COSTCO WHOLESALE CORPORATION FINANCIAL STATEMENT ANALYSIS

Roll nos. 19 ± 24 Financial Analysis & Accounting MBA Pharm. Tech. IV yr., SPTM, NMIMS

Topics covered
‡ Financing growth by COSTCO ‡ What is common size income statement & preparing common size statements ‡ Year on year performance of Costco & competitors based on its common size income statement ‡ Costco¶s performance vis-à-vis its competitors ‡ Suggestions to Margarita Torres based on the analysis

FINANCING GROWTH STRATEGIES

Value to customers
‡ Not marking up products more than 14% over distributors price ‡ Optimal container size ‡ Delivering lowest per unit price ‡ Target markets ‡ Middle class customers ‡ Small businesses ‡ Kirkland Signature store brand ‡ Brand name quality at discount prices

Value to manufacturers
‡ Broad distribution channel ‡ Few SKU¶s ‡ Run continuous production lines ‡ Powerful purchaser

Ancillary services
‡ Numerous products shoppers can add to basket ‡ Increased sales per store

Operating efficiency
‡ Cost conscious approach ‡ Low gross margin on products ‡ High return on assets ‡ High inventory turnover ‡ Lower operating expenses than competitors
‡ Possible increase in tax efficiency

Minimizing capital expenditure
‡ No frills warehousing ‡ Cross-docking ‡ Reduce transportation ‡ Full capacity utilization

Growth drivers
No dividend Increase in current liabilities ‡ Decrease in liquidity

Capital structure
‡ Debt/equity ratio of approximately 1 ‡ Moderate financial leverage
‡ High return on equity ‡ Reinvestment of earnings

Common Size financial statement
A financial statement, which expresses the different values in form of percentage, is called a Common size financial statement

‡ Horizontal common size statement (trend analysis) ‡Vertical common size statement

Common Size Statement
‡ Financial statements reveal the financial credibility of a company. ‡ Helps in comparing two companies, which differ in size.
CS components

Balance sheet

Income statement

Net assets are taken as 100 %

Net sales are taken as 100 %

Horizontal analysis
‡ Horizontal analysis ( or trend analysis ) shows the changes between years in the financial data in percentage and dollar form. ‡ Highlights changes that are unusual.

Formulas
‡ Dollar change = Current year fig. ± Base yr. fig.

‡ Percentage change = Dollar change X 100 Base year fig.

E.g.

CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31 Increase (Decrease) 2008 2007 Amount % Net sales $ 520,000 $ 480,000 $ 40,000 8.3 Cost of goods sold 360,000 315,000 45,000 14.3 Gross margin 160,000 165,000 (5,000) (3.0) Sales increased by 8.3%, yet Operating expenses decreased by126,000 128,600 2,600 2.1 net income 21.9%. Net operating income 31,400 39,000 (7,600) (19.5) Interest expense 6,400 7,000 (600) (8.6) Net income before taxes 25,000 32,000 (7,000) (21.9) Less income taxes (30%) 7,500 9,600 (2,100) (21.9) Net income $ 17,500 $ 22,400 $ (4,900) (21.9)

CLOVER CORPORATION There were increases in both Horizontal Analysis cost of goods Comparative Income Statements

sold (14.3%) and operating expenses (2.1%). For the Years Ended December 31 These increased costs more than offset the Increase increase in sales, yielding an overall (Decrease) decrease in net income. 2008 2007 Amount %
Net sales $ 520,000 $ 480,000 $ 40,000 Cost of goods sold 360,000 315,000 45,000 Gross margin 160,000 165,000 (5,000) Operating expenses 128,600 126,000 2,600 Net operating income 31,400 39,000 (7,600) Interest expense 6,400 7,000 (600) Net income before taxes 25,000 32,000 (7,000) Less income taxes (30%) 7,500 9,600 (2,100) Net income $ 17,500 $ 22,400 $ (4,900) 8.3 14.3 (3.0) 2.1 (19.5) (8.6) (21.9) (21.9) (21.9)

Trend percentages
‡ Trend percentages state several years financial data in terms of a base year which equals 100%. ‡ Horizontal analysis can be even more useful when data from a number of years are used to compute trend percentages.

Trend analysis
‡ Trend % = Current yr. amount Base yr. amount X 100

Trend analysis (e. g.)
‡ Berry products financial info. (2001 ± ¶05)

‡ The base year is 2001 and its amounts = 100%

‡ Analysis - cost of goods sold is increasing faster than sales, which is slowing the increase in gross margin.

