m annaggeerriiaall ffiinnaannccee bus 635 co stco · the scope of this term paper was based on the...
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
1
1.1 INTRODUCTION & OVERVIEW OF THE COMPANY
This term paper has been undertaken as one of the requirements of
Managerial Finance course (BUS 635) and has been prepared for Dr. H. M.
Mosarof, faculty of North South University. The basic purpose of this term
paper is to analyze a merchandising company‟s financial condition over a four
year period. Merchandising companies purchase the products in a ready-to-
sell condition and then sell it to other companies. Since they do not have to
make the inventory, their operating cycle is typically shorter. Here, in this term
paper, we have chosen COSTCO as the merchandising company.
Costco Wholesale Corporation and its subsidiaries (“Costco” or the
“Company”) began operations in 1983 in Seattle, Washington. In October
1993, Costco merged with The Price Company, which had pioneered the
membership warehouse concept, to form Price/Costco, Inc., a Delaware
corporation. In January 1997, after the spin-off of most of its non-warehouse
assets to Price Enterprises, Inc., the Company changed its name to Costco
Companies, Inc. On August 30, 1999, the Company reincorporated from
Delaware to Washington and changed its name to Costco Wholesale
Corporation, which trades on the NASDAQ under the symbol “COST.” As of
December 2010, the Company operated a chain of 582 warehouses in 40
states and Puerto Rico (425 locations), nine Canadian provinces (80
locations), the United Kingdom (22 locations), Korea (seven locations),
Taiwan (six locations, through a 55%-owned subsidiary), Japan (nine
locations) and Australia (one location), as well as 32 warehouses in Mexico
through a 50%-owned joint venture.
1.2 PURPOSE OF THE TERM PAPER
The purpose of this term paper is to know about the comparative financial
conditions of COSTCO over a four year period.
1.3 SCOPE OF THE TERM PAPER
The scope of this term paper was based on the annual reports of COSTCO.
We had done ratio analysis, common size analysis and trend analysis to know
about the financial condition of COSTCO.
The ratio had been analyzed with respect to time series analysis. In the ratio
analysis five major types of ratios had been considered, namely
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
2
Liquidity Ratio
Debt Management Ratio
Asset Management Ratio
Profitability Ratio
Market Value Ratio
1.4 METHODOLOGY
We have collected secondary data from the balance sheet and income
statement of annual reports of 2007 to 2010. Both primary and secondary
information was used to prepare this term paper were collected from annual
reports and websites of the company.
1.5 LIMITATIONS
Because of time constraints we had to limit our analysis within the last
4years of data.
In the financial statements of the company some information was not
present.
We also had to rely heavily on the information that was provided on the
internet. As COSTCO is situated in Washigton we had to collect data from
its website since it was impossible for us to visit the company‟s head
office.
Primary data such as interviews with the company‟s managers and
officials are not collected due to time constraint which can provide great
insight into the actual scenario of the company from the inside.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
3
2.1 ANALYSIS OF BALANCE SHEET
Asset
Current Asset
Current assets of Costco Wholesale Corporation have grown quite steadily
over the years. In 2007 current assets of company was 9324 million US
dollars. In 2009 it was $10337 million. In 2010 current assets of company
increased to $11708 dollars. From the graph, we see that from the year 2007
to year 2009 there is a steady growth but in the year 2010 the rate of growth
was higher than the previous years. A healthy amount of current assets are
important for any company as it will eventually increase its solvency and
improve creditworthiness.
Fixed Asset
Costco Wholesale Corporation has invested quite intensely an amount of
$9519 million in the year 2007. In the year 2008 there is a sharp increase in
the total fixed assets. After that fixed asset continued to grow quite steadily till
year 2010.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
4
Total Asset
There is a steady increase in the company total asset from year 2007 to 2010.
The total asset in the year 2007 was $ 19606 million which stood at $23815
million in the year 2010.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
5
Liability and Equity
Total Liabilities
Total liabilities of Costco Wholesale Corporation continued to rise over the
years from 2007 and 2010. From 2007 to 2009 total liabilities increased
steadily but it showed a sharp increase in 2010. In 2009 total liabilities was
$11875 million and in 2010 it was $12885 million.
