If interest on debt was $2 billion, then the
implied average interest rate was 4.8%.
At first sight, that looks high to me.
What could be driving that high percentage?
Walmart's annual report lists the credit ratings
it has received from major agencies, these are in the
very respectable double-A category for long term debt.
This means that Walmart's reputation as a borrower
is very solid, which usually leads to lower interest rates.
So the high 4.8% interest rate is certainly not driven by
a shaky credit reputation.
I think the answer can partially be found in this table:
the expected maturity date and the average interest rate
for the major debt categories.
As long term debt is the main element of overall debt
at Walmart, let's focus on that area:
4.7% weighted-average interest rate.
Most of the long term debt is truly long term in its
maturity: $27.6 billion is due after fiscal year 2022.
Walmart did not have any material long-term debt
issuances during fiscal 2017 or 2016,
so my educated guess is that most of the debt
that we see on this page has been issued many
years ago, when overall interest rates were much higher.
To find out whether this educated guess is correct,
we would have to browse through the
annual report archive of Walmart for the past
10 to 15 years, and see how the
debt position has developed.
I consider that out of scope for this video,
you are welcome to do so and comment below
this video.
That's 3 out of the 4 items on our "To Do List" done,
let's take a quick look at taxes before we wrap up.
The provision for income taxes in the P&L
has decreased over the past three years, which
sounds logical as the income before income taxes
has also dropped.
A useful number to calculate is the effective tax rate,
which is simply the provision for income taxes
divided by the pre-tax profit.
This comes out to 30.3% for 2017.
Walmart provides more information about the
effective tax rate in the annual report.
The US statutory tax rate is 35%, and most of
Walmart's income is taxed at that rate
given the relative size of the Walmart US
in overall results.
The overall effective tax rate for the company
is lower than the 35% statutory rate, primarily
due to non-US income being taxed at
lower local country rates.
That completes our analysis.
We have looked into the major drivers of
revenue growth, analyzed the trends in margin rates,
and explained the gap between operating income
and net income by looking into interest and taxes.
If you want to learn more about Walmart's
financial statements, I would encourage you
to read the annual report,
and listen to the earnings releases.
Please comment below, as I would love to hear
what you think!
I hope you enjoyed this video on how to perform
a high-level income statement analysis.
I have many more videos available, that can help you
as a non-finance manager to understand
the basics of how financial statements work.
On this end screen, there are a few suggestions
of videos you can watch next.
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Thank you.