FACULTY OF BUSINESS, ECONOMICS AND ACCOUNTANCY

UNIVERSITI MALAYSIA SABAH

MANAGERIAL ACCOUNTING AND FINANCE

SEMESTER 1 2021/2022
CASE STUDY 3
“KRISPY KREME DOUGHNUTS, INC.”

PREPARED BY:

NUM. NAME MATRIC NUMBER

1- NORFAHIMAH BINTI ABDUL HAMID MB2112163T
2- FARISYA NABILA BINTI MOHD HAMIDI MB2112181T
3- SYAFIQAH HANIM BINTI MAT RADI MB2112071T
TABLE OF CONTENTS

1.0 Summary ..................................................................................................................... 2

2.0 Question 1 ................................................................................................................... 3

3.0 Question 2 ................................................................................................................... 5

4.0 Question 3 ................................................................................................................... 8

5.0 Question 4 ................................................................................................................... 9

6.0 Question 5 ................................................................................................................. 11

6.0 References ................................................................................................................. 11

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1.0 SUMMARY

Vernon Rudolph founded Krispy Kreme as a single doughnut shop in Winston-Salem, North
Carolina in 1937. Following Rudolph's death in 1973, Beatrice Foods has purchased the company
and expanded it to more than 100 locations, as well as introducing new products such as soups
and sandwiches and reduce the cost with change the appearance of the stores and substitutes
the ingredients of doughnuts into cheaper quality. In 1982, Joseph McAleer purchased the
company from Beatrice Foods for $24 million. Between 1989 and 1998, the company was a
success and the number of stores expanded in many states and countries. Krispy Kreme
Doughnuts earned money from four main sources which is on-premises retail sales at company-
owned stores, off-premises sales to grocery and convenience stores, manufacturing and
distribution of product mix and machinery, and franchisee royalties and fees.

However, in 2004, the company informed investors that they expected earnings to fall
10% due to the low-carbohydrate diet trend in the United States. This had a negative impact on
the company's wholesale and retail sales and resulting in a significant drop in net income in 2004.
Krispy Kreme's sales will be harmed by competitors such as Starbucks, Panera Bread Company,
and CKE Restaurants in the food-service industry. One of the most serious issues that Krispy
Kreme must address is the company's rapid expansion. This is because the community's lifestyle
has changed.

Aside from that, Krispy Kreme also linked to the increase in the number of franchised
stores because Krispy Kreme relied heavily on the high profit-margin requirement that franchisees
must meet for each new store. Finally, the primary goal of this case study is to investigate how
current issues affect the company's share price and financial health.

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2.0 QUESTION 1

WHAT CAN THE HISTORICAL INCOME STATEMENTS (CASE EXHIBIT 1) AND BALANCE
SHEETS (CASE EXHIBIT 2) TELL YOU ABOUT THE FINANCIAL HEALTH AND CURRENT
CONDITION OF KRISPY KREME DOUGHNUTS, INC.?

The historical of income statements and balance sheets provides an investors and other
interested parties a glimpse of the company’s expenses, future debt obligations and past
performance that allowing them to make investment predictions in the future. The details
information of Krispy Kreme Doughnut in income statement gives insight about their current
position and the future prospect of the company, whereas the balance sheet shows is much more
of an overview of its assets as well as liabilities.

When looking at the income statement, the first thing that stood out was the increase in
both total revenue and operating expenses. Based on the Exhibit 1, the revenues increased from
$220, 243 million to $665, 592 and net income has also increased from $5 956 million to $57,
087 million. The operating expenses climbed $190, 003 million to $507, 396 and these increases
indicate that the company shows a positive sign in operating due to reasons such as acquisitions
of Montana Mills and the expansion of Krispy Kreme outlet across the world. Despite a dramatically
increased in operation report for year by year, there is negative growth because of the interest
income incredibly decreased. This indicates that the company may have closed some of their
franchisee store.