Shareholder’s Equity
Over the years shareholders of Costco Wholesale Corporation have
experienced healthy growth in the total equity. In 2007 it was $8623 million. In
2010 it becomes $10930 million.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
6
2.2 ANALYSIS OF CASH FLOW
Cash flow is a statement reporting the change in net cash position, from the
beginning to the ending affected by firms operating, investing and financing
activities. It is designed to show how the firm‟s operations have affected its
cash position by examining the investment (use of cash) and financing
decisions (sources of cash) of the firm. It helps us to identify whether the firm
is generating sufficient cash to purchase additional fixed assets for growth,
whether the firm has excess cash flows to repay debt or to invest in new
products. This information is useful for both financial managers and investors.
So we constructed the cash flow statement of COSTCO for four consecutive
years and interpret on few important items of the statement which cause
major changes in net cash of the firm and also determine its liquidity position.
After constructing the cash flow for four years we found that the ending cash
balance was positive throughout the whole four years. From the graph we see
that the cash holding position of the company improved over the five years
except a decline in 2008. But there was a sharp upward movement in 2009. At
the year end 2010 the company is holding 3214 million US dollars which
indicate the high liquidity of the company. The company can able to maintain
such cash because of the well cash management in Operating & Financing
activities. Those are explained below:
Cash flow from Operating Activity
The operating cash flows generated principally from the day to day operation
of the firm.
There are both ups and downs in net cash flow from operating activities. In FY
2007 net cash from operating activities was $2780 million. The figure declined
drastically in the year 2008. After that it continued to rise. Net cash provided
by operating activities totalled $2,780 in 2010 compared to $2,092 in 2009.
This net increase of $688 was primarily attributable to a $371 decrease in
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
7
Costco‟s net investment in merchandise inventories an increase in net income
of $224, and a $141 increase from the change in our other current operating
assets and liabilities
.
Cash flow from Investment Activity
The second section of cash flow shows cash flow from investing activities.
After constructing the cash flow statement we found that Costco‟s cash flow
from operating activities was fluctuating over the years and remained
negative. Net cash used in investing activities totalled $2,015 in 2010
compared to $1,101 in 2009, an increase of $914. This increase relates
primarily to a $1,113 decrease in cash provided by the net investment in
short-term investments, partially offset by a $195 decrease in cash used for
purchase of property and equipment.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
8
Cash flow from financing Activity
Cash flow from financing deals with long term loan, notes payable, any
dividend offered in the FY and also any change in common stock.
From the cash flow statement we see that the company has negative cash
flow at financing activities from 2007 to 2010. Net cash used in financing
activities totaled $719 in 2010 compared to $439 in 2009, an increase of
$280. This increase was primarily attributable to a $482 increase in cash used
to repurchase common stock, a $78 increase in repayments of long-term debt
and a $42 increase in dividends paid. These were partially offset by a $124
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
9
increase in the net proceeds from stock-based awards and, a $116 increase
in the net proceeds from short-term borrowings.
2.3 RATIO ANALYSIS
Ratio analysis is the calculation and comparison of ratios which are derived
from the information in a company's financial statements. The level and
historical trends of these ratios can be used to make inferences about a
company's financial condition, its operations and attractiveness as an
investment. To evaluate a firm‟s financial condition and performance, the
financial analyst usually performs analysis on various aspects to find out the
financial health of the firm; among which ratio analysis is one of the most
important and commonly used methods.
Here in this section we are going to derive few commonly used financial ratios
over time which will help us to determine the improvement or deterioration in
its financial position.
Five major categories of ratios are:
Liquidity ratios
Asset Management ratios
Debt Management ratios
Profitability ratios
Market Value ratios
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
10
2.3.1 LIQUIDITY RATIO
Liquidity or Short Term Solvency ratios are used to determine a company's
ability to pay off its short-terms debts obligations. The higher the value of the
ratios, the larger will be the margin of safety that the company possesses to
cover short-term debts. It shows the relationship of a firm‟s cash and other
current assets to its current liabilities. Different types of liquidity ratios are
discussed below.
Current Ratio
Current Ratio is the ratio of current assets to current liabilities. The current
ratio indicates the ability of a company to pay its current liabilities from current
assets and shows the strength of the company‟s working capital position.
