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Determining a company's financial health is a very important step in making a decision whether or not to invest or to stay invested. There are many different ways to compute a company's financial health. In this test, I will be taking into consideration Emerson Electric Company's (NYSE:EMR) profitability, debt and capital, and operating efficiency. Based on this criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.

Profitability

Profitability is a class of financial metrics that are used to assess a business' ability to generate earnings as compared with expenses and other relevant costs incurred during a specific period of time.

In this section we will look at four tests of profitability. They are: Net Income, Operating Cash Flow, Return on Assets and Quality of Earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  1. Net Income 2011 = $2.480 billion

To pass, the company needs to have a positive net income. Emerson Electric passes.

  1. Operating Cash Flow 2011 = $3.631 billion

Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

To pass, the company needs to have a positive operating cash flow. Emerson Electric passes.

  1. ROA - Return On Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • ROA in 2010 = 9.47%

  • ROA in 2011 = 10.39%

  • Net income growth, 2010 = $2.164 billion to 2011 = $2.480 billion, a increase of 14.60%

  • Total Asset growth, 2010 = $22.843 billion to 2011 = $23.861 billion, a difference of 4.45%

In 2010 to 2011, Emerson Electric's ROA rose from 9.47% to 10.39%. Emerson electric passes.

  1. Quality of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory.

  • Operating Cash Flow 2011 = $3.631 billion

  • Net Income 2011 = $2.480 billion

To pass, the operating cash flow must exceed the net income. Emerson Electric passes, Operating Cash Flow exceeds net income.

Debt and Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

  1. Total Liabilities to Total Assets or TL/A ratio.

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total Assets - 2010 = $22.843 billion

  • Total Assets - 2011 = $23.861 billion

  • Equals an increase of 14.60%

  • Total Liabilities 2010 = $13.051 billion

  • Total liabilities 2011 = $13.462 billion

  • Equals an increase of 3.14%

Emerson Electric's increase in total assets was more than the percentage increase of total liabilities. Total assets increased by 14.60%, while the total liabilities increased by 3.14%. As the total assets exceeded the total liabilities, Emerson Electric passes.

  1. Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

  • Current Assets / Current liabilities

  • Current Ratio 2010 = 1.43

  • Current Ratio 2011 = 1.45

Emerson Electric's current ratio went from 1.43 in 2010 to 1.45 in 2011. As Emerson Electric's current ratio increased, Emerson Electric passes.

  1. Shares Outstanding
  • 2010 Shares Outstanding = 752.69 million

  • 2011 Shares Outstanding = 738.88 million

To pass, the company's shares must increase less than by 2%. Emerson Electric's decrease in shares was 1.86%. Emerson Electric passes.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally-efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

  1. Gross Margin: Gross Income / Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue / sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.)

  • Gross Margin 2010 = $8.326 billion / $21.039 billion = 39.57%

  • Gross Margin 2011 = $9.557 billion/ $24.222 billion = 39.45%

The gross profit margin decreased slightly in 2011 from 2010. The gross margin went from 39.57% to 39.45%. Even though the gross margin only fell a very slight amount Emerson Electric does not pass.

  1. Asset Turnover:

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue.

The numerator of the asset turnover ratio formula shows revenues found on a company's income statement and the denominator shows total assets which is found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Sales growth - 2010 sales = $21.039 billion

  • Sales growth - 2011 sales = $24.222 billion

  • 15.12% sales increase

  • Asset growth - Assets in 2010 = $22.843 billion

  • Asset growth - Assets in 2011 = $23.861 billion

  • Asset increase of 4.45%

As the sales growth is exceeding the asset growth, this implies that the company is producing revenue on its assets. Emerson Electric passes.

Based on the nine tests that Emerson Electric received on profitability, debt and capital, and operating efficiency, the company received eight passes out of nine - this is a strong grade for financial health. The company did not pass the Gross Margin aspect of the test. This implies that the company was less efficient in its manufacturing and distribution during the production process. As the degradation in the gross margin was so slight, there are no red flags raised in this aspect. As the company's revenues has been quite steady and are up 5% over 2006 numbers there are no red flags raised in regards to these aspect of the company.

As Emerson Electric passed eight out of nine tests, this shows that Emerson Electric is very profitable, efficient and is using its assets to produce revenue. Based on the nine tests, overall the company is showing very strong results.

Source: Emerson Electric: Inside The Numbers