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Starbucks Corporation roasts, markets and markets specialty coffees and has operations in more than 75 countries. The Company sells coffee through stores and channels such as licensed stores, hospitality and grocery stores. His popular coffees His brands are Tazo, Ethos and Evolution Fresh. Starbucks is working hard to become the world's most admired brand. The company's strategy is to open stores in China's growing market and strengthen its position in the United States.
The purpose of this report is to provide financial analysis of Starbucks' performance, financial condition and stock market position by analyzing its financial statements. Another aim is to examine the role of accounting regulations and reporting requirements in preparing financial statements. Recognizing that Starbucks is a global company, the information is of great use to Coffee Connection in analyzing the competition it faces and identifying a benchmark to improve profitability and expand the coffee shop’s operations.
The analysis is in four parts: Part 1 carries out a horizontal and vertical analysis of the accounts receivable, fixed assets, and debt financing. Part II carries out a ratio analysis that focuses on the liquidity, management’s efficiency, solvency, profitability, and market position. Part III examines the U.S GAAP financial reporting rules that guide Starbuck’s control procedures, segment information, fair value, and leases. The final part provides a concise conclusion of the financial analysis and provides a recommendation for the company’s long-term success.
Horizontal and Vertical Financial Analysis
The accounts receivable show an increase of $49.8 million, representing a 6.93% growth. Starbucks receivables consist of the CPG and foodservice sales as well as product and equipment sales to its licenses. The revenues from CPG business increased by 10.2%, and therefore, the increase in the receivables directly results from the higher sales for the financial year 2016. For the year 2015, the proportion of the accounts receivable to the total assets was 5.79%. However, this has declined to 5.37% in 2016. The 15.41% growth in Starbucks assets exceeds the 6.93% growth in its accounts receivable, and this explains the slight decline of 0.42%.
Starbucks accounts for its receivables net of the allowance for doubtful accounts. The company uses “historical experience, the customer credit risk, and the specific identification method” to calculate the allowance. Starbucks analyzes each customer’s account focusing on their ability to pay and their past payment behavior to determine the likelihood of default. The allowance for 2015 was $10.8 million, which declined to $9.4 million for the year 2016 leading to a lower reduction in the accounts receivables.
The increase in Starbucks fixed assets is $1127.3 million, a 13.31% increase. The increase in PPE is 10.90%, long-term investments 265.34%, and intangible assets (goodwill) 9.15%. On the other hand, the equity and cost investments have declined by 27.70%, and others (deferred income taxes, long-term assets, and intangibles) have decreased by 9.33%. Therefore, the increases in Starbuck’s PPE and long-term investments contribute to the growth in the fixed assets. On the other hand, the depreciation and amortization expense increases by 4141.2 million, a 16.82% increment.
The proportion of the fixed assets to the total assets in 2015 was 68.02, and it declines to 66.78% in 2016. The PPE has the highest percentage of the total assets; 32.93% in 2015 and 31.64% in 2016. The proportion of goodwill decreases from 12.69% in 2015 to 12% with the long-term investments increasing from 2.52% to 7.97% in 2016. On the other hand, amortization and depreciation as a percentage of sales decreased slightly from 4.66% to 4.60% in 2016. Therefore, Starbucks main fixed assets are the PPE, long-term investments, and goodwill.
The depreciation expense relates to the PPE, “using the straight-line method over the estimated life” of the different assets. The PPE comprises of “land, buildings, leasehold improvements, store equipment, roasting equipment, and furniture and fittings”. The amortization expense relates to the company’s leasehold property (stores and warehouses), and the finite-lived intangible assets (from its acquisitions and divestitures). It is essential to point out that PPE and goodwill are not amortized but annually tested for impairment. The slight decline in the depreciation and amortization expense is because of the decision of Starbucks to slow down the opening of new branches (it is closing down some). The major asset additions in 2016 were the opening of 476 new company-owned stores. However, Starbucks sold their ownership interest in its German retail store, and this explains the 27.7% decline in the equity and cost investments.
The amortization and depreciation are operating expenses, and they reduce profits in the income statement. Depreciation reduces the book value of the PPE, recorded at cost less the accumulated depreciation. Starbucks, therefore, the net-book values to account for its PPE on the balance sheet. The recording of the long-term investments is at their fair values, with increases in the FV recognized as unrealized gains accounted for in the statement of comprehensive income.
Starbucks long-term debt increases by $898.8 million, a 24.64% increase. Long-term debt to total assets (equity plus liabilities) ratio also increases from 29.38% in 2015 to 31.73% in 2016. Starbucks raises debt through credit facilities and commercial paper programs. The increases, as shown above, show that the company is relying on debt financing to fund its core operations. Starbucks uses the debt proceeds to invest in its core business through capital expenditures, introducing new product innovations and expanding the reach of its marketing and digital campaigns. Also, the long-term debt is used to finance the share repurchase program as well as take advantage of emerging new business opportunities.