Current ratio of 2:1 is considered to be a healthy condition for most
businesses. The ratio is calculated as follows:
Current Ratio = Current Assets / Current Liabilities
The following table shows the Current Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 1.09 X 1.07 X 1.11 X 1.16 X
Explanation The Current Ratio measures the firm‟s ability to meet its short-
term obligations. From the graph above, we have found that in 2007 COSTCO
current ratio was 1.09X, which in 2008 came down to 1.07X. However, since
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
11
that year COSTCO was able to raise the current ratio till 2010 through
controlling its level of current assets and current liabilities. In 2010, the
company‟s current ratio was 1.16X which means that COSTCO now has
better ability to meet its short-term obligations than before.
Quick Ratio
The Acid-test or quick ratio measures a company's ability to meet its short-
term obligations with its most liquid assets. Inventories typically are the least
liquid of a firm‟s current assets – they are the assets on which require more
time to be sold and losses are most likely to occur in the event of liquidation.
Therefore, it is important to measure the firm‟s ability to pay off short term
obligations without having to rely on the sale of inventories. Quick ratio of 1:1
is considered to be a healthy condition for most businesses. It is calculated as
follows:
Quick Ratio= (Current Assets- Inventories)/ Current Liabilities
The following table shows the Quick Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 0.52 X 0.50 X 0.53 X 0.60 X
Explanation The Quick Ratio is similar to the current ratio except that it
excludes inventory, which is generally the least liquid current asset. From the
graph above, we see that in 2008, COSTCO had the lowest Quick Ratio of
0.50X throughout its four year period. However, in 2007 and 2009 the
company was unable to hold onto a high level of Quick Ratio due to high
inventory level. But in 2010, COSTCO was able to reduce its inventory level
which resulted in 0.60X Quick Ratio.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
12
Overall comment on Liquidity Ratios
COSTCO liquidity position gradually improved over the four years and it
slightly fall down in 2008 because of huge amount of inventory piled up from
which company will get the benefits in future. However, Compared to its
competitor WAL-MART1 Costco‟s overall liquidity position was much better
over the years.
2.3.2 ASSET MANAGEMENT RATIO
A set of ratios that measure how effectively a firm manages its assets
compared to its sales. These ratios are designed to find out whether the total
amount of each type of asset as reported on the balance sheet appear
reasonable, too high, or too low considering current and projected sales
levels. Asset Management Ratio is done based on inventory turnover ratio,
day‟s sales outstanding and fixed asset and total asset turnover ratio.
Inventory Turnover Ratio
Inventory turnover measures the speed with which inventories move through
operations. It is computed as follows:
Inventory turnover ratio= Cost of goods sold or Sales Revenue / Average
Inventory
This ratio is used to assess the efficiency in managing (selling) the inventory.
An increase in the inventory turnover is normally desirable. However, if the
turnover is low it means that the company is either overstocking or building up
a stock of obsolete merchandise. Too high an inventory indicates excess
resources are being used up in working capital instead of being used to earn a
return. If the turnover is too high, the company may lose sales because the
goods are not in inventory when customers want them.
1 www.wikiinvest.com
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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The following table shows the Inventory Turnover Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 11.95X 12.8X 11.94X 12.31 X
Explanation The increase in Costco‟s inventory turnover from 11.95 to 12.8
indicates that the management of inventory has improved in 2008. In 2009
inventory turnover ratio declined from 12.8 to 11.94, a 6.7% decline compared
to the previous year. However, in the year 2010 the ratio started to increase
once again.
Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO): 365/Accounts Receivables turnover
Year 2007 2008 2009 2010
Costco Wholesale 3.84
days
3.88
days
5.1
days 4.11 days
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
14
Explanation: The Average Collection Period or Days Sales Outstanding is
useful in evaluating collection of credit from its customers. Here, we found that
in 2007 and 2008 Costco had low DSO of 3.84 days and 3.88 days
respectively. In 2009 the ratio was increased to 5.1 days but in 2009 DSO
decreased to 4.11 days.
