Nick Ioriatti Executive Summary: Gap INC.

Accounting 102 2/28/12 Gap certainly had improvements in some key areas from 2009 to 2010, which, resulted in their stock price increasing from the prior year. That being said, their financial year from 2010 was not an entirely good year, as they had some areas of weakness and negative trends from 2009 to 2010. The first number of significance is the fact that net sales increased by 3 percent during 2010. This was the result of a slight recovery from the economic collapse of 2008. Despite the increase of 3 percent, the profit margin of the company only increased by .4%. This is an indication that expenses increased right along with net sales. The increased profitability of the company was not only the result of the increased net sales, but also a slight decrease in percentage of net sales represented in the cost of goods sold and occupancy expenses, as well as operating expenses. The resulting higher operating income led to the higher profit margin in 2010 for Gap. Another important item to make note of when looking over Gaps financial statements is that cash and cash equivalents were down by a 33.5%, a very significant margin considering the size of Gap. Now this decrease isnt the result of an inability to collect accounts receivable, rather a large portion of cash was utilized to purchase treasury stock during the 2010 fiscal year. This resulted in overall lower total liabilities and stockholders equity for Gap in 2010 compared to 2009. Gap may have purchased a significant amount of treasury stock to distribute to employees through stock-option

compensation or in an effort to increase demand for their stock by limiting the amount of shares available for sale at a particular time. In addition to the decrease in cash and cash equivalents, Gap also saw their shortterm investments decrease by a large margin, roughly 56%. This had a significant impact when evaluating Gaps liquidity, as resulted in a lower current ratio for the 2010 fiscal year. This important measurement indicating that Gaps ability to pay its short term decreased by roughly 15%. Overall Gaps decreased assets were not necessarily positive. Rather than the decrease occurring in merchandise inventory, which would have resulted in a faster inventory turnover and a lower days inventory on hand, the decrease occurred in key current assets: cash and cash equivalents and short-term investments. Inventory turnover did remain consistent from 2009 to 2010, which was the result of increased cost of goods sold as well as increased inventory. While assets decreased significantly in 2010, this did help Gap in terms of their profitability. The return on assets increased as a result of net income increasing more than average total assets did from 2010 to 2009. Gap was able to use fewer assets to achieve a greater net income during 2010. This is an indication that in the past they may have been utilizing those assets in an inefficient manner and are now working more efficiently while at the same time utilizing fewer assets. This is a very good indication of Gaps profitability and along with the increased profit margin, makes it very clear that Gap was more profitable in 2010 than they were in 2009. Gap may have been more profitable in 2010 than in 2009, however their long-term solvency decreased during 2010. Their debt to equity ratio was weaker in 2010, as the

stockholders equity decreased more than the debt did. While the ratio didnt change by an alarming rate, the increase in debt to equity indicated that Gap was financing its assets with more debt in 2010 than it did in 2009. This was the result of stockholders equity declining by a larger margin than debt, which was the result of the purchase of treasury stock by the company in 2010; stockholders equity itself decreased by roughly 17% during 2010. This in turn impacted the basic financial structure since it impacted the accounting equation. In addition to the increased debt to equity ratio, Gaps interest coverage ratio changed significantly as the result of a reversal of interest expense. This trend indicated that Gap would have a tougher time in the future years paying off their interest expense based on 2010 than the financial data from 2009 indicated. Another trend noted in 2010 would be the cash flow adequacy of the company. Cash flows to sales decreased by almost 2%, which means that net sales increased faster than the cash flows provided by the operations of the business. This could be an indication that the company was having less success collecting accounts relievable during the year, however it is important to note the purchase of treasury stock that took place in 2010. A significant amount of cash was utilized to purchase that treasury stock and that resulted in the decreased in cash and cash equivalents in 2010 and ultimately the decrease in cash flows to sales. A similar explanation can be given for the decreased cash flows to assets. The decline in cash flow to assets indicates that average total assets increased at a slower rate than the cash flows provided from operations. This was the result of not only decreased cash and cash equivalents, but also decreased short-term investments. The increases in merchandise inventory and other current assets helped lessen the effects of the decrease in total assets when computing this value.

2010 was certainly cloudy in terms of evaluating the success of Gap compared to the previous year. Despite increased profitability and profit margin, as well as increased dividends per share, investors confidence in the stock dropped as the price to earnings ratio dropped in 2010 compared to 2009. This decline went against the increased earnings per share that occurred in 2010 in 2009.