Starbucks accounts for its long-term debt at face value less unamortized premium or discount. Recognizing a long-term liability requires that an obligation must exist as a result of a past transaction and requires usage of future economic resources. The same method is used for the issuance of debt, although the company estimates the fair value of the debt issue. The use of face value is appropriate because it shows the amount that Starbucks needs to settle all the debt. The fundamentals characteristics of financial information are reliability and relevance, and the use of face value limits the relevance of the information to the external users.
The current ratio (CR) has remained relatively stable; 1.05 in 2016 and 1.09 in 2015. A CR higher than 1 indicates that Starbuck’s current assets are sufficient to pay off its current liabilities. With an industry average of 0.93. Starbucks is in a better liquidity position than its peers. The quick ratio shows an increase; from 0.59 to 0.67. However, a quick ratio less than 1 indicates that the company does not have enough quick assets it can convert into cash to pay off the short-term obligations. The quick ratio industry average is 0.38, and Starbucks is in a better position than its peers.
Asset management ratios
The inventory turnover shows an increase; from 5.96 to 6.17 in 2016. The meaning is that during 2016, Starbucks sold its inventory 6.17 times. An increase in this ratio shows improved efficiency since fewer days are required to convert inventory into sales. However, the industry average of 10.49 indicates that the peers are more efficient at managing their inventory than Starbucks. On the other hand, the accounts receivable turnover has also increased; from 26.65 in 2016 to 27.73 in 2016. For the year 2016, Starbucks collected its accounts receivables 27.73 times. An increase in this ratio shows improved management of the accounts receivable since fewer days are required to collect cash (Weygandt, Kimmel, & Kieso, 2009). However, the industry average of 71.81 shows that Starbucks peers collect cash more times than Starbucks.
The debt to assets ratio has slightly increased from 0.53 to 0.59. Debt to asset ratio of 0.59 means that 59% of Starbuck’s assets are financed using borrowed funds. An increase in the use of borrowed funds increases the financial risk of a company, a cause of concern for investors. The debt to equity ratio has also increased from 1.13 in 2015 to 1.43 in 2016. For the year 2016, there were 1.43 as many liabilities as there is equity. An increase in this ratio means that the debtors rather than the investors, are funding Starbucks operations. When debtors finance the activities of a company, the financial risk increases and Starbucks investors will demand a higher compensation for the higher risk. The time's interest earned has remained relatively stable at 51, and the industry has a much lower ratio of 17. It means that Starbucks generates sufficient before interest earnings can cover the interest expense 51 times.
Starbuck’s net profit margin slightly declines to 13.22% in 2016 from 14.39% but is much higher than the industry’s average of 4.15%. Starbuck’s attributes the increase in profit to customer growth in its company-owned stores, and the impact of the new stores opened during the year. The gross margin (60.07%) has marginally increased from 2015 59.36%, and it is much higher than the industry average of 24.59%. The increase is attributable to the growth in revenues and the slight reduction in the cost of sales, and as a result, Starbucks has a higher proportion of revenues left to cover the operating and fixed expenses.
Starbuck’s ROI (42.65%) has slightly increased from 41.07% in 2015, and it is higher than the industry average of 13.37%. A high ROI is evidence that the company is efficient in utilizing its operating assets to generate income. Also, the investors receive a higher compensation for the risk of investing in the business. The ROE has remained relatively stable (48%) but is higher than the industry average of 22.63%. Starbucks’s has a higher ROE because of its share repurchase program (reduces equity) and the use of debt which “magnifies shareholder’s earnings.”
The earnings per share has slightly increased from 1.84 to 1.91 in 2016. An increase in the EPS is an evidence of growth in profits, and this is attractive to potential investors. Starbuck’s price earnings ratio using 11th November 2017 price is 29.96. A P/E of 29.96 means that investors are willing to pay 429.96 for a dollar of Starbuck’s earnings showing the market’s confidence in the ability of Starbuck’s to generate better earnings.
Rules of Financial Reporting
Reporting for control procedures
The management of every public company has the responsibility to prepare and provide reliable financial information. The quality of such information is dependent on the processes and safeguards put in place over financial reporting. The reporting of these control procedures seeks to ensure that companies establish and maintain adequate controls over its financial reporting. Also, it ensures that they are effective in reducing the risk of financial statement misstatement and fraud. Starbucks points out that the procedures and controls over disclosure are adequate; it prepares and files all material information promptly as required by the SEC. Also, the company appropriately maintains its records and ensures that they faithfully represent its transactions and management's authorization of asset acquisition or disposal.
A segment takes part in business operations and will generate revenues, incur expenses. Segment reporting seeks to provide useful information to investors to enable them get a better understanding of the future prospects of a company’s operations. Starbucks is a large organization, and by providing information on its segments, external decision makers are in a position to assess the risk and return of the enterprise. It seeks to ensure that managers provide as much information as possible to the external users to facilitating better decisions.
