Financial Analysis

Running head: FINANCIAL ANALYSIS 1 FinancialAnalysisNameInstitution

Financial analysis is important during investment decision making.The objective of the investor is to maximize return and minimize therisks. Evaluating the financial performance of a company or projecthelps to reveal possible returns from the investment (Helfert, 2001).Given the importance of the financial analysis in investment decisionmaking, this report evaluates the viability of the StarbucksCorporation and Settle`s Best Coffee as an investment opportunity byevaluating its financial performance. The financial analysis of thecompany is carried out for a period between 2007 and 2011. The studygives a comprehensive financial analysis comprising of vertical,horizontal and ratio analysis. To arrive at a decision concerninginvesting in the Starbuck Company, this report compares theperformance of Starbucks and Settle Best Coffee with that of itscompetitor (McDonalds) and that of the industry. The report commencesby evaluating the background to the two companies (StarbucksCorporation and Settle’s Best Coffee).

Background to theCompanies

  1. Starbucks Corporation

This is Coffeehouse Chain from America. The company was founded in1971 and has it’s headquarter in Seattle, Washington U.S. thecompany has 23, 768 restaurants around the world which include 13,107 restaurants in U.S.A., 1, 418 in Canada, and 2, 204 in China.Settle Best Coffee is the subsidiary of the Starbucks Corporation.The company serves cold and hot drinks, micro-ground Instant coffee,whole-bean coffee, Caffe-latte, and espresso and it employs 191, 000people. The company is publicly traded and listed on NASDAQ. Onaddition to this Starbucks is a component of the S&ampP 500.Starbucks started to make a profit in the 1980s, and by the end ofthe year 2014, the company had total assets valued at US$ 10, 752billion, and total equity valued at US$ 5. 272 billion. The companygenerated total income amounting to US$ 32. 081 billion in the sameyear (Thompson &amp Gamble, 2015).

  1. McDonald`s

McDonald`s is one of the major competitors of the StarbuckCorporation. Headquarter of McDonald’s is at Oak Brook U.S. Thisis the largest fast food chain. McDonald’s employs 1.9 millionemployees of which, 1.5 million are from its franchises. The companyserves about 68 million customers from its 36, 538 outlets located in119 countries. It was established in 1940 and the business wasreorganized as a hamburger stand in 1948. The outlets of the companyare operated either as the corporation itself, affiliate orfranchise. Some of the products of the company include soft drinks,breakfast items, chicken, hamburgers, and French fries. The companyis listed on NYSE. In 2014, the total value of the company was U.S.$ 37.939 billion in terms of assets and U.S. $7.088 billion in termsof shareholders’ equity (Chase &amp Apte, 2015).

FinancialAnalysis

  1. Vertical Analysis

Vertical analysis considers value of each item in the incomestatement as a proportion of total sales. For the balance sheet,vertical analysis evaluates each component as a proportion of totalassets (Weygandt, Kieso &amp Kimmel, 2010). For the Starbucks, theincome statement vertical analysis reveals that the cost of sales tototal revenue for the company increased from 28.24% in 2007 to 42.30%in 2011. This shows that the cost of sales increased more than theincrease in revenue, which might have resulted from the adoption ofwrong transportation and supply chain method. This raises the riskthat the company will not generate enough revenue to cater for itsother expenses. The gross profit margin to revenue ratio decreasedfrom 79.72% in 2007 to 57.7%. This indicates the ability of thecompany to create enough gross profit from the revenue decreased overthe years.

The industrial cost of sales to sales ratio increased from 32% in2007 to 43.8% in 2011. This indicates that Starbuck Company has arelatively better way of managing its cost of sales compared to itspeers. However, Starbucks’s ability to convert its revenue intoprofit was lower than that of the market average. In 2007, the marketaverage gross profit to sales was 65.3% which decreased to 47.5%.This indicates that Starbuck ability to convert sales into grossprofit was less than that of its peers. Compared to the McDonald’scost of sales that was 18.84% in 2007 increased to 23.43%. McDonald’shas an effective raw material cost management than the StarbucksCompany.

On addition to this, Starbuck net income to revenue ratio increasedto 14.77% in 2011 from 0.07% in 2007. This shows that the company hasa high ability to manage its expenses. Ability to manage expenses andoperational costs is important in ensuring that the company remainsliquid and generates returns for its shareholders. The operatingexpenses to revenue ratio for the Starbuck increased from 0.21% in2007 to 3.44% in 2011. The increase in expenses was lower than theincrease in revenue. This indicates that the company has an effectiveexpenses management strategy. The industrial average operatingexpenses to revenue increased from 2.5% in 2007 to 4.1% in 2011. Thisindicates that Starbuck has a better cost management strategycompared to its peers. Cost management is essential for the companybecause it helps the management to create high value for the owners.

