Financial statement analysis involves analyzing the financial statements of a company to evaluate its financial performance. It is mainly done by using horizontal and vertical analysis and financial ratios.
The coffee connection is a midsized coffee shop located in the Mid-west; its competitor is Starbucks Corporation. It has taken to analyzing its competitor Starbucks. The purpose of the analysis is getting a better understanding and develops an approach that can give it an edge towards profitability. The firm focuses on making and marketing of premier coffee. It was established in the years 1985 and now operates in over 75 countries. The model of operation is to purchase high-quality coffee together with handcrafted tea, coffee in addition to several other beverages. There are also high-quality food items that include snack offering by partnering with stores.
An in-depth analysis of Starbucks financial statement will be carried out with a goal of gaining insight on what the numbers in the financial statements reveal and how this numbers can aide the management of Coffee connection make informed business decisions. This will be done by horizontal and vertical analysis of Starbucks Income statement and balance sheet.
Secondly, an analysis of Starbuck Corporation utilizing financial ratios will be done. This is to determine the solvency, liquidity, and ratios of profitability. From this information, it will become possible to reveal more about Starbucks.
Thirdly the focus is to develop an understanding of the usefulness of a firm adhering to reporting and accounting regulations the preparation of the GAAP policies. The GAAP would provide the control procedures and the segment reporting disclosures.
Vertical and Horizontal Analysis
Horizontal analysis of Starbucks income statement reveals net income raised by +5% from 2016 to 2017; this was attributed to growth in revenues from company-operated stores. There was an increase of +6.2% in cost of sales including occupancy costs from 2016 to 2017, the cost of s sales typically encompasses the cost of materials used in production, occupancy costs and labor costs.
Growth in revenues sometimes translates to an increase in the cost of sales; it could, however, be argued that Starbucks should strive to lower their cost of sales to increase the gross profit. Operating Expenses are generally higher in 2017 compared to 2016, restructuring and impairment cost is a new expense, one that was not there in 2016, all this has caused an increase in operating expenses by +7.3% from 2016 to 2017.
From the balance sheet extract, we can conclude that there could be a possible relationship between net revenues and accounts receivable. As net income increased in 2017, the accounts receivable in 2017 increased too, indicating a correlation. Further horizontal analysis of the balance sheet reveals that Starbucks had an increase of +13.22% in the receivable between 2016 and 2017. Additionally, and in carrying out the vertical analysis, it highlights that fact that the receivable accounts made up 5.37% and 6.06% of the sum of assets between the years 2016 and 2017.
Through the analysis of the above about the fixed assets, vertical analysis, make up a sum of 34.25% in 2017 and 31.68% in 2016. Besides, the intangible assets accounted for about 3.07% in 2017and 3.61 in 2016. Goodwill accounts for 10.71 in 2017% and 12.61% in 2016. While the company may experience an increase in the in fixed assets, the growth might necessitate the need for more furniture, equipment, and improvements.
In the examining of horizontal analysis in Starbucks’ the short-term debt that brings together the current long term debt and liabilities, that reveals that there is the full payment of the current long term debt of 2017 is a big difference. Starbucks has worked hard in trying to roll over the debt before waiting for it to become due and thus overcome paying the principal payments.
There has been an increase in Stored Value Card Liability. This is an excellent debt to have as it shows consumer confidence. Clients won’t buy gift cards if they don’t think you will be around to redeem them. From the vertical analysis, the short-term debt accounts for 2.79% of the sum of the liabilities in 2016. There was also an increase of about 22.26% reported in 2016 in the long-term debt and accounted for about 27.38% of the sum of the liabilities in 2017.
Financial ratios are used to express a relationship between two or more components in the financial statement and would include liquidity ratios, debt/solvency ratios, and profitability ratios.
To find the ration there is a need to divide the current asset by total current liabilities Industry average for the coffee industry is 1.14. Starbucks had a current ratio of 1.25 in 2017 and improvement from 1.05 in 2016; that represents an increase of short-term financial strength. If on the other hand, the current ratio is too high, this could reveal that the business is not efficiently utilizing current assets.
To analyze how a company can easily convert its asset into cash to offset its current liquidity then there is need to use the liquidity and quick test ratio. In the analysis of the fast rates in the firm for 2016 and 2017 show that the value was 0.74 and 0.93. However, most firms focus on a quick ratio of 1. When the analysis shows, a value of 1 would often point that the current liabilities is equal to the quick assets. Starbucks data reveal that it has a quick ratio of 0.74 in 2016 and 0.93 in 2017. It is probably best for Starbucks to achieve a rate above 1.
