COSTCO WHOLESALE CORPORATION FINANCIAL STATEMENT ANALYSIS

Roll nos. 19 – 24Financial Analysis & AccountingMBA 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

• Horizontal common size statement (trend analysis)

•Vertical common size statement

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

Common Size Statement

• Financial statements reveal the financial credibility of a company.

•Helps in comparing two companies, which differ in size.

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 CORPORATIONComparative Income Statements

For the Years Ended December 31Increase

(Decrease)2008 2007 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1

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)

Sales increased by 8.3%, yet net income decreased by 21.9%.

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31Increase

(Decrease)2008 2007 Amount %

Net sales 520,000$ 480,000$ 40,000$ 8.3Cost of goods sold 360,000 315,000 45,000 14.3

Gross margin 160,000 165,000 (5,000) (3.0)Operating expenses 128,600 126,000 2,600 2.1

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)

Horizontal AnalysisThere were increases in both cost of goods sold (14.3%) and operating expenses (2.1%). These increased costs more than offset the

increase in sales, yielding an overall decrease in net income.

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 X 100 Base yr. amount

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

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31Common-Size Percentages

2008 2007 2008 2007Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000

Gross margin 160,000 165,000 Operating expenses 128,600 126,000

Net operating income 31,400 39,000 Interest expense 6,400 7,000

Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600

Net income 17,500$ 22,400$

Net sales Net sales is the

base and is

expressed as 100%.

e. g.

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31Common-Size Percentages

2008 2007 2008 2007Net 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 Operating expenses 128,600 126,000

Net operating income 31,400 39,000 Interest expense 6,400 7,000

Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600

Net income 17,500$ 22,400$

2007 Cost ÷ 2007 Sales × 100% ( $315,000 ÷ $480,000 ) × 100% = 65.6%

2008 Cost ÷ 2008 Sales × 100% ( $360,000 ÷ $520,000 ) × 100% = 69.2%

CLOVER CORPORATIONComparative Income Statements

For the Years Ended December 31Common-Size Percentages

2008 2007 2008 2007Net 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

• 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.

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.

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

Year on Year Vertical Common -Size Income Statements

COS TCO

S E ARS

WALMART

BJ corp

Costco vis-à-vis competitors – vertical common size

income statements.

• 1997

• 1998

• 1999

• 2000

•2001

Vertical Common – Size Income Statement Analysis

COSTCO BJ Wholesale corp

SEARS WAL-MART

Year – on – Year Horizontal Common - Size Income

Statements

COSTCO

SEARS, ROEBUCK

WAL-MART

BJ WHOLESALE CORP.

Year – on – Year Horizontal Common - Size Income

Statements Analysis

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

Threat!

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

Suggestions to COSTCO

COSTCO

Membership feeIn house brands

Portfolio expansionDomestic expansion

International expansion

Virtual retailer

Value added services

Financial agencies

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