The net income to revenue over the years increased from 0.48% to10.65% between 2007 and 2011. This shows that the company’s abilityto generate income from its revenue increased over the years. Theincrease was contributed by the adoption of an effective expensesmanagement strategy. The industrial ability to convert profit fromsales was 9.89% in 2011. This means that Starbuck Company has ahigher ability to convert its revenue to income compared to itspeers. The total current assets to total assets ratio for theStarbuck Company increased from 31.75% in 2007 to 51.56% in 2011.This shows that the value of the current assets to total assetsincreased over the years. The increase in current assets is anindication of increased liquidity for the company. Having an optimallevel of liquidity helps the company to manage its operations andmeet its obligations.

Cash and cash equivalent to total assets ratio increased from 5.26%in 2007 to 15.6% in 2011. This indicates that the company ismaintaining more cash to cater for the increased level of activities.The increase in the proportion of cash and cash equivalent is anindication that the company is growing over the years, where anincrease in activities leads to an increase in cash needed to caterfor daily operations. The proportion of the total liabilities tototal assets decreased from 40.34% in 2007 to 28.2% in 2011. Thedecrease indicates that the company has reduced its reliance on theloans and debt to finance its operations.

The company relies more on equity capital. This is illustrated bygrowth in the proportion of total equity to assets, where the ratioincreased from 42.74% in 2007 to 59.61% in 2011. Reliance of equitycapital ensures that the company has a low level of leverage andreduces financial encumbrances that come from loan interest payments.This lowers the risk of loss for the company. The proportion of theretained earnings to assets increased from 40.97% in 2007 to 58.39%.This indicates a reduction of money that is apportioned to theshareholders over the years regarding dividend. However, the dividendof the company increased gradually over the years under evaluation,which is an indication that the net income for the company increasedat a higher rate than the decrease in the portion that is given tothe shareholders.

  1. Horizontal Analysis

This is the method that looks at the growth of various items of thebalance sheet and income statements over the given period. Therevenue of the Starbucks grew by 9.27% in 2011 which was higher than-92.65% decline in 2008. This indicates that the company has aneffective sales strategy. The hospitality and fast food industry areexperiencing high competition with the industry. The revenue increasewas less than the increase in the cost of sales, where the cost ofsales increased by 11.01% in 2011. This shows that the company needsto improve its selling price to match with the increasing cost ofsales.

The industrial revenue growth for 2011 was 8.25%. This shows that theStarbuck Company performed relatively well than its peers regardingrevenue growth. The total expenses grew by 5% in 2011. This was alower growth than 2008 of 21.16%. This is an indication that thecompany should have a more competitive expenses management strategy.The gross profit increased by 8.04% in 2011 which was a low increasethan 14.665 increase of the year 2010. This was caused by highergrowth in the cost of sales in the year 2011. This was a lower growthcompared to 9.28% gross profit growth of the McDonald’s company.However, the company performed better than the industrial average,where the industrial gross profit growth for the year 2011 was 7.8%.This indicates that the company performed well than most of thepeer`s companies. The general expenses incurred at a lower rate in2011 than in 2010.

In 2011 the general expenses increased by 25.72%, and in 2011 inincreased by 11.69%. This indicates that the company has an effectiveway to manage its expenses. The general expenses growth for theMcDonald’s was 13.2%, and the industrial average general expensesgrowth was 13.1%. This shows that Starbucks and Settle Best Coffeeperformed well than McDonalds and other competitors regardingexpenses management. The income for the Starbucks and Settle BestCoffee increased 31.74% in 2011 which was less than 141.97% growthregistered in 2011. The company had slightly lower growth thanMcDonalds which had an income increase of 32.1%. However, the companyperformed well than the market average growth of 28.1%.

Trade receivables for the company increased by 27.68% in 2011 whichwas higher than 14.45% increase registered in 2007. The increase inaccount receivables indicates that the company is selling more incredit. This can be due to increase sales or due to poor debtcollection strategy of the company. Increased receivables can lowerthe available cash and cash equivalents for the company which canhurt the business. The company should maintain a balance of accountreceivables to ensure that it satisfy its customers while havingoptimal liquidity. Compared to McDonald, Starbucks has a loweraccounts receivable which is an indication of a better way to collectall the debts compared to its close competitors.