Fixed Asset Turnover
Fixed Asset Turnover ratio measures the amount of sales generated for every
dollar's worth of fixed assets. The fixed asset turnover ratio is calculated by
dividing sale by total assets. It is calculated as follows:
Fixed Assets Turnover Ratio = Sales Revenue/ Fixed Assets
The following table shows the Fixed Asset Turnover Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 6.62X 6.85X 6.41 X 6.74 X
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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Explanation: The Fixed Assets Turnover Ratio measures how effectively the
firm uses its fixed assets including plant and equipment to help generate
sales. We can see that Costco‟s fixed asset turnover ratio had soared up from
6.62X in 2007 to 6.85X in 2008. Although the ratio has declined in 2009, it
showed an increasing trend again in 2010.
Sales Turnover or Total Asset Turnover
Sales Turnover or Total Asset Turnover ratio measures the amount of sales
generated for every dollar's worth of assets. The total asset turnover ratio is
calculated by dividing sale by total assets. It is calculated as follows:
Sales Turnover or Total Assets Turnover = Sales Revenue/ Total Assets
The following table shows the Sales Turnover or Total Asset Turnover data of
COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 3.22X 3.43X 3.18X 3.2X
Explanation: The Total Assets Turnover indicates the efficiency with which
the firm uses all its assets to generate sales. Like the previous ratio, Costco
had higher Total Assets Turnover ratio of 3.43X in 2008, but it failed to
maintain that level till 2010.It means that Costco is not generating a sufficient
volume of business given its investment in total assets.
Overall comment on Asset Management Ratio
By analyzing the all types of asset management ratio, we see that all the
ratios showed rising trend in 2008. After that all the ratios started declining.
This is partly because of financial crisis that hit the whole financial market
adversely in the year 2008. Nonetheless, all the ratios started increasing
again from 2010. Compared to its competitor WAL-MART2 Costco was able to
2 www.wikiinvwst.com
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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manage high inventory turnover ratio through out all the four years. That
means the company is efficiently managing its inventory. Higher DSO of
Costco compared to WAL-MART also indicates that Costco has a effectively
managed credit and collection department than that of the competitor.
2.3.3 DEBT MANAGEMENT RATIO
Debt Management ratios help to evaluate a company's long-term solvency
measuring the extent to which the company is using long-term debt. This ratio
reflects how effectively a firm is managing its debts. It helps the analyst to
determine the extent to which borrowed funds have been used to finance
assets and review how well operating profits can cover fixed charges such as
interest.
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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Debt Ratio
The debt ratio indicates how much of a company's assets are provided
through debt or the percentage of the firm‟s assets financed by creditors. Total
debt includes both current liabilities and long term liabilities. Creditors prefer
low debt ratios, because the lower the ratio, the greater the cushion against
creditor‟s losses in the event of liquidation. The owners on the other hand can
benefit from leverage because it magnifies earnings, and thus the return to
stockholder. But, too much debt often leads to financial difficulty, which
eventually might cause bankruptcy. It is calculated as follows:
Debt Ratio= Total Debt/ Total Assets
The following table shows the Debt Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 56% 55% 54% 54%
Explanation: The Debt Ratio measures the percentage of the firm‟s assets
financed by creditors. Lower ratio of debt is preferred than the higher ratio,
because it works as a cushion against creditor‟s losses. In 2007 Costco had
highest debt ratio of 56% among the four year period. The debt ratio
decreased significantly from 2008, it was 55% indicating that Costco was
reducing its investment. However, we can see that the company‟s debt ratio
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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was declining over the years. It is an indication that Costco is repaying its
debt.
Time Interest Earned Ratio
The TIE ratio measures the extent to which earnings before interest and taxes
(EBIT), also called operating income, can decline before the firm is unable to
meet its annual interest cost. Failure to meet this obligation can bring legal
action by the firm‟s creditor, possibly resulting in bankruptcy. The TIE ratio is
computed by dividing earning before interest and taxes (EBIT) by interest
charges. It measures the ability of the firm to meet its annual interest
payments. The TIE ratio is calculated as follows:
Interest Coverage Ratio or Times interest earned ratio = Operating
Income or EBIT/ Interest expenses
The following table shows the Interest Coverage or Times interest ratio data of
COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 27.68 X 20.48 X 17.00X 19.50 X
Explanation: Times Interest Earned ratio measures the ability of the firm to
meet its annual interest payments. The higher its ratio value, the better is the
firm‟s ability to fulfill its interest obligations. Costco‟s had 27.68X TIE ratios in
2007, but it had decreased to 20.48X in 2008. The company‟s TIE ratio further
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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plummeted to 17.00X in 2009.TIE ratio started to increase again in 2010. This
means that Costco‟s is not as much able to meet its annual interest payments
as it was in 2007.