Starbucks has four segments: “Americas, China/Asia Pacific, Europe, Middle East, and Africa (EMEA), and channel development”. For each segment, the company discloses the total net revenues, cost of sales, the operating expenses, and operating income. Such information is crucial in assisting a shareholder to assess and evaluate the performance of the company in the various geographical regions it serves. For instance, The Americas segment contributes to 37.1% of its sales (2016), and it means that poor business in this area will hurt the company.
Reporting of estimates and assumptions
With the growing complexity of financial transactions and standards, companies have to make significant estimates on issues like the useful life of the fixed assets, goodwill, discount rates for leases, and allowances for doubtful accounts. Management is under pressure to meet the analysts and budget estimates, and there is a likelihood of manipulating these estimates (earnings management) (Feng, Ge, Luo, & Shevlin, 2011). Therefore, the reporting seeks to ensure that the estimates used accurately and fairly present the financial position of a company as well as examine that management’s assumptions adhere the internal controls. The focus is on the process, the alternatives, the methods, and the critical assumptions applied in making the estimate.
Starbucks discloses that it makes assumptions and estimates such as in estimating inventory reserves, impairment of goodwill, stock-based compensation, and future asset retirement programs. For instance, during the assessment of impairment for intangible assets, Starbucks estimates the discount rates based on the cost of capital, which is subjective.
Reporting of investment and fair value
The reporting of investments and fair value enhances transparency and relevance of financial information. Fair value refers to the “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Reporting investments at fair value show the price that a company would receive if it sells them in an orderly transaction. Also, for the assets, the FV is their price if sold today while for the liabilities, it is the price that the company would pay now. Therefore, the purpose of this reporting is to enhance the relevance of financial information and facilitate the comparability of financial instruments bought at different times (Laux & Leuz, 2009).
Starbucks in Note 4 measures its “assets and liabilities at fair value on a recurring basis”, and it uses the current market price quoted for an item. It also records the long-term investments at their FV as well as the derivative assets and liabilities. Such information will show its investors the prevailing market prices of the assets and liabilities, enhancing the decision usefulness.
Reporting of leases
Under the new standards for reporting for leases, companies are required to recognize their “lease assets and liabilities on the balance sheet” as well as the rights and obligations that arise. Currently (without the new accounting standards by the FASB), companies should record their capital leases on the balance sheet and disclose the operating leases in the notes section. The reporting of leases is crucial to help investors accurately determine the financial obligations of a company as well as the amount, timing, and uncertainty of the cash-flows (Bragg, 2010). Starbucks discloses the rent expense under its operating leases, and this relates to retail stores, office space, and warehouse facilities. Also, the company constructs and makes improvements to its stores for leasing, and these are reported as leasehold improvements, found under plant, property, and equipment.
From the liquidity analysis, the company has sufficient current assets but not enough quick assets to pay the current liabilities when they fall due. However, it is important to point out that many successful companies still operate with a quick ratio less than 1. The asset management ratios have increased and this is an indicator of improving efficiency over the management of inventory and accounts receivable.
The debt to asset and debt to equity ratios have increased, an evidence of increased use of debt financing. However, the time's interest earned indicates that Starbuck generates sufficient before interest earnings to cover the interest expense, showing that it can sustain its debt levels. The profitability of Starbucks is increasing because of the improvement in its profitability ratios. Also, the ROI shows improving efficiency in the use of the company’s operating assets. Based on rising EPS and the P/E ratio of $29.66, investors and analysts can expect better earnings the coming year. Therefore, Starbucks’s performance is improving, but it requires to improve the management of the inventory and accounts receivable. It is financially healthy and not in danger of failing to pay its current liabilities as they fall due or the interest payments on the debt.
The first recommendation is that the company should leverage on digital and online capabilities to enhance the customer experience. Approximately 9 million customers visit a Starbuck’s store, and this is an opportunity for the company to use social media to raise greater awareness and most importantly, earn the attention of its customers. The company has been embarking on introducing mobile payment for its customers, and this is an opportunity to forge a stronger customer identify. The company should also leverage its personalization feature where it can tailor its products unique to each of its customers. Starbucks should drive its CPG products by increasing the occasion of use; for instance, providing drinks for the “at home” and driving market segment. There are also opportunities for enhancing the customer experience, such as coffee education for its customers and focus on the opening of its coffee roasteries, which promise an ultra-premium experience for customers.
Bragg, S. M. (2010). The Ultimate Accountants' Reference Including GAAP, IRS & SEC Regulations, Leases, and More. John Wiley & Sons
Feng, M., Ge, W., Luo, S., & Shevlin, T. (2011). Why do CFOs become involved in material accounting manipulations?. Journal of Accounting and Economics, 51(1), 21-36
Laux, C., & Leuz, C. (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, organizations and society, 34(6), 826-834.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2009). Managerial accounting: Tools for business decision making
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