The total assets increased by 5.92% in 2011. This is an indication ofrelatively high growth in valuation compared to 4.98% averageindustrial total assets growth for the year 2011. However, McDonald’stotal assets grew at 6.98% in 2011 which was a higher rate than thatof the Starbucks. The total liabilities for the Starbucks Companyincreased by 9.97% in 2011 which was a higher growth than 3.98% ofthe year 2007. This indicates that the company financed growth inassets using a larger proportion of debt than in the previous years.However, the company relied more on equity to finance its expansionprojects than the debt. The total equity for the company increased by19.15% which a higher growth than 9.05% growth for the year 2007.Compared to its cross competitors such as McDonald’s, Starbucksrelied more on equity. McDonald’s liability growth for the year2011 was 23.9% which was higher than that of the Starbucks. As suchStarbucks is less risk than other companies to invest in.

  1. Ratio Analysis

Average RatioAnalysis

  1. Liquidity Ratios

The accounts receivables for the Starbucks was 30.27 in 2011 and490.8 in 2007. This shows that the company collected the debt 30times in 2011 while it collected 490 times in 2007. This shows thatthe Company is taken more days to collect its debts than it used todo in 2007. Regarding days it took 12 days for Starbucks to collectits debt in 2011, while it took 0.74 of a day to collect debt in2007. This is an indication deteriorating debt collection mechanism.The working capital for the company increased to $622.55 billion from-$229.55 billion. The current ratio increased to 1.3 from 0.78 in2007. This is an indication of increasing liquidity level of thecompany. A current ratio of 1.2 in considered optimal for the companyand as such, Starbucks has an optimal liquidity. Compared toMcDonald’s current ratio of 0.18, Starbuck has a better liquiditylevel. The acid test ratio indicates that the company has a higherability to meet its short-term obligations. The company has an acidtest ratio of 0.65 which is relatively low they 0.67 of the McDonald.This shows that Starbucks holds more inventory than the McDonald’s.

  1. Leverage ratios

Leverageratios tend to measure the ability of a company to meet its financialobligations such as paying both long-term and short-term debt withoutdifficulties. Leverage ratio is an important tool for assessing theamount of debt that is company utilized to finance its assetsaccusation. It also shows the commitment of the firm on debts. Basedon the McDonald Excel computations, it can be observed that debtratio has been decreasing for the last four years. For example, in2007 the average debt ratio was 3.95. This ratio has declinedsignificantly to 2.70 in 2011. Such decrease in debt ratio is anindication the company ability to meet its long-term creditobligation is increasing. The standard debt ratio should be one (1),however, based on the McDonald debt ratio is still high (Welch,2011).

The companystill has more debt than the assets. Besides, the debt to equityratio of McDonald indicates that from 2007 to 2011, the debt toequity ratio has been increasing. It implies that the shareholders ofMcDonald have more credit obligation. For example, in 2007 debt toequity ratio was 0.97 but in 2011 the ratio had increased to 1.13.Such increase is an indication that the company equity shareholdershad more credit obligation. For every dollar owned by the McDonaldshareholders, there were 1.13 debts. Normally, in a situation wherethe corporation has higher equity to debt, it is an indication thatthe organization cannot generate adequate equity capital to meetavailable debts. However, despite high having higher average leverageratios the performance of McDonald is improving and more improvementsare anticipated to occur in the coming years (D’Hulster, 2009).

  1. Profitability

Profitabilityratios are utilized to assess the ability of the company to generateprofits by minimizing expenses. A firm whose profitability ratios arenot declining is a bad signal to all the stakeholders of theenterprise. Some of the most significant average profitability ratioscomputed includes a net profit margin, totals assets turnover, andreturn on assets. Besides, return on equity, return on investment,return on total equity and gross profit margin were also utilized.McDonald net profit margin had been increasing over the last fouryears commencing from 2007 to 2011. For example, in 2007, the netprofit margin was 0.01, but it had increased to 0.14 in 2011. Itimplies that the performance of McDonald regarding its profitabilityhas been increasing significantly. Each year the amount of profitsmade after all expenses were deducted continued to grow. Such changeis a good indication that McDonald is a good company for investment.The total asset turnover ratio for McDonald has been decreasing forthe last four years. For example, in 2007 the ratio stood 34.27 butin 2010, the ratio decreased up to 2.75. Such decrease is anindication that the amount of revenues generated from the averagetotal sales was declining and hence, there is a need for the McDonaldmanagement to put necessary measures into consideration to rectifythe issue (Lesáková, 2007).

