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Analysis of Financial Statements

Introduction

The selected company will be Starbucks Corporation. Starbucks Corporation is an American coffee company. Starbucks Corporation is based in Seattle, Washington. Currently, it is the largest coffeehouse company in the whole world. It has a total of 20891 stores. It operates in 62 countries. Most of its operations are based in Canada, Japan, United Kingdom and the People’s Republic of China. The aim of the paper is to carry out an analysis of the company’s financial statements (Per V. Jenster, 2011, p. 89). Starbucks Corporation main competitor is Greggs Corporation.

According to Fridson (2011), financial ratios are crucial in comparing the relationship between the variables in the annual financial statements of a company. For example, financial ratios are crucial in explaining the time it takes to convert raw materials into liquid cash. Liquidity ratios are beneficial in measuring the liquidity risk of the firm (David K. Flynn, 2012, p. 89).

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The gearing ratio helps to measure the amount of debt capital in the capital structure of the firm. The asset management ratios measure the effectiveness of a firm with regard to the assets. This involves the extent to which the firm’s asset contributes to profit. The profitability ratios are essential in determining the efficiency of the firm’s management with respect to sales and investment. Debt management ratios measure the overall performance of a business.

However, there are limitations inherent in using the financial ratios in measuring the financial position of a firm. One of the main limitations is that financial ratios are subjective in nature. Another limitation is that financial ratios are prepared using historical financial ratios. Therefore, the ratios cannot be used in making decisions since the financial position of a firm may have changed. Financial ratios are also ambiguous. This is because there is no standard definition of items used in the preparation of the financial statements.

The paper will involve an analysis of Starbucks Corporation’s financial statements. This will involve the computation of the financial ratios for the period ended 31st December 2011, 2012, and 2013. The analysis will also involve the comparison of the firm’s financial ratios.

  • Profits, earnings and dividends
  • Earnings

The following table shows a summary of the company’s sales and profits for the past four years (2009, 2010, 2011 and 2012). The summary is also shown on a graph.

Starbucks Corporation
 2009201020112012
Sales9,800.0010,700.0011,700.0013,290.00
Net Income391.00946.001,246.001,384.00
Profit as a percentage of sales3.998.8410.6510.41

 

  • Financial ratios
 Profitability ratios
RatioFormula201120122013
Profit Margin = Earnings before Interest (EBI)12.45%8.28%13.14%
Sales Revenue
Net Operating Profit Margin (NOPM) =NOPAT12.27%8.12%13.01%
Sales Revenue
Gross Profit Margin (GPM) =Sales Revenue – Cost of Goods Sold57.99%56.29%57.13%
Sales Revenue
Return on Assets = Earnings before Interest (EBI)15.30%16.70%18.90%
Average Total Assets
Return on Equity = Net Income25.78%26.00%25.45%

The profitability ratios computed are profit margin, net operating profit margin, gross profit margin, return on assets and return on equity. The profitability ratios are essential in determining the efficiency of the firm’s management with respect to sales and investment (Scott, 2012, p. 443).  The net profit margin ratio, profit margin, return on equity (ROE) and gross profit margin ratio are examples of profitability ratios. The effectiveness of Starbucks Corporation with respect to sales and investment can be measured by the use of profitability ratios. The net profit margin ratio for Starbucks Corporation shows an increasing trend, from 1.8% in 2009 to 4.0% in 2013. The increase in the net profit margin ratio of Starbucks Corporation is as a result of the increase in the profit over the four financial periods. Starbucks Corporation is effective in generating revenue with respect to the expenses as shown by the net profit margin ratio. (Earl K. Stice, 2010, p. 56).

The gross profit margin for the company has not changed significantly over the four financial periods. In 2011, gross profit margin ratio was 57.99% while in 2013, the ratio was 57.13%. Starbucks Corporation is efficient in controlling the cost of sales in comparison with other expenses. The profitability ratios of Starbucks Corporation indicate the company is efficient. From the financial statements of Starbucks Corporation, net profits for the corporation have been relatively constant since 2011 (Gibson, 2010, p. 67).

