Cash Flows Google example essay topic

Google, Inc. Overview Google is a global technology leader, focused on improving the ways people connect with information. Through innovations in web search and advertising, Google is now a top Internet destination and possesses one of the most recognized brands in the world. Available to anyone with an Internet connection, Google maintains the world's largest online index of web sites and other content. Revenue is generated by delivering relevant, cost-effective online advertising. Businesses use the Google Ad Words program to promote their products and services with targeted advertising.

Furthermore, Google maintains advertising on thousands of third-party web sites using the Google Network and Google Ad Sense. While Google continues to expand its product line into new and existing territories, the company considers its primary industry to be web search technology. However, Google also faces competition from online advertising companies, particularly those that provide pay-per-click services. Currently, Google considers its primary competitors to be Microsoft and Yahoo. Future operating performance will be directly related to the role of information technology in the marketplace. Information technology is an area experiencing constant growth and innovation, which existing companies must address in order to overcome product obsolescence.

A variety of factors exist that will affect the success and future growth of Google. First, Google must protect its proprietary search algorithms accounting for its success to date. If such methodology reaches competitors, its competitive advantage is suddenly lost. In addition, it must be able to maintain its competitive advantage over Microsoft in areas of expertise. Microsoft is a proven industry leader in many aspects of technology, having the financial strength to compete in every capacity.

Key Accounts The growth in revenues that Google is experiencing is astonishing. However, all of its revenues at the moment are the direct result of two business segments. The two primary sources of revenue are Google owned sites and the Google network, each accounting for approximately 50% of revenues (Exhibit 6). For this reason, the cost of revenues becomes a key account on its income statement. As demonstrated in the vertical income statement, the cost of revenues rose from 11.46% in 2002 to 45.71% in 2004 (Exhibit 3). This is ideally due to traffic acquisition costs (TAC) that Google incurs as it drives consumers to its sites.

While these costs have been rising relative to sales, the company believes that its future success will be a result of its increased knowledge in effectively and efficiently generating traffic. As illustrated in Exhibit 6, quarterly revenues increased significantly throughout 2004, while traffic acquisition costs as a percentage of revenues began to decline. In addition, the financial statements demonstrate that liquidity remains strong. The horizontal balance sheet illustrates that cash and cash equivalents rose 639% over the three-year period beginning with fiscal year 2002. Furthermore, short-term investments increased 1839% over the same period (Exhibit 2). These measures are important for a variety of reasons.

As Google attempts to become the front-runner in the web search and online advertising industries, it is beginning to face considerable litigation regarding its advertising policy. Paris courts recently reached a decision surrounding this issue and luxury goods maker Louis Vuitton (Exhibit 7). Secondly, as the marketplace witnesses the current success and growth of Google, it is inherent that more competitors will emerge. These companies may draw interest in terms of acquisition from Google, potentially complementing current operations. Strong liquidity will allow the company to handle the presence of lawsuits and the ability to fund such acquisitions without the need for additional capital through debt or equity financing. Financial Ratios The company providing financial ratios in this analysis, Rue ters, uses the "Computer Services" industry as a basis for comparing Google to industry standards.

Overall profitability is slightly lower when comparing net profit margins. For fiscal year end 2004, Google reported a net profit margin of 12.52%, slightly lower than the industry's 13.45%. It appears that this is largely due to the elevated effective tax rate that pertains to Google, as the company's operating margin is actually superior to the industry average (Exhibit 5). Two financial ratios will prove very important over the next several years: gross margin and return on assets.

As mentioned earlier, cost of revenues increased significantly over the past 3 years. In turn, the gross margin percentage began to decline as well (Exhibit 3). For fiscal year end 2004, Google reported a gross margin of 54.29%, significantly higher than the industry average of 45.93% (Exhibit 5). This becomes particularly relevant when considering that Google is still in adolescent stages of efficiently generating traffic to its web sites. If Google can prove more efficient in this area, cost of revenues would decline, leading to a more dominant gross margin relative to the industry.

All companies in the technology sector experience high costs associated with asset acquisition. Google operations require a continuous investment in information technology assets to handle additional traffic. For this reason, Google must continue to demonstrate a strong return on its assets, justifying such expenditures. For fiscal year end 2004, Google reported a return on assets of 12.05%, slightly higher than the industry average of 11.03% (Exhibit 5). This return has declined considerably, around 22.7%, over the past three years (Exhibit 4).

Much of this decline is likely due to the increase of nearly $71 million in intangible assets over the three-year period (Exhibit 1). While this figure seems very large, it may actually be reasonable. While the brand name Google is becoming synonymous with web search technologies, the company is now acquiring smaller ventures that complement its current services. They are also developing numerous revolutionary technologies that should arrive in the marketplace over the next several years. ROE Dupont Analysis The ROE Dupont analysis (Exhibit 4) provides further explanation of the company's ROA. As illustrated in the chart, the ROA declined by 22.7% over the past 3 years.

As mentioned above, this is largely due to the increase in intangible assets. This large increase resulted in total assets of over $3.3 billion, lowering the asset turnover. Despite increases in revenue over the three-year period, the revenue growth rate was considerably smaller than that of the total assets, causing lower asset turnover. Additionally, the financial leverage declined significantly from 1.6 in fiscal year 2002, to 1.1 in 2004. This is primarily due to the company's change in capital structure. In August 2004, Google made its initial public offering.

Consequently, the amount of equity used to finance operations increased by $2.75 billion over the same period. Conversely, debt financing experienced a mild increase of only $271 million. The return on equity fell drastically by 43.7% over the three-year period beginning 2002. While revenues experienced large growth rates from 2002 to 2004, the costs of revenues also rose appreciably. Declining profit margins and lower asset turnover played an integral role in the decline of ROE. Secondly, the change in capital structure diluted the ROE as leverage fell over the same period.

For fiscal year 2004, Google reported ROE of 13.6%, down from 57.3% in 2002. Cash Flows Google continues to experience strong increases in free cash flows as a result of operations (Exhibit 9). Over the three-year period beginning in 2002, cash flows provided by operating activities increased 529%. This increase in operating cash flows arises as a result of higher net income each year. Supporting earlier statements in this analysis, the most substantial change in cash flows over this period came in investing activities. Net cash flows used in investing activities increased from $109.7 million in 2002, to $1.9 billion in 2004.

Short-term investments account for the majority of this increase in expenditures, strengthening the overall liquidity of the company. Finally, cash flows related to financing activities provided Google with nearly $1.2 billion in free cash flows. An important source of cash flows, financing activities demonstrated negative cash flows in fiscal year 2002. The overall result of these impressive increases in net cash flows is a higher cash balance at fiscal year end 2004, up 639% from 2002. Takeaway Based on this financial analysis of Google, the company's financial condition appears to be very strong. However, the company's short history makes it very difficult to assess the company at this point in time.

While financial ratios and changes over the three-year period may be indicative of a young company experiencing abnormal growth, Google is simply settling into the marketplace and drawing plenty of attention. On February 14,176 million new shares of Google will enter the marketplace (Exhibit 8). Typically, more supply without more demand means a decline in price. Although, the promising performance of Google makes many believe that the company can withstand the flood. All of the financial measures in this analysis will continue to converge with the industry as Google matures, but they are simply approaching reality, as this type of growth cannot be sustained forever. Non-Firm Specific In Looking for Red Flags, Howard Schilit discusses how Tyco used acquisitions to overstate cash flows.

These acquisitions would allow Tyco to obtain large amounts of receivables, which it would place on its books. The additional receivables are collected at the end of the quarter, in turn, increasing operating cash flows. Realistically, Tyco is paying for these receivables when it acquires the other company. Hence, the collection of receivables in not a free operating cash flow. In order to uncover such practice, many compare cash flows from operations to profits.

These two measures should reveal the same type of result, whereas, Tyco is showing high cash flows and little profit.