Besides, theaverage return on assets for McDonald Corporation was declining. Forexample, in 7007 the ratio was 0.16, but it dropped to 0.00. Suchdecline is an indication that the company to generate revenues usingits existing asset is compromised. There is a need for the financialmanagers of McDonald to consider putting into use idol assets andgenerate more revenues. Based on average return on total equityratio, it can be observed that the ratio decreased from 0.38 in 2007to 0.73 in 2011. It implies that the ability of equity to generateprofits is compromised, and hence, remedies should be put forth.Besides, the gross profit margin declined from 1.29 in 2007 to 0.752011. However, between 2008 and 2009, gross profit margin remainedstable at 0.72 (Dai, 2016).

  1. Investment Analysis

Theinvestment analysis ratio helps to evaluate the viability and theability of the company to generate returns from its investments. Theexcel file indicates that McDonald earning per share was declining.For example, in 2008 the ratio was 2.99 it decreased to 2.29 in 2009and 2.20 between 2009 and 2010. In 2011, it even dropped further to2.0. Such decline is an indication that the company ability to engagein profitable investment and deliver a return to its shareholders wasdeclining. Decrease in earnings per share is a sign that the value ofthe company was falling. On the other hand, the price-earnings ratiowas improving for instance in 2007 it was 1.43 but over the years itimproved up to 57.24. The dividend payout ratio continued to increaseeach year, but the amount of dividend yield was declining. Forexample, in 2007 the amount of dividend yield was 1.26, but itdecreased to 0.34 in 2011. However, the general performance ofinvestment for McDonald’s was good based on the analysis ofinvestment ratios (Dai, 2016).

End of the YearRatio Analysis

  1. Liquidity ratios

Liquidity ratios atthe end of the years consistently indicate that Starbucks is thebetter choice of the two Companies. In reference to the Currentratio, Starbucks afforded to maintain its figure at above two, whichshows its ability as a company to clear its short-term debts. In thelast year of the analysis or 2012, Starbucks rated at 4.06 whileMacdonald struggles at 0.20. To an investor, this would mean thatStarbucks is much more appealing to invest in, as there is a higheravenue of making money since the short term debts are kept at baywhile other stakeholders such as the creditors will always want toassociate with this company, which means the company will always bein business.

The Acid test ratioin these two company’s also can be used to show the liquidityperformance of these two companies. Macdonald outwits Starbucks byhaving a higher acid ratio of 840.24 meaning most of the company’scurrent assets can be used to meet its short-term needs. Starbuckslags behind at 14.06. The acid test ratio shows one the level ofinvestment that Starbucks has made towards its inventory sinceinventory is never included in the acid or quick test ratios.Further, it also allows one to begin to look at the support figuresin regards to inventory. In these Starbucks rates at 32.27 in theaccounts receivable while Macdonald stands at 15.05.

  1. Leverage Ratio’s

In comparison to both Starbucks and Macdonald by relying on theleverage ratios at the end of the year, Starbucks seems much morefavorable and would be recommendable to investors. The debt ratio ofStarbucks has consistently been at a figure of two point and alwayslesser than MacDonald’s ratio. This simply implies that Starbucksis at a much better chance of being preferred by would be investorssince the debt have been keep at a low figure. Current debt rationstanding of both of these companies is 2.7 for MacDonald and 2.4 forStarbucks which is the much favorable. The fixed charge coverage orthe interest coverage ratios for the two companies are favorablemarketwise to the two companies but Starbucks rates higher with ahigher rating showing its ability to handle any interest paymentswhile showing its capacity to make profits in future for theinvestors. This would mean Starbucks at its rate of 56.37% is muchbetter position than Macdonald who only stands at 3.41 and 4.49.

The second category of ratios that this review outlines is the cashflow to total debt ratios. Being the coverage ratio, it focuses onthe ability of a company to cover the existing total debts with thefunds it raises from its yearly operations or the cash flows. Inthese two companies, Starbucks rates way higher in comparison toMacdonald whose ratios stand between 2.03 and 1.78 in the highestlevel and the lowest levels within the five years. Starbucks ispositioned at a ratio of 3.27 with its lowest figure within the fiveyears being 2.08. This lower figure of Starbucks is much higher incomparison to four years of MacDonald’s being in operation. Inoverall terms all the leverage ratios point favorably towardsinvesting at Starbucks as it does not have a high level of financialcommitment and can pay most of its debts faster.