The return on equity (ROI) ratio indicates the returns the shareholders will receive from their investment in a company. ROI for Starbucks Corporation  has been increasing over the three financial periods under consideration. This implies that the shareholders will get the same returns from investing in the two companies (Georgiades, 2008, p. 89).

Financial stability and liquidity

Liquidity ratios

Liquidity ratios
RatioFormula201120122013
Liquidity ratioCurrent Ratio =Current Assets0.961.120.72
Current Liabilities
Liquidity ratioQuick Ratio =Quick Assets0.590.640.53

Current ratio and the acid test ratio are examples of liquidity ratios. As discussed earlier, the liquidity ratios of Starbucks Corporation would help to show whether it is able to meet its short term obligations as and when they fall due. Insolvency and bankruptcy are some of the effects of low liquidity ratio. From the analysis above, Starbucks Corporation has a low current ratio (Roman Weil, 2009, p. 189). The current ratio for the Starbucks Corporation shows a downward trend over the four financial years under consideration. There was a slight decline in the current ratio in 2013. This is an indication that Starbucks Corporation has not been performing well over the last two financial periods (Clyde Pierce Stickney, 2010, p. 99).

The quick ratio also referred to as the acid test ratio, shows the relationship between the current assets, but excluding inventories, and the current liabilities. The quick ratio would help to show whether Starbucks Corporation has invested a lot of funds on inventory. Like current ratio, Starbucks Corporation’s quick ratio shows a downward trend. However, the change is not significant. The liquidity ratios of Starbucks Corporation indicate high performance of the company. Starbucks Corporation has been investing its funds on inventories. The liquidity position of Starbucks Corporation is favorable. The company has a good liquidity position as compared to its competitors (Clyde Pierce Stickney, 2010, p. 78).

Analysis of Starbucks Corporation

Strategic capabilities

Strategic capability refers to the ability of a company, to successfully utilize competitive strategies that will allow it to survive and increase its market share and value. The strategic capabilities of a company focus on the company’s assets, resources, future projections and resources. Strategic capability measurement is crucial for firms as it helps in decision making by the key stakeholders. Investors, employees and government agencies, are some of the interested parties in the strategic assessment report of a company. Strategic value analysis is the procedure of evaluating the strategic capability of a business. In analyzing the strategic capabilities of Starbucks Corporation, the following techniques will be used.  These include benchmarking, value chain, activity systems and SWOT analysis (Per V. Jenster, 2011, p. 7).

There are three types of general strategies that are used to achieve and uphold competitive advantage in the market. The strategies were described by Michael Porter in the book; Competitive Strategy: Techniques for Analyzing Industries and Competitors (1980). The strategies include segmentation strategy, cost leadership and differentiation strategy. The strategies are also applicable in the case of Starbucks Corporation.

Starbucks Corporation applies differentiation strategy in maintaining its competitive position in the market. The strategy involves the production of different types of products in order to compete successfully in the market. Starbucks Corporation has various products on its menu. The company’s recipe is made up of products such as savouries, sandwiches, sweets, snacks and rolls.  The different products help Starbucks Corporation in targeting different types of customers. Starbucks Corporation also manufactures unique products compared to those of competitors. The company produces high quality fresh food of outstanding value to its customers (Arturo Capasso, 2005, p. 35).

Industry analysis

Starbucks Corporation operates in the food industry in United States and United Kingdom. The food industry in UK is worth £96.1 billion. According to the government latest figures, the agriculture-food sector in UK contributes £96.1 billion (7.3%) towards the economy. According to the report, food and drink manufacturing sector contributed the highest amount towards the national gross value. From the Food Statistics Pocketbook in UK, households spend an average of 11.3% of their income on food consumption. However, the food prices are very high (Spary, 2013, p. 89).

Key change factors (PESTLE Analysis)

PEST is an external strategic tool which is used by organizations and businesses in understanding the changes in the market. This involves analyzing the market for potential external opportunities and internal threats. The tool is relevant when an organization joins a new market.  A PESTLE is an acronym which refers to political factors, economic factors, social-cultural factors and technological factors. The economic and political climate in United Kingdom provides favorable conditions for Starbucks Corporation to carry out their operations. The factors are not within the control of Starbucks’ Corporation management.