In most cases, the firms are often required to understand if the firm is efficiently managing its assets. The Assets management ratio is more effective in making such type of analysis. The rations are at the time termed as efficiency and turnover ratios. Besides the Inventory turnover ratio play a key role in the management ratios. The most important focus is in revealing to the frequency of inventory sells and restocking every year. The analysis of the firm shows that there was a 6 times inventory turnover for the years 2016 and 2017. This is a lower value to the industry average of 8. This could be an indication that two Years in a row, Starbucks had a low turnover rate and therefore may not be selling their products efficiently.
The receivable turnover ratio indicates how many times each year a business collects on their accounts receivable. A higher receivables turnover means collecting on credit accounts is timely. If the receivables turnover is otherwise low, special attention should be at the credit limit and collection policy. The firm accrued in the accounts receivable for the years 2016 and 2017, of about 27.73 and 25.72, which was apparently above the industry average of 22.42. The data thus show that the firm was collecting their credit accounts on a timely basis.
Solvency focuses on long term debt. If a company seeking to be solvent then the value of the assets should be higher than the debt value. Their solvency is one of the practical measures of financial stability. “The debt-to-asset ratio is the ratio of total debt to total assets. It is used to show whether a company has taken on too much debt and whether it can meet the debt obligations. Besides, the ration would often give an idea of whether the firms can achieve long term and the short-term. A lower solvency ratio would often lead the company might default on its debts.
Debts to assets is a solvency ratio. The Debt to Assets focuses on much of Starbucks assets are financed with borrowing. They are borrowing money to buy new long-term assets. This is Leverage. The ratios of debt to the asset for the period running between 2016 and 2017 were 0.59 and 0.62, higher than the industry average of 0.53. This could mean that the firm is a ca greater risk of not being able to pay its debts since the cash flows might not sufficiently pay for the interest and principal on debts.
Debt to Equity looks at the preference to use debt over equity to finance their borrowing. Starbucks prefers to borrow money then sell new shares. Worth noting that Total Equity has gone down as Starbucks has used some of the borrowed money to fund dividend and share buyback programs. In the cases where the ratio of debt to equity show above average interest expenses, then the company’s credit rating might be affected that affect the ability to raise more debt. The obligation to equity ratios for the company within the 2016 and 2017 period were 1.43 and 1.63 much higher than the industry average of 0.17.
Times interest earned ratio is essential in estimating the long-term solvency in a firm. The most important role it plays is that it helps in projecting and of whether a prospective borrower might be able to acquire any additional debt. In the analysis of the firm, it emerged that times interest earned ratios in 2016 and 2017 were 52.64 and 47.68. This rate was an apparent decrease from 2016 to 2017. However, the ration was still higher than the average in the industry that stood at 37.96. Cases of higher ratio would mean that the company has a better chance of paying interest and servicing a debt
A profitability ratio focuses on the efficiency of a company to turn the business activity into a profit. Net profit margin is a ratio of the probability that will consist of net earnings to revenues. The ratio would always show the cost of each dollar collected by the company as revenue. However, there is still a variation of the ration from one firm to another, and the difference might even be visible in the industry. However, it is important to mention that a firm might have low-profit margins, but that would not mean that it has low profits. Starbucks has a profit margin ratio of 13.22% and 12.89% in 2016 and 2017. The margins were above the industry average of 9.1% and a slight decrease from 2016 to 2017.
The gross profit on sales ratio plays a vital role in showing how a company is an ability to use its labor and supply efficiently. The ratio represents a crucial role in demonstrating a firms production efficiency of a given time. Starbucks had a gross profit of sales ratios of 60.07% and 59.63% for the years 2016 and 2017 was 60.07% and 59.63%. There was a marginal decrease from 2015 to 2016 but higher than the industry average of 57.99%.
The return on assets ratio plays a vital role in showing the firms earnings compared to their overall resources. In the cases where the company has a higher ratio, then it would mean that it is better managed. This is an effective way of assessing a firm in the industry. Starbucks had a return on assets ratio of 19.69% and 20.08%% within 2016 and 2017 that was an increase from 2015 to 2016 and lower than the industry average of 35.03%.
Another important ration of profitability is the return on equity that has an essential role in showcasing after-tax profit a firm has earned in comparison to the shareholder equity. In the cases where is a high return on investment, then it shows that the business is most likely generating internal cash. Starbucks had a return on equity ratio of 47.89% and 52.86%, in 2016 and 2017 was a slight increase from 2015 to 2016. Both ratios were above the reported industry average of 25.23%.
Generally accepted accounting principles (GAAP)
Generally accepted accounting principles (GAAP) are sets of rules that envelop the details, legalities, and complexities of corporate and business accounting. The Financial Accounting Standards Board (FASB) utilizes GAAP as the base for its comprehensive sets of approved accounting practices. United States laws require that organizations disclose their statements to the public.