  1. Profitability Ratios

Profitability ratios are financial analytic tools used in assessing afirm’s ability to generate profits in relation to its expensesduring the period under consideration. Where a company records ahigher profitability ratio than its competitor’s or maintains thesame ratio as the preceding period, it is said to be performing well(Gibson, 2012). From the ratio end, profitability ratioscalculations, it is visible that the net profit margin for Starbuckshas been increasing from 2007 to 2011. Similarly, the net profitmargin for McDonalds has also recorded an increasing trend. However,the net profit margin for Starbucks has a higher value thanMcDonalds. This indicates that Starbucks is doing better thanMcDonalds with respect to net profit margin.

Under the total asset turn over, Starbucks recorded a high ratio in2007 which drastically decreased in the following three years butsignificantly increased in 2011. McDonalds recorded high assetturnover ratio in 2007, but severely fell 2008 and continued todecline through 2011. This is an indicator that Starbucks has abetter ability to generate sales from its assets than McDonalds. Thereturn on assets for Starbucks also indicated an inclining trend from2007 through 2011. On the contrary, the return on assets forMcDonalds recorded a declining trend from 2007 through 2011. This isan indication that profitability for Starbucks assets is growingwhile that of McDonalds is declining.

The operating income margin for Starbucks shows an increasing trendbut at a very low margin. The trend is similar to that observed withMcDonalds for the same period. Starbucks operating income margin ishowever higher than McDonalds’. The ratio end operating assetturnover for Starbucks improved in the period 2007 through 2011 whilethat of McDonalds declined. The return on operating assets forStarbucks showed an inclining trend while McDonalds recorded adeclining trend and at a lower ratio. This shows that Starbucks ismore profitable than McDonalds with respect to total assets. Thesales to fixed assets of Starbucks were high in 2007 but fellseverely in 2008 and increased at an insignificant margin through2011. A similar trend is also observable with McDonalds but at alower ratio. The return on investment and return on total equity forStarbucks was higher than McDonalds during the period. Similarly, thereturn on total equity and gross profit margin for Starbucks was alsohigher than McDonalds during the period. This indicates thatStarbucks had higher profitability performance than McDonalds duringthe period (Wahlen et al, 2011).

  1. Investor Analysis

StarbucksCorporation recorded a higher degree of financial leverage thanMcDonalds over the period. This implies that the EPS for Starbucks ismore volatile to changes in operating income than that of McDonalds.The earnings per share for Starbucks are higher than that ofMcDonalds for the period. The opposite is observed with the priceearnings ratio. This indicates that investors are likely to attainhigher profitability from their shares at Starbucks than McDonalds.The P/E ratio indicates that it is costly to invest in McDonalds thanStarbucks. The percentage of earnings retained for Starbucks ishigher than McDonalds for the period. Starbucks has a retainedearnings average of 2.0 while McDonalds has an average of 0.8 whichindicates that Starbucks has high potential for business growth andexpansion than McDonalds.

Similarly, the dividend yield and the dividend payout for Starbucksare higher than McDonalds during the period. This is an indicationthat investors at Starbucks are earning a higher cash flow returnsfrom their investments than those at McDonalds. The book value pershare for Starbucks is 50%. This implies that common shareholderswould get 50% of remaining value after liquidation of the company.McDonalds has a book value per share of 39%. The materiality ofoptions for Starbucks is constant at 2.01 for the period while thatof McDonalds is 0.02. This implies that Starbucks has high degree offinancial information disclosure than McDonalds. The operating cashflow per share as well as operating cash flow for Starbuck has beenon an inclining trend and at a higher percentage while that ofMcDonalds has been declining. This indicates that McDonalds’financial strength has been weakening over the period. Year-endmarket price for McDonalds during the period was been higher thanthat of Starbucks although both stocks had considerable volatility.The trend for year-end market price for both companies had incliningtrend which shows that the value of the stocks is improving (Wahlenet al, 2011).

Conclusion andRecommendation

The financial analysis reveals that Starbucks and Settle’s BestCoffee has a healthy financial position. The company relies more onequity to finance its operations which lower the degree of risk thatcomes from high reliance on debt. The company has on averagedperformed above the industrial average and as such it as a betterfinancial performance that most of its peers. Even though McDonald’shas a more profitable and finically health business than Starbucks,Starbucks projections indicate that the company is expanding and assuch offers a chance to increase shareholders’ value. As such, itwould be recommendable to invest in the company.

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