Debt Equity Ratio
The ratio between total debt & total equity is termed as Debt Equity Ratio.
Debt Equity Ratio (DER) gives an indication by what factor the total debt is,
compared to the total equity of a company.
Debt Equity = Total Debt / Total Equity
The following table shows the Debt Equity Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 1.26X 1.24 X 1.17X 1.18 X
Explanation: Costco‟s debt Equity ratios has decreased to 1.24 in 2008 than
the following year also decreased than it‟s started increasing. As lower debt
equity ratio is better for a company, so we can say that Costco‟s condition is
improving.
Overall comment on Debt Management Ratio
The management is efficient enough in managing their debt since over the
five year period their debt ratio was in the range of 50-60%. Although the
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MMAANNAAGGEERRIIAALL FFIINNAANNCCEE
BUS 635 COSTCO
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management should be concern in improving the TIE ratio, compared to WAL-
MART3 it performed much better.
2.3.4 PROFITABILITY RATIO
Profitability ratios show the combined effect of liquidity, asset management,
and debt management on operating results. It is the net result of a number of
policies and decisions. A group of ratios showing the effect of liquidity asset
management, and debt management on operating results, the ratios are profit
margin on sales, return on asset (ROA) and return on equity (ROE).
Net Profit Margin
Net Profit Margin is the ratio of profitability calculated as net income divided by
sales revenues, or net profits divided by sales. It measures how much out of
every dollar of sales a company actually keeps in earnings. Profit margin is
very useful when comparing companies in similar industries. A higher profit
margin indicates a more profitable company that has better control over its
costs compared to its competitors. Profit margin is displayed as a percentage;
a 20% profit margin, for example, means the company has a net income of
$0.20 for each dollar of sales. It is calculated as follows:
Net Profit Margin = Net Income/ Sales Revenue
The following table shows the Net Profit Margin Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 1.7% 1.8% 1.5% 1.7%
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Explanation: The Net Profit Margin measures the percentage of each sales
amount remaining after all costs and expenses, including interest, taxes, and
preferred stock dividends. A higher net profit margin is ideal. In this case, we
see that Costco‟s experienced ups and downs in earning net profit from
business. Its net profit margin was 1.7% in 2007, 1.8% in 2008, the net profit
margin fell to 1.5% in 2009 and again rose to 1.7% in 2010. This was due to
incurring high operating expenses and repaying debt payments which the
company borrowed for investment purposes.
Gross Profit Margin
The ratio between Gross Profit & Sales Revenue is termed as Gross Profit
Margin (GPM). Gross Profit Margin (GPM) gives an indication of profit per
Taka of sales and is calculated by dividing the Gross Profit by the Sales
revenue.
Gross Profit Margin = Gross Profit / Sales Revenue
The following table shows the GPM Ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 12.6% 12.65% 13.00% 13.04%
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Explanation:
The gross profit margin ratio is used as one indicator of a business's financial
health. The higher the gross profit margin ratio the better is the financial
performance. Here, we can see that Costco‟s gross profit margin continued to
increase over the last four years which is an indication of better financial
health.
Operating Profit Margin
The ratio between Operating Profit & Sales Revenue is termed as Operating
Profit Margin (OPM). Operating Profit Margin (OPM) gives an indication of
operating profit per Taka of sales and is calculated by dividing the Operating
Profit by the Sales revenue.
Operating Profit Margin = Operating Profit / Sales Revenue
The following table shows the OPM ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 2.55% 2.77% 2.54% 2.72%
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Explanation: Operating profits are „pure‟ because they measure only the
profit earned on operations and ignore interest, taxes, and preferred stock
dividends. A higher profit margin is ideal. Here, we found that Costco‟s
operating profit margin declined in 2.55% in 2007, with a little hike in 2008, to
2.54% in 2009. In 2010 it again rose to 2.72%, slightly lower compared to the
year 2008. