analysis of financial statements

Ramdev Gowda Aneganahalli Nagesh, Accounting for Decision Making, MBA 640 Pace University- New York CityFall 2009 Required research paper Dr. John Paul

Financial Statement Analysis of five class one railroad companies in the United States of America

By Ramdev Gowda Aneganahalli Nagesh

Pace University- New York City

Accounting for Decision Making, MBA 640

Fall 2009

Dr. John Paul

Required research paper

of 14


TABLE OF CONTENTS.

Introduction……………………………………………………………………………Page 3 of 14

Return on Investment………………………………………………………………….Page 5 of 14

Debt Ratio……………………………………………………………………………..Page 6 of 14

Profit Margin…………………………………………………………………………..Page 8 of 14

Current Ratio…………………………………………………………………………..Page 9 of 14

Return on Stockholder’s Equity……………………………………………………...Page 11 of 14

Conclusion…………………………………..……………………………………….Page 13 of 14

References……………………………………………………………………………Page 14 of 14

of 14


INTRODUCTION

Analysis of the financial statements of a company is an important step before one can invest

one’s money in the company. ‘Financial statement analysis applies analytical tools to general-

purpose financial statements and related data for making business decisions’. ‘Financial

statement analysis reduces our reliance on hunches, guesses, and intuition as well as our

uncertainty in decision making. It does not lessen need for expert judgment; instead it provides

us an effective and systematic basis for making business decisions’ (Wild, Shaw and Chiappetta,

680, 2009). A company’s financial statement is a good indicator of its performance over the

years when compared to itself and to its competitors. Hence using the financial statements to

make investment decisions would result in better future returns. The analysis of financial

statements not only helps the prospective stock buyers but it also helps other internal and

external users to take better decisions in the face of uncertainty. Internal users such as managers,

internal auditors and supervisors use financial statements to ‘improve efficiency and enhance

their effectiveness in providing products and services’ (Wild, Shaw, Chiappetta, 680, 2009).

External users such as shareholders, creditors, suppliers, external auditors, press, employee

unions and regulatory bodies use financial statements to judge the company’s performance over

a period of time. Shareholders use the financial statements to decide whether to hold the shares

or sell them, creditors use financial statements to judge whether the company will be able to

repay its debts, suppliers use financial statements to decide whether they can extend credit to the

company, external auditors use financial statements to check whether the financial statements

have been prepared in accordance with the Generally Accepted Accounting Principles(GAAP),

employee unions use financial statements to judge the fairness of wages and to negotiate for

better wages.

of 14


In this research paper I would be analyzing the financial statements, namely, Statement of

Income, Statement of Change of Owner’s Equity, Balance sheet and Statement of Cash Flow, of

five class one railroad companies in the United States of America using horizontal analysis and

ratio analysis to determine which company would be the most ideal one to invest in. The five

railroads chosen for the research paper are Union Pacific Corporation and Subsidiary

Companies, Burlington Northern Santa Fe Corporation and Subsidiaries (BNSF), Norfolk

Southern Corporation, CSX Corporation, and Kansas City Southern and Subsidiaries (KCS).

These five railroad companies are the five largest and only class one freight railroads operating

in the United States of America and in parts of Mexico. The best company to invest in would be

judged based on the return on investments, debt ratio, profit margin, current ratio and the return

on stockholder’s equity.

of 14


RETURN ON INVESTMENT.

The return on investment is given by the equation,Returnon investment=netincome

average totalassets .

Return on investment is a measure of profitability used to forecast profits and measure the

profits earned by selling products and services. The net income is drawn from the statement of

income and the average total assets are drawn from the balance sheet. Return on investment is

also known as rate of return, return on assets, and rate of profit or return. Exhibit 1.1 shows the

return on investment for the five class one railroad companies.

Exhibit 1.1

Return on Investment (%)Fiscal year 2005 2006 2007 2008Union Pacific 2.92 4.45 4.98 6.01BNSF 5.17 6.09 5.59 6.04Norfolk Southern 5.06 5.71 5.61 6.54CSX 4.69 5.31 5.27 5.27KCS 2.94 2.40 3.22 3.55

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

Union Pacific

BNSF Norfolk Southern

CSX KCS

Average return

average return

of 14


The average return on investment for Union Pacific and Kansas City Southern are lower than

the other companies and have an average return on investment of less than 5 %, whereas BNSF,

Norfolk southern and CSX show good return on investment with an average of more than 5 % in

all the four years from 2005 to 2008. Norfolk Southern has the highest average return on

investment (5.732%) and exceeds the average returns of all the other companies and shows

productive use of assets in generating income, thus Norfolk Southern would be the most

profitable investment according to the return on investment ratio.

DEBT RATIO.

It is given by the equation,Debt ratio=total liabilitiestotal assets

. The debt ratio indicates the financial

leverage of a company. It is important to determine the debt ratio of a company before investing

in it since it helps us to determine whether the company will be able to pay its debts with the

available assets. The debt ratio shows the extent to which a company’s assets are financed by

liabilities or equity. A high financial leverage shows that most of the assets are financed by

liabilities and a high financial leverage means that the company’s ability to pay its debts could be

in doubt. A debt ratio of one indicates that the liabilities are equal to the assets whereas a debt

ratio of less than one indicates that the assets are more than liabilities. A debt ratio of more than

one is not good for a company since the liabilities are more than the assets of a company and a

company’s ability to repay debts is definitely in doubt. A debt ratio of one or greater than one

would give no returns on investment and thus investing in such a company should be avoided.

Exhibit 1.2 shows the debt ratio of the five class one railroad companies in the United States of

America.

of 14


Exhibit 1.2

Debt RatioFiscal year 2005 2006 2007 2008 Average

Union Pacific 0.615 0.581 0.590 0.611 0.599

BNSF 0.686 0.671 0.668 0.694 0.680

Norfolk Southern 0.641 0.631 0.628 0.635 0.634

CSX 0.672 0.644 0.660 0.694 0.667

KCS 0.678 0.659 0.650 0.649 0.659

0.500

0.550

0.600

0.650

0.700

0.750

Union Pacific


CSX KCS

2005

2006

2007

2008

From the horizontal analysis of the debt ratio in exhibit 1.2 it can be observed that Union

Pacific has the lowest average debt ratio (0.599). The other companies have an average debt ratio

of over 0.6. The average debt ratio of BNSF is the highest (0.680), but since it is lesser than one,

the company is not in a risk of not paying its creditors. All the railroad companies have a

moderate financial leverage. Union Pacific has the least financial leverage and hence has a low

risk from its financial leverage. All the railroad companies except Kansas City Southern and

Subsidiaries have their debt ratio increasing over time, which is definitely not a good since it

shows that companies are relying more on liabilities to finance their assets. At present, all the of 14


companies would be good to invest in since none face the risk of not paying their debts. Among

all the companies Union Pacific would be a good railroad company to invest in since it has the

lowest debt ratio and thus lower risk of investing.

PROFIT MARGIN.

It is given by the equation,Profit margin=net incomerevenue

. Profit margin is also known as return on

sales. ‘This ratio is interpreted as reflecting the percent of profit in each dollar of sales’ (Wild,

Shaw and Chiappetta, 106, 2009). The higher the profit margin the better is the company’s

performance. Exhibit 1.3 shows the profit margin of the five railroad companies.

Exhibit 1.3

Profit Margin(%)Fiscal year 2005 2006 2007 2008 Average

Union Pacific 7.56 10.31 11.39 13.01 11.25

BNSF 11.79 12.59 11.57 11.74 13.76

Norfolk Southern 15.02 15.74 15.52 16.10 14.35

CSX 13.29 13.69 13.32 12.13 10.65

KCS 7.46 6.56 8.82 9.93 8.19

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

Union Pacific


CSX KCS

2005

2006

2007

2008

of 14


From Exhibit 1.3 the horizontal analysis of the profit margin of the five companies shows that

the profit margin of Union Pacific has steeply increased from 2005 to 2008 whereas the rest of

the companies have seen their profit margins fluctuate around the mean value. Norfolk Southern