The GAAP ensure that the process of financial reporting is transparent’ and standardizes terminology, definitions, assumptions, and methods. Because GAAP guidelines ensure transparency and continuity, they allow investors and stakeholders to make informed, evidence-based, and sound decisions. This paper explores the significance of these factors, and how Starbucks appropriately reports its financial information.
The Sarbanes-Oxley Act requires the reporting of control procedures. The sole purpose of reporting of control procedures is to show how a company attempts to reduce fraudulent practices as well as other unnecessary errors in its financial records and statements. Control procedures ensure that companies can only audit financial records that are valid and accurate to promote a good image.
Control procedures can be conducted by different consultants or company personnel handling various tasks and also ensuring that only people authorized can sign the financial statements of an organization. The Act also mandates company management to disclose any material weaknesses, and if these weaknesses are present, then the company cannot hold claims that its financial reporting is effective.
Starbucks disclosed its control procedure under section rules 13a-15(e) and 15d-15(e) of the 1934 Security Exchange Act. The company conducted analysis and evaluation with its Chief Executive Officer and Chief Financial Officer. The assessment focused on the design effectiveness and the operations of their controls and procedures disclosure. The company’s fourth quarter of 2015 financial statements showed controls and procedures to be efficient and that no changes in their internal controls and procedures interfered with financial reporting.
The executives also list the company’s internal control procedures including maintenance of records in sufficient details, record transactions significant for financial statements, expenditures and receipts are provided with the authority of the management, and unpermitted access or use of company resources and assets would be prohibited and prevented if discovered on time. Therefore, the use of control procedures was significant in helping the company reduce fraud and make improvements on accuracy.
Additionally, reporting of segment information is required by ASC 208. Organizations are required to report information concerning a company’s operating segments, geographic locations of their operations, and their major customers. Reporting of such information is crucial in providing the investors and debt holders vital information about which segments are making good progress, and they can thus make informed decisions about investing. Segment information reporting assists company management with resource allocation following the financial information provided about different segments.
The segment report allows management to allocate more resources to segments that incur significant expenses and generating reasonable revenues. Companies are required to report revenue information about each type of product or service produced, as well as the locations where they earn incomes or hold assets. For Starbucks, the evaluation of segment information reporting is conducted by management. The company has four segments that generate revenues to the economy. These include America (the US, Canada, and Latin America), China/ Asia Pacific (CAP), Europe, Middle East, and Africa (EMEA), as well as Channel Development selling single served products and packaged coffee. The company provides overall information about the operations of each segment, as well as the products that they offer. Starbucks additionally disclosed that the management selected the parts by operating income and net revenues. It also lists the profit and loss margins for each section.
ASC 275 “risk and uncertainties” mandates that companies disclose that financial figures are estimates and sometimes approximations of numbers. This disclosure is necessary because it allows users of financial reports to make better and informed decisions with the knowledge that the numbers are not exact figures. Furthermore, companies are also required to disclose assumptions.
Such disclosure is essential to help financial report users not to give ‘unwarranted degrees’ of reliability to them. Some of the estimates and assumptions made may include depreciation, amortizations, allowance of doubtful debts, taxes, future cash flows, employee benefits, as well as contingent liabilities. Starbucks discloses that its management makes assumptions and estimates that directly affect revenues, expenses, assets, and liabilities. For the company, the assumptions and forecasts made are goodwill and assets impairment.
Investments and fair value
Similarly, ASC 820 “fair value measurement” describes the methods of measuring fair amount and report in financial records. It states that the fair market value is used to determine an asset’s price through observables or non-observables. Reporting of the investment and fair amount is crucial in showing the exchange price to be received when purchasing or selling an asset or expected payment when a company wants to transfer liability.
The final price settled upon should be similar to the one chosen by the participants in the market for asset purchasing. The lack of fair market valuation can result in assets becoming too subjective and may not be accurately measured. Starbucks discloses that it uses a similar definition to determine fair value and assigns three different categories to assets. Category 1 assets are cash and its equivalents. Category 2 assets are securities available for sale, over the counter contracts, swaps, and collars. Category 3 assets include credit and liquidity spread, auction rate securities, and maturity.
Lastly, ASC 840 “leases” mandates the reporting of leases. The leases are divided in to three categories: operating leases, capital leases, and also sales-leaseback transactions. Lease reporting is essential as it assists investors to understand the amount they are expected to get from leasing their property, time of the lease, as well as any uncertainties related to cash flows from the lease. Starbucks has both the operating contracts reduced using the straight-line method and the commercial lease requirements. The company discloses that it uses operating leases for roasting, distribution, retail stores, office space, and warehouse facilities.
The company also discloses that most of its lease agreements include tenant allowances, holiday rents, lease premiums, and contingent rent provisions. Starbucks unveils that it is occasionally involved in property construction and when it does not qualify for sales lease back, it is recorded as a capital lease.
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