United Kingdom is a unitary state without an uncodified constitution referred to as a Constitutional Monarchy. The political climate in United Kingdom provides a favorable climate for Starbucks Corporation to carry out its operations. There is political stability in the country. United Kingdom has a rapidly growing economy. UK’s economy is ranked 6th in the world and 3rd, in Europe. The high population in the country creates high demand for the company’s food products. The social cultural factors such as education and healthcare in United Kingdom are considered among the best in the world. In UK, for example, public healthcare is free to all permanent residents.

SWOT analysis

SWOT analysis is a strategic capability used by companies in order to identify internal and external strengths and weaknesses facing the company. The aim of SWOT analysis is to identify the correlation between the ecological factors and the strategic capabilities of a firm. SWOT analysis provides the basis for generating strategic options of a company. The analysis is also useful in identifying the extent to which the strengths and weaknesses of the firm are relevant towards its success. Starbucks Corporation has adopted various strategies to improve on its performance such as differentiation strategy, low cost strategy and expansion strategies (Constance E. Helfat, 2009, p. 80).

Growth and competition

Starbucks Corporation operates in a perfectly competitive market. This is a market in which the competitive market forces of demand and supply influence the market price of the food products produced by Starbucks Corporation. The features of perfectly competitive are many buyers and sellers in the market, limited conditions regarding entry into the market and exit, homogenous products and perfect substitutability of products. The characteristics of the perfect competitive market highlighted above are also the competitive assumptions (O’Connor, 2004, p. 117).

Starbucks Corporation analysis as portrayed by journalists and other financial reports

On Monday, 27th January 2014, the New York Times highlighted about the performance of Starbucks Corporation. According to the newspaper, Starbucks Corporation has a very diverse portfolio of products including Tazo Tea, Seattle’s Best Coffee, Starbuck’s VIA Ready Brew and Refreshers beverages. Starbucks Corporation has adopted various types of strategies to help increase its marketplace share and at the same time acquire and maintain competitive advantage over its rival companies (The New York Times, 2014).

Share price performance

A summary of the share price performance for the past five years is shown in the following table. The summary is from the annual reports of Starbucks Corporation for the past five years.

Market price per share
 20092010201120122013
Market price per share21.7929.3242.2951.1981.46

Starbucks’ Corporation market price per share has been increasing since 2008. This can be attributed to the increase in the net profit. As a result, the high performance attracts investors into the company. Apart from the increase in profit, dividend per share has been increasing over the last five years. This leads to an increase in the corporation’s market price per share (Dubey, 2013, p. 158).

Section B

  1. Annual cash flows
ALAMA ENTERPRISES LIMITED
COMPUTATION OF CASH FLOWS
Year12345
Sales
Units6,000.0012,000.0018,000.0018,000.006,000.00
Unit price14.0014.0014.0014.0014.00
Total sales84,000.00168,000.00252,000.00252,000.0084,000.00
Disposal value0.000.000.000.0020,000.00
Total income84,000.00168,000.00252,000.00252,000.00104,000.00
Less; expenses
Variable costs60,000.00120,000.00180,000.00180,000.0060,000.00
Depreciation30,000.0030,000.0030,000.0030,000.0030,000.00
Total expenses90,000.00150,000.00210,000.00210,000.0090,000.00
Earnings before tax-6,000.0018,000.0042,000.0042,000.0014,000.00
Tax-1,800.005,400.0012,600.0012,600.004,200.00
Earnings after tax-7,800.0023,400.0054,600.0054,600.0018,200.00
Add; depreciation30,000.0030,000.0030,000.0030,000.0030,000.00
Annual cash flows22,200.0053,400.0084,600.0084,600.0048,200.00
  • NPV, IRR, ARR and PBP
  • NPV
ALAMA ENTERPRISES LIMITED
NPV COMPUTATION
YearCash flow (A)PVIF12%,5PVs
122,200.000.893019,824.60
253,400.000.797042,559.80
384,600.000.712060,235.20
484,600.000.636053,805.60
548,200.000.567027,329.40
Present value of cash inflows203,754.60
Initial cost 150,000.00
NPV53,754.60
  • PBP

Payback period (PBP) method can be used in comparing and ranking the two mutually exclusive projects. Payback period refers to the minimum time taken to recover the initial cash outlay of a project. It is computed by accumulating the cash flows of the project. The most preferred project is the one with the shortest payback period. Payback period is computed using the accounting profits, and not the cash flows (Shapiro, 2008, p. 156).