Liquidity Current Ratio: Determines the ability of a company to pay short-term debt. Current Assets/Current Liabilities 2009: 4,664/2,131 = 2.2 times 2010: 3,926/2,095 = 1.9 times Gap had a higher current ratio in 2009 than it did in 2010, which indicates that they had a higher ability to pay their short-term debt in 2009 than they did in 2010. Inventory Turnover: The number of time a company inventory is sold during an accounting period. Cost of Goods Sold/Average Inventory 2009: (8,473)/((1,477+1,506*)/2) = 5.7 times 2010: (8,775)/((1,620+1,477)/2) = 5.7 times Gap had the same inventory turnover for 2009 and 2010, which indicates that inventory was sold the same number of times within the accounting period. Profitability Profit Margin: measures how a company is managing cost per dollars of sales. It is an income statement calculating and indicates the percentage of each sales dollar that contributes to net income. Net income/Net Sales 2009: 1,102/14,197= 7.8% 2010: 1,204/14,664= 8.2% Gap had a greater profit margin in 2010 than they did in 2009 which is indicative of more efficient company operations, as income grew more quickly than expenses did during the accounting period.

Return on assets: measures how efficiently a company is using its assets to produce income. It is a measure of the amount earned on each dollar of assets invested into the company. Net income/ Average Total Assets 2009: (1,102)/((7,564*+7,985)/2)=14.2% 2010: (1,204)/((7,985+7,065)/2)= 16% Gap had a higher return on assets in 2010 in 2009, which indicates they were using those assets more efficiently to generate more income than they did in the previous year.

Long Term Solvency Debt to Equity Ratio: measures the proportion of a companys assets financed by creditors to the proportion that is financed by the owners of the business. Total Liabilities/Total Stockholders Equity 2009: 3,094/4,891= .6 times 2010: 2,985/4,080= .7 times Gap had a higher debt to equity in 2010 than it did in 2009. This indicates that Gap was using a greater percentage of debt to finance its assets in 2010 than it did in 2009; in this particular scenario stockholders equity decreased more than debt financing decreased. Interest Coverage Ratio: measures the degree of protection a company has from default on interest payments. (Income before income taxes + interest expense)/(interest expense) 2009: (1,816+6)/(6) = 303.7 times 2010: (1,982-8)/(-8)= -246.8 times The negative interest coverage ratio in 2010 is the result of the reversal of interest expense. The interest expense was positive in 2009 and resulted in the positive number that was an indicator that Gap could pay its interest obligations over 300 times over.

Cash Flow Adequacy Cash Flows to sales: a ratio of net cash flows from operating activities so sales. This measures the ability of sales to generate operating cash flow. Net Cash flows from Operating Activities/ Net Sales 2009: 1,928/14,197= 13.6% 2010: 1,744/14,664= 11.9%

The decline of the cash flow to sales from 2009 to 2010 means Gaps net sales increased faster than the cash flows provided by its operations. Cash flows to assets: a ratio that measures the ability of assets to generate operating cash flows. It measures the ability of assets to generate operating cash flow. Net Cash flows from Operating Activities/ Average Total Assets 2009: (1,928)/((7,564*+7,985)/2) = 24.8% 2010: (1,744)/(7,985+7,065)/2) = 23.2% The decline of cash flow to assets from 2009 to 2010 indicates Gaps average total assets increased at a slower rate than the cash flows provided from its operations. Market Strength Ratios Dividends Yield: measures the current return to an investor or stockholder in the form of dividends. Dividends per share/market price per share 2009: .34**/19.08**=1.8% 2010: .40**/19.20**=2.1% The increase in dividends yield indicates that the stockholders within the company saw a greater return in the form of dividends compared to market price in 2010 than they saw in 2009. Price/earnings ratio: measures investors confidence in a companys future and is utilized as a way to compare stock values. Market price per share/ earnings per share 2009: 19.08**/1.59= 12 times 2010: 19.20**/1.89= 10.2 times The decrease in the price/earnings ratio indicates decreased investor confidence in Gap in 2010 compared to 2009 despite the increase in earnings per share.

Unless indicated otherwise, information was gathered from the 2010 Gap Annual Report *indicates that the information was referenced from the 2009 Gap Annual Report **indicates the information was taken from Google Finance 1/28/11: price was $19.20 1/29/10: price was $19.08