Trend analysis ( graph )

Vertical analysis
‡ Vertical analysis focuses relationships among financial statement items at a given point of time ‡ In a common size financial statement each item is expressed as a percentage

Vertical analysis
‡ In income statements, all items are expressed as a percentage of sales ‡ In balance sheets, all items are usually expressed as a percentage of total assets

e. g.
CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31 Common-Size Percentages 2008 2007 2008 2007 Net sales $ 520,000 $ 480,000 100.0 100.0 Cost of goods sold 360,000 315,000 Gross margin 160,000 165,000 Net sales is Operating expenses 128,600 126,000 the base Net operating income 31,400 39,000 and is Interest expense 6,400 7,000 expressed Net income before taxes 25,000 32,000 as 100%. Less income taxes (30%) 7,500 9,600 Net income $ 17,500 $ 22,400

CLOVER CORPORATION Comparati I ome tatement or t e ears Ended ecember Common- i e Percentages 2008 2007 00.0 00.0 69.2 65.6

2008 2007 Net sales $ 520,000 $ 80,000 Cost of goods sold 360,000 315,000 ross margin 160,000 165,000 Operating expenses 128,600 126,000 2008 income Net operating Cost ÷ 2008 Sales00 100% 31, × 39,000 Interest ( $360,000 ÷ $520,000 ) × 100% = 69.2% expense 6, 00 7,000 Net income before taxes 25,000 32,000 2007 Cost × 100% Less income taxes (30%) ÷ 2007 Sales 9,600 7,500 ( $315,000 ÷ $480,000 ) 00100% = 65.6% Net income $ 17,500 $ 22, ×

CLOVER CORPORATION Comparative Income Statements For the Years Ended December 31 Common-Size Percentages 2008 2007 2008 2007 Net sales $ 520,000 $ 480,000 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 30.8 34.4 Operating expenses 128,600 126,000 24.8 26.2 Net operating income 31,400 39,000 6.0 8.2 Interest expense 6,400 7,000 1.2 1.5 Net income before taxes 25,000 32,000 4.8 6.7 Less income taxes (30%) 7,500 9,600 1.4 2.0 Net income $ 17,500 $ 22,400 3.4 4.7

What can we conclude?

Common size statement for comparison
‡ Useful when comparing data from diff. companies

‡ In 2002, Wendy¶s net income is $219Mn and McDonald¶s net income is $893Mn. Comparison is misleading due to diff. sizes of the companies. ‡ Wendy¶s net income as 8% of the sales and McDonald¶s net income is 5.80% of sales. In this light, Wendy¶s performance is better than that of McDonald¶s.

Advantages
‡ The size of the companies being compared is not relevant. The companies being compared may be small or big. Hence, it is termed as common size. ‡ Removes any kind of bias ‡ Changes in different values pertaining to company's performance can also be ascertained during a particular period. Eg: to know how the cost of goods sold over a span of time has changed, the common size financial statement can be helpful. ‡ Predicts future trends and analyzes prevailing trends in the industry.

Limitations
As with financial statements in general, the interpretation of common size statements is subject to many limitation, in the accounting data used to construct them. ‡ Different accounting policies may be used by different firms or by the same firm at different points of time. Adjustments must be made ‡ Different firms may use different accounting calendars, so accounting periods may not be directly comparable.

COSTCO·S & COMPETITORS· COMMON SIZE FINANCIAL STATEMENTS & ANALYSIS

Year on Year Vertical Common Size Income Statements

C O S T C O

S E A R S

W A L M A R T

B J c o r p

Costco vis-à-vis competitors ² vertical common size income statements.

‡ 1997

‡ 1998

‡ 1999

‡ 2000

‡ 2001

Vertical Common ² Size Income Statement Analysis

COSTCO

BJ Wholesale corp

High operational efficiency

Lower net income in 2001 due to lease obligation

SEARS

WAL-MART

High operating expenses

High gross margin Higher operational efficiency Lower operating expenses

Year ² on ² Year Horizontal Common - Size Income Statements

COSTCO

SEARS, ROEBUCK

WAL-MART

BJ WHOLESALE CORP.

Year ² on ² Year Horizontal Common - Size Income Statements Analysis

Costco

‡ The graph of net sales has been above the operating expenses hence showing that the firm is growing without increase in oper.exp. ‡ Consistent gross margin over time.

Sears

‡ Sharp decline in the gross income around 2001 along with rising operating expenses as compared to the net sales

Wal-mart

‡ Consistent increase in net sales and gross income ‡ Stable growth

BJ wholesale Corporation

‡A sharp decline in the gross income between 2000-01 ‡Rising operating expenses do not contribute to sales

Threat!
he major threat for COSTCO is the increasing market share of its major competitor Wal-Mart, which it needs to tackle

Suggestions to COSTCO

COSTCO
Value added services Portfolio expansion

Suggestions to Margarita Torres

As per the analysis, ‡ Costco & Wal-mart are market leaders. ‡ Monitor the performance of Costco and keep the existing shares of Costco ‡ Wal-mart is a good option from an investment perspective

Margarita should purchase Wal-mart shares as well ; retaining the present shares of Costco

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