Financial Statement Analysis Essay

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Financial statement analysis is a tool by which one can examine the publicly-available financial statements to determine the financial condition of a company. The role of the financial statements is to provide information for both internal and external stakeholders, including shareholders and regulators, about a company's finances. Thus, the SEC demands that financial statements are produced in a specific format so that there is easy comparison between companies and across industries (SEC.gov, 2014). One of the most common means of analyzing statements is to examine the trends in the statements, and to conduct analysis by a set of ratios that will explain about the liquidity, solvency, efficiency and returns for the company (Investopedia, 2014). This report will contain a financial statement analysis of Starbucks.

Trends

Starbucks has demonstrated progressive revenue growth. Revenue in FY 2014 was $16.4 billion, compared with $14.8 billion in 2013, an increase of 10.8%, and the prior years also saw strong increases. Profits have also grown for the company. In FY2014, the net income was $2.068 billion, a record high for the company. The prior year, the company paid a $2.79 billion settlement to a company called Mondelez International, bringing net income to almost nothing (Burritt, 2013).

Starbucks' balance sheet indicates that the company has a generally high level of financial health. It is highly leveraged, but its financial position has been stable over the course of the past several years, leading to a process of slow equity growth. The financial statements highlight one area of concern, which is that even though Starbucks is growing its revenues rapidly, and for the most part experiencing strong growth in its net income, that is not translating to overall shareholder wealth, and the value of equity seems to be increasing more slowly than the overall size of the business. A ratio analysis should reveal more.

Ratio Analysis

The first set of ratios to be studied are the profitability ratios. The gross margin reflects the pricing power of the company with respect to both suppliers and customers. The higher the gross margin, the better that pricing power. Starbucks has a gross margin of 58.3% at present, compared with 57% last year, indicating that the company has increased its pricing power of late. The operating margin reflects the company's ability to control costs internally. The current operating margin is 18.7%. The FY2013 operating margin, not including the settlement, was 16.5%, which again reflects the improved pricing power and the greater ability of Starbucks to leverage economies of scale and build its operating margin by using its resources more efficiently.

The net margin also has to take the settlement into account. Starbucks is currently earning a net margin of 12.5%, while last year the company would have outperformed that figure, but partly because it received a tax benefit from the writedown, rather than having to pay income tax. The provision for income tax was much higher for Starbucks in part because it earned more money but also because it had to change its tax policies in Europe (Titcomb, 2014).

Another form of ratio analysis is the liquidity analysis. The balance sheet is used for this. This form of analysis takes a look at the ability of the company to meet its obligations for the coming year, and its longer-run solvency concerns as well. The first ratio is the current ratio, which for Starbucks stands at 1.37 versus 1.01 last year. That the company had to pay out on that settlement resulted in the $2.9 billion sitting on the liabilities side under "accrued expenses, current," meaning that category had a huge spike, and that this year's current ratio is more in line with the company's long-run financial condition than the current ratio for FY2013. The same will be true of the other ratios. The quick ratio is at 1.01, which is a healthy number and the cash ratio is 0.6, which again indicates healthy liquidity for the company.

The debt-to-equity ratio is another way of looking at the financial condition of the company, taking into account long-run factors. The debt-to-equity ratio is presently 1.04, whereas last year it was 1.57, but that was the result of the settlement, which was showing in the short-term liabilities. Still, in FY2012, the debt-to-equity ratios was 0.6, so there is a long-run trend towards increasing the amount of leverage at the company, which might be of concern for investors. Operating efficiency metrics are another set of ratios.

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The first of these is the accounts receivable turnover, which measures the degree to which Starbucks collects on its debts. The company has an A/R turnover ratio of 27.5, versus 28.4 last year. While both figures are generally strong -- collecting in a couple of weeks on most debts -- the company would not want the decline in this ratio to continue. The next operating ratio is the inventory turnover ratio. Inventory turnover at Starbucks improved last year, to 6.2 times from 5.4 times. The overall level is fairly low, but there are two factors to consider here. First, most of the company's inventory is non-perishable, or perishes slowly in the case of the beans. Second, the company has a massive coffee bean inventory, estimated to be over a year's worth (Sayre, 2014). Thus, Starbucks carries an extensive inventory of raw materials, as a hedge because of the volatility in coffee prices and its sensitivity to global agricultural conditions. Having a slow inventory turnover is, in part, a strategic choice based on the principles of cost management. Lastly, there is the total asset turnover, which reflects how well the company converts its assets into revenue. This was 1.47 times last year, and 1.50 times in FY2013.

There are also the return ratios, which are important for investors. For Starbucks, the five-year average return on equity is 42%, versus an industry average of 37%. This figure can reflect, however, the relatively high degree of leverage that the company has, or at least the increasing leverage. The return on assets has also been historically higher than that of the industry average, at 18.5%, versus 14.5%. Starbucks has been also been able to have a higher than average return on capital, which sits at 32%, versus 19%. This indicates that in general Starbucks outperforms its peers in the quick service restaurant industry, earning better returns on all of its ratios. This can be perhaps a function of the company's consistently strong pricing power, which allows it to earn much better margins. Consider that these are five-year ratios, which means FY 2013 when they barely earned enough profit to buy a venti Mocha Frappucino is included -- remove the settlement and the degree to which Starbucks outperforms its rivals is only further amplified.

A final ratio worth mentioning is the price/earnings ratio. The denominator is something that reflects the company's performance, but the market price reflects market sentiment, which is out of the company's control for the most part. Starbucks' P/E at present is 26.6, which indicates that at least some growth is projected by investors. This is probably based on the company's strong position in Asia, where there remains tremendous growth potential and where Starbucks continues to enjoy first over advantages over other western chains that have aggressively pursued this market (Gloria Jean's, Costa Coffee, etc.).

Conclusions

Financial analysis allows the observer to examine both the current state of a company's finances and the trends in its finances as well. The current state of Starbucks is generally healthy, with the company outperforming its peers. Starbucks is liquid and solvent, despite an increase in the debt-to-equity ratio in recent years. The company has also been able to maintain a stable or improving set of efficiency ratios, and its profits are very healthy, indicating that Starbucks has significant pricing power in its market, something many other QSR companies cannot boast. If there are reasons for concern, they lie with the company's increasing debt, something that is used to fuel expansion, but some of that expansion has been into other businesses like juice and tea, that have yet to pay off in terms of revenues. Should Starbucks have to write down those businesses, profits will be hurt further.

Financial statement analysis is a powerful tool, but not one to be conducted in a vacuum. For example, the settlement in 2013 has a significant impact on the company's financial performance. Where there is a deviation from the norm, the source of that deviation must be understood and put into context. Even the inventory turnover, where the company seems to have slow turnover, relates to a specific operational decision to manage the company's costs. So while financial analysis can tell a lot about a company, it is always important to put the financial analysis into its proper context, by understanding a thing or two about the company's operations, its industry.....

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