Corporation makes more net profit for every dollar of revenue the company earns since it has an

average profit margin of 14.35 % followed by BNSF and Union Pacific. Kansas City Southern

and subsidiaries earn the lowest average profit margin of 8.19 % which also means that it makes

lesser net profit for every dollar of revenue earned. But Kansas City Southern and Subsidiaries

have seen a steep rise in the profit margin over the years and the low profit margin could be

attributed to their small size of operation compared to the other class one railroad companies. A

higher profit margin is what an investor looks for before investing in a company since higher net

income would mean higher returns (dividends). Hence among all the railroad companies,

Norfolk Southern Corporation would be an ideal company to invest in based on the average

profit margin.

CURRENT RATIO.

Current ratio is given by the equation,Current ratio=current assetscurrent liabilities

. Current ratio shows the

ability of the company to pay off its current liabilities with its current assets. It is also known as

liquidity ratio. This ratio is useful to suppliers who extend goods and services on credit to a

company. It helps suppliers to judge whether the company will be able to pay its debts in the

near future. The current ratio helps creditors to determine the rate of interest, the date by which

the debt is due and also to decide the amount of collaterals required to extend a loan. A current

ratio of 1 indicates that the liabilities are equal to the assets, which means that the debt paying

ability of the company could be in doubt. A ratio of more than 1 is desirable whereas a ratio of

less than one means that the company will not be able to pay its liabilities with its current assets. of 14


‘The current ratio is one measure of a company’s ability to pay its short-term obligations’ (Wild,

Shaw and Chiappetta, 148, 2009). Exhibit 1.4 shows the current ratio of the five class one

railroad companies in the United States of America.

Exhibit 1.4

Current RatioFiscal year 2005 2006 2007 2008 averageUnion Pacific 0.69 0.68 0.85 0.98 0.80BNSF 0.58 0.66 0.67 0.73 0.66Norfolk Southern 1.38 1.15 0.86 0.95 1.08CSX 0.80 1.06 0.93 0.99 0.95KCS 0.81 0.95 0.59 0.63 0.75

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Union Pacific


CSX KCS

2005

2006

2007

2008

The current ratio helps an investor to take decisions as to which company to invest his/ her

money in. The statement of financial position shows the current assets and the current liabilities

and using the current ratio the investor can determine whether to invest in the company or not.

Based on the horizontal analysis in exhibit 1.4, Norfolk Southern Corporation has an average

current ratio of more than 1(1.08) followed closely by CSX Corporation which has an average

current ratio of 0.95. BNSF and Union Pacific have seen a steady increase in their current ratio of 14


over the years whereas the other companies have seen a decline in their current ratio in the year

2007 and an increase again in the year 2008. BNSF has the lowest average current ratio and thus

an investor would avoid a company with a low current ratio since the probability of getting a

high return could be in doubt. An investor would also avoid investing in Norfolk Southern based

on its current ration because the company has seen a steep decline in its current ratio from 2005

to 2007. This indicates that the company’s current liabilities have increased considerably where

as its current assets have not changed much over the years. Investing in CSX would involve a

higher risk since the current ratio has been fluctuating around 1. An investor would rather prefer

to invest in Union Pacific since the company’s current ratio has been increasing over the years

and shows signs of going over one in the future.

RETURN ON STOCKHOLDER’S EQUITY.

It is given by the equation,

Returnon Stockholder ' s Equity=net income−preferred dividends declaredAveragecommon stockholde r ' sequity

. The return on

stockholder’s equity is probably the most important value to look for before one could invest in a

company. This ratio gives us the earnings for every dollar invested by the shareholders. The

higher the value of return on stockholder’s equity, the higher would be the dividends paid to the

share holders. A company which generates more income than the amount invested by the

shareholder’s would be a good company to invest in since the prospects of returns is higher.

The net income to calculate the return on stockholder’s equity can be found in the Statement of

Income and the average common stockholder’s equity can be found in the Statement of Change

in Owner’s Equity. The return on stockholder’s equity is a measure of profitability which an

investor could use to base his / her decisions whether to invest in a company or not to.

of 14


Exhibit 1.5 shows the return on stockholder’s equity for the five class one railroad companies in

the Unites States of America.

Exhibit 1.5

Return on Stockholder's EquityFiscal year 2005 2006 2007 2008 AverageUnion Pacific 0.08 0.11 0.12 0.15 0.11BNSF 0.16 0.19 0.17 0.19 0.18Norfolk Southern 0.15 0.16 0.15 0.18 0.16CSX 0.16 0.16 0.15 0.16 0.16KCS 0.08 0.07 0.09 0.10 0.09

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.18

0.20

Union Pacific


CSX KCS

2005

2006

2007

2008

From the horizontal analysis of exhibit 1.5 it can be seen that BNSF offers the highest average

return on stockholder’s equity while Kansas City Southern and Subsidiaries offer the lowest

average return on owner’s equity. The returns from Union Pacific also look promising since the

return on stockholder’s equity has risen sharply since 2005. The returns from Norfolk Southern

Corporation and CSX seem to be stable and do not seem to have changes much over the years

except that they have seen a small increase in the year 2008. Based on the returns on

stockholder’s equity an investor would most probably invest in BNSF. of 14


CONCLUSION.

The financial statement analysis of the five class one railroad companies have given us an

insight as to which one would be the best to invest in. The Return on Investment, Debt ratio,

Profit margin, Current ratio and Return on stockholder’s equity have allowed us to get into the

financial statements and extract valuable information which would be helpful in taking

investment or management decisions to a considerable extent. The analysis of the financial

statements in the research paper gives us a clear picture as to which railroad company in the

United States of America would be the best to invest in with the least risk involved in doing so.

Finally, as per the financial statement analysis it can be inferred that Norfolk Southern

Corporation would be the best company to invest in as it projects growth and good returns on

investment with least risk to the investor. Burlington Northern Santa Fe Corporation and

Subsidiaries too, would be a good company to invest in considering its Return on Stockholder’s

equity and Profit margin. An investor would rather choose to avoid investing in Kansas City

Southern and Subsidiaries and CSX Corporation at present owing to their low or fluctuating

Return on Investment, Current ratio and Profit margin. The Union Pacific Corporation and

Subsidiary Companies would be a company to look out for investing in the future as it projects

rapid growth and thus better returns.

of 14


REFERENCES.

1. "Annual Reports." Kansas City Southern. Kansas City Southern and Subsidiaries. 20

Nov. 2009 <http://www.kcsouthern.com/en-us/Investors/Pages/AnnualReports.aspx>.

2. "BNSF Investors - Annual Reports and Proxy Statements." Welcome to BNSF.

Burlington Northern Santa Fe Corporation and Subsidiaries. 20 Nov. 2009

<http://bnsf.com/investors/reports/annual-rpt-proxy.html?tab=archives>.

3. "Norfolk Southern." Norfolk Southern - Home. Norfolk Southern Corporation. 20 Nov.

2009 <http://www.nscorp.com/nscportal/nscorp/Investors/Financial_Reports/Annual

%20Report/>.

4. "UP: Annual Reports and Proxy Statements." Union Pacific. Union Pacific Corporation

and Subsidiary Companies. 20 Nov. 2009

<http://www.up.com/investors/annuals/index.shtml>.

5. "Welcome to CSX.com: Investors - Annual Reports and Proxy Statements." Welcome to

CSX.com: Investors - Investor Relations Home. CSX Corporation. 20 Nov. 2009

<http://investors.csx.com/phoenix.zhtml?c=92932&p=irol-reportsannual>.

6. Wild, John J., Ken W. Shaw, and Barbara Chiappetta. Fundamental Accounting

Principles. 19th ed. New York: McGraw -Hill/ Irwin, 2009.

of 14

analysis of financial statements

Economy & Finance