ALAMA ENTERPRISES LIMITED
PBP COMPUTATION
YearCash flow (A)Cumulative cash flows
122,200.0022,200.00
253,400.0075,600.00
384,600.00160,200.00
484,600.00244,800.00
548,200.00293,000.00

PBP = 3 years + (84600 / 160200 * 12)

PBP = 3 years + 6 months

PBP = 3 years and 6 months

  • IRR

Internal rate of return (IRR) is the amount of return that investors or shareholders expect to receive from their investment in a particular project. It is the rate of return which equates the net present value of a project to zero.

ALAMA ENTERPRISES LIMITED  
NPV COMPUTATION  
YearCash flow (A)PVIF12%,5PVsPVIF30%,5PVs
122,200.000.893019,824.600.769017,071.80
253,400.000.797042,559.800.592031,612.80
384,600.000.712060,235.200.455038,493.00
484,600.000.636053,805.600.350029,610.00
548,200.000.567027,329.400.269012,965.80
Present value of cash inflows203,754.60129,753.40
Initial cost 150,000.00150,000.00
NPV53,754.60-20,246.60

IRR = A% + M / (M + N) B% – A%

Where

A% – lower discount rate

B% – higher discount rate

M – Negative NPV

N – Positive NPV

IRR = 12% + [53754.30 / (53754.60 + 20246.60)] 30% – 12%

IRR = 17.00%

  • ARR

ARR = Average Accounting profit / Average Investment

Average accounting profit = (23400 + 54600 + 54600 + 18200 – 7800) / 5

= 143000/5

= 28600

Average Investment = Total investment / 2

= 150000/2

= 75000

ARR = 28600 / 75000

ARR = 38.13%

References

Arturo Capasso, G. B. (2005). Strategic Capabilities And Knowledge Transfer Within And Between Organizations: New Perspectives from Acquisitions, Networks, Learning And Evolution. New York : Edward Elgar Publishing.

Clyde Pierce Stickney, P. R. (2010). Financial Reporting, Financial Statement Analysis, and Valuation: A Strategic Perspective. South Melbourne: Cengage Learning.

Constance E. Helfat, S. F. (2009). Dynamic Capabilities: Understanding Strategic Change in Organizations. New York: John Wiley & Sons.

David K. Flynn, E. U. (2012). Financial Management: 6th Edition. Kenwyn: Juta and Company Ltd.

Dubey, C. (2013, 5 3). Better know a company: Greggs PLC. Retrieved 06 26, 2013, from Guru Focus: http://www.gurufocus.com/news/218080/better-know-a-company-greggs-plc

Earl K. Stice, J. D. (2010). Accounting: Concepts & Applications. South Melbourne, Vic: Cengage Learning,.

Georgiades, G. (2008). GAAP Financial Statement Disclosures Manual 2008-2009. North Ryde: CCH.

O’Connor, D. E. (2004). The Basics of Economics. Westport: Greenwood Publishing Group.

Per V. Jenster, D. E. (2011). Company Analysis: Determining Strategic Capability. New York: Wiley.

Roman Weil, K. S. (2009). Financial Accounting: An Introduction to Concepts, Methods and Uses. South Melbourne, Vic: Cengage Learning.

Scott, P. (2012). Accounting for Business: An Integrated Print and Online Solution. London: Oxford University Press.

Shapiro. (2008). Capital Budgeting And Investment Analysis. New York: Pearson Education.

Spary, S. (2013, April 11). The Grocer. Retrieved April 11, 2013, from The Grocer: http://www.thegrocer.co.uk/topics/food-industry-worth-961bn-to-uk-economy/238292.article

The New York Times. ( 2014, January Monday). Business Day. Retrieved January Monday, 2014, from The New York Times: http://topics.nytimes.com/top/news/business/companies/starbucks_corporation/

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