The interest income of the company from the year of 2001 to the year 2003, it was much
greater due to the factor of their aggressive accounting procedure that enable the firm somewhat
appeared healthier toward all the external parties than it has been. In addition, the company's
net income increased between the year of 2001 and the year of 2004. Previous income records
demonstrate that Krispy Kreme has made significant progress and that the company is profitable.
However, compared to the corresponding quarter in 2003, income before taxes and net income
have decreased for the next two quarters, indicating that the financial situation has worsened.
On May 2, 2004, the company reported a loss of $24.438 million. Overall, the historical income
statement of Krispy Kreme Doughnuts demonstrate that the company has made a significant
progress and in profitable condition.

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 The balance sheet of the Krispy Kreme Doughnuts shows that the majority items listed
have been seen significant increases. In term of assets, it indicates that the total assets surged
year over year for over a four-year period. In the year 2004, the company has eliminated long
term investment and boosted their intangible assets from $0 million to $176, 078 million. The
aggressive accounting method for franchise purchases contributed to the huge increase in
intangible assets. However, based on the balance sheet statements the main issues appeared
because the company has not amortized their reacquired franchise right where it led to excessive
in assets and net income. Besides, when reviewing the liabilities and equities side, the worrying
fact about the company is regarding the rolling of the credit lines.

In conclusion, the company's financial health is not in an excellent condition. This has
been evidenced by both the income statements and the balance sheet, as it is experiencing
challenges with accounting procedure, which will result in a fall in net income after made an
adjustment.

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3.0 QUESTION 2

HOW CAN FINANCIAL RATIOS EXTEND YOUR UNDERSTANDING OF FINANCIAL

STATEMENTS? WHAT QUESTIONS DO THE TIME SERIES OF RATIOS IN CASE EXHIBIT
7 RAISE? WHAT QUESTIONS DO THE RATIOS ON PEER FIRMS IN CASE EXHIBITS 8
AND 9 RAISE?

Financial ratios enable entrepreneurs to assess their company's performance and compare
it to that of other similar businesses in their industry. Ratios also quantify the relationship between
two or more financial statement components. They are most effective when comparing results
over multiple time periods. This allows you to track your company's performance over time and
spot potential problems. Leverage ratios, liquidity ratios, profitability ratios and operations ratios
are some key financial ratios that can measures financial health of company (Business
Development Bank Canada (BDC), 2019).

Firstly, liquidity ratios where it is a financial measure that used to assess a company's
capacity to meet its short-term loan obligations. The metric is used to determine if a company's
current assets, or liquid assets, can cover its current liabilities. The current ratio, quick ratio, and
cash ratio are the three most widely utilized liquidity ratios. The current liabilities amount is placed
in the denominator of each liquidity ratio, while the liquid assets amount is placed in the
numerator. Generally, the higher the ratio's value, the greater the company's margin of safety in
covering its short-term loans (Corporate Finance Institute , 2018). The current ratio is the easiest
to calculate and interpret of the liquidity ratios. The current assets and current liabilities line items
on a company's balance sheet are immediately accessible to everybody. The current ratio is
calculated by dividing current assets by current liabilities (Corporate Finance Institute , 2018).
According to analytical financial ratios for Krispy Kreme from Exhibit 7, the current KKD ratio has
risen from 1.39 times in 2000 to 3.25 times in 2004. This indicates that KKD's current ratio has
gotten more liquid, resulting in a positive trend indicating that KKD's liquidity has improved from
2000 to 2004. According to the current ratio of 3.25 times in 2004, the KKD had $3.25 in current
assets for every $1 in short-term debt. Based on an analytical financial ratio for Quick Service
Restaurants at the end of FY2003 (Exhibit 8 from the case study), the KKD current ratio was 3.25
times.

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 Second is leverage ratio where it is one of numerous financial metrics that examines how
much money comes from debt (loans) and evaluates a company's capacity to satisfy its financial
obligations. The leverage ratio category is essential because organizations employ a combination
of stock and debt to fund their operations, and knowing how much debt a company has can help
determine whether it will be able to pay off its loans when they are due (hayes, 2020). Based on
Exhibit 7, the debt to capital ratio fluctuated erratically during the five years, starting at 32.41
percent in 2000, dropping to 0 percent in 2001, increasing to 16.29 percent in 2002, and then
dropping to 10.12 percent. According to an analytical financial ratio for Quick Service Restaurants
at the end of FY2003 (Exhibit 8 from the case study), KKD's debt to equity ratio was 10.12%.
This is because, as compared to other companies, a company with a high debt-to-capital ratio
may reflect weak financial strength because the expense of these debts may weigh on the
company and increase its default risk.

For the debt to equity ratio, we can see it fluctuated erratically during the five years,
starting at 47.96 percent in 2000, down to 0 percent in 2001, increasing to 19.46 percent in 2002,
and then dropping to 11.26 percent. According to the case study's analytical financial ratio for
Quick Service Restaurants at the end of FY2003 (Exhibit 8), the KKD debt to equity ratio was
11.26 percent, which appeared to be greater than Starbucks' 0.21 percent. When compared to
Starbucks, this shows that KKD has a bad financial position. This is because the higher the ratio,
the greater the risk we take in investing in the company. However, the potential return may be
greater as well if the company uses the debt to expand its sales and earnings.

Next Is profitability ratios where the function can be used to compare income statement
accounts and categories to illustrate how profitable a company's operations are. The return on
investment in inventory and other assets is the focus of profitability ratios. These numbers
essentially demonstrate how profitable a company's operations can be (My Accounting Course,
2020). For net profit margin, the higher the net profit margin is the better the company is thought
to control costs. As shown in the exhibit 7, the ratio is increasing along the 5 years. As compared
year 2000 as well as year 2004, there is an increment from 2.70% to 8.58%. This shows that the
company has successfully executes their strategies. On the other hand, based on analytical
financial ratio for Quick Service Restaurant at end of FY2003 (Exhibit 8 from case study), the KKD
net profit margin is 8.58.

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 Last but not least, activity ratios are financial indicators that are used to assess a
company's operational efficiency. The phrase can refer to a variety of ratios that measure how
effectively a corporation uses its capital and assets (Corporate Finance Institutes , 2019).
Inventory turnover can be used to determine how successfully a firm or potential investor
maintains its inventory. It is thought that a higher inventory turnover is beneficial. Krispy Kreme
Doughnuts has an unfavorable inventory turnover tendency. When comparing the years 2000
and 2004, there is an approximately 7% decrease. According to an analytical financial ratio for
Quick Service Restaurants at the end of FY2003 (Exhibit 8 from the case study), KKD inventory
turnover is 17.76, lower than its peers. A low turnover implies poor sales and causing excess
inventory occurred.

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4.0 QUESTION 3

IS KRISPY KREME FINANCIALLY HEALTHY AT YEAR-END 2004?

The financially in Krispy Kreme at year-end 2004 is not healthy. This can be proven when
Securities and Exchange Commission (SEC) make an investigation towards Krispy Kreme. They
make this investigation because one of them become curious on Krispy Kreme accounting
especially in franchise as they are increase drastically. This company did not key in the amortized
in the balance sheet, so it makes this profit for this company is increasing every year. This
amortization is really important for every company to include in their balance sheet to know the
real profits that the company can get every year. Next, as we can see in exhibit 7, the return on
assets in profitability ratios is increasing from 2003 to 2005 which is 8.16% to 8.64% respectively.
We can consume that this company has a financially healthy as they can increase their net income.
This company is not healthy when we see their leverage ratio. We can see that the shareholders’
equity, interest expense, total assets in leverage ratios, all are decreasing from the year 2003 to
2004. This decreasing is affected when there is an interference from SEC in this company. The
closing share in Krispy Kreme is $15.71 as they share is drop 15% because of this issue. 50% of
the stakeholders has an instinct that something worst will happen about the stock, so they decided
to downgrade the stock that they hold.

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5.0 QUESTION 4

IN LIGHT OF YOUR ANSWER TO QUESTION 3, WHAT ACCOUNTS FOR THE FIRM’S

RECENT SHARE PRICE DECLINE?

Low-carbohydrate diet trend is one of the reasons that the share price in this company is
decline. This trend has made Krispy Kreme tell all their investor that their earnings is decreasing
10% than before. Krispy Kreme has planned all their earnings regarding their new menu, Montana
Mills which they expect they can adapt with the low-carbohydrate diet trend. This has made
Krispy Kreme to make a huge decision which is close the three Hot Doughnut and Coffee shops.
This shop is the result of Krispy Kreme aggressive decision regarding their store expansion in the
beginning. Next, the financial scandal that has been published by Wall Street Journal regarding
Krispy Kreme did not amortize in the balance sheet. This result makes the company profit increase
drastically every year. We can see the total revenue are increasing from $220,243 to $665,592
within 4 years. Although it is a good figure in the company as it shows that the company is good
in their operating but for this company, it has internal issue regarding the amortize. Then, the
investor has loss their confidence in this company as the company expand too aggressive.
Although the financial is goods in the surface but actually there are a lot of internal problem in
this company.

Other than that, the interference of SEC in this company also has make the price share
decline. As mention in question 3, SEC has made an investigation in this company. The
investigation has reduced the share drastically. In April 2000, Krispy Kreme share price is $40.63
but the share price fall until $15.71 when SEC has made an investigation towards this company.
It shows the public that the financial in this company is not good as their financial statement. All
of this problem has made the investor downgraded and think badly towards this company. They
will follow the professional analyst decision in making an analysis in this company as they are
trust on their prediction in the future. This investor will follow all the step that has given by the
professional in order to secure their individual securities. The reveal from the Wall Street Journal
also has affect the decision of this investor to downgrade their stock.

Last but not least, the management issue also one of the factors that has made this price
share decline. Their chief operating officer has retired on 2004 which is the year that all the
leverages ratios is decreasing. It shows that there is something wrong in their management.
Lastly, the higher fee for the franchise also one of the issues. There is high profit margin

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equipment in Krispy Kreme as this company obligate each of the new franchise to buy the
equipment from Krispy Kreme. It is the reason why Krispy Kreme drastically increase their
franchise as they can get high profits from this situation. In conclusion, all the reason stated
above is the factors has affect Krispy Kreme share price and decline during the recent year.

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6.0 QUESTION 5

What is the source of intrinsic investment value in this company? Does this source
appear on the financial statements?

Intrinsic value is an exact value of a company or in other words is an asset that underlying
understanding of its actual value that include intangible and tangible factors of the company. The
value of current market might not be the same as the intrinsic value. The Krispy Kreme’s intrinsic
value appears to be dependent on its potential for expansion. The intrinsic investment value in
this company is the “hottest brand in America” with its neon sign of “Hot Doughnuts Now” which
this is the sign for the customers that new doughnut is coming off in the line. Through this brand,
Krispy Kreme slowly free from debt and begun to expand their business. Followed by, the CEO of
the company has brought the company to the public in April 2004 and turned out become one of
the largest initial public offerings (IPO). Surprisingly, after one day of the offering, the share price
of Krispy Kreme was $40.63

However, when expansion ambitions were stopped, the company lost a chunk of its capital
because it expanded too quickly and saturated the market, diluting the product market ability.
The market response to Krispy Kreme was severely reduced as a result of internal
mismanagement and a formal investigation commenced with analysts indicating bad capital
spending.

The source of intrinsic investment value appears on the balance sheet in the category of
total current asset, which is reacquired franchise right, goodwill and other intangible. Based on
the balance sheet, it shows that the value has risen up from $0 million for the year 2000 to $176,
045 for the year 2004. The brand is very valuable in term of competitive advantage. The Krispy
Kreme relies on the brand because it gives the customers experience the product provides by the
company as well as experience the fulfillment in the product.

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References
Business Development Bank Canada (BDC). (2019). How to use financial ratios to improve your
business. Retrieved from Business Development Bank Canada (BDC):
https://www.bdc.ca/en/articles-tools/money-finance/manage-finances/financial-ratios-
what-are-how-use

Corporate Finance Institute . (2018). What is a Liquidity Ratio? Retrieved from Corporate
Finance Institute :
https://corporatefinanceinstitute.com/resources/knowledge/finance/liquidity-ratio/

Corporate Finance Institutes . (2019). What are Activity Ratios? Retrieved from Corporate
Finance Institutes :
https://corporatefinanceinstitute.com/resources/knowledge/finance/activity-ratios/

hayes, A. (2020, April 30). Leverage Ratio Definition. Retrieved from Investopedia :
https://www.investopedia.com/terms/l/leverageratio.asp

My Accounting Course. (2020). Profitability Ratios. Retrieved from My Accounting Course:

https://www.myaccountingcourse.com/financial-ratios/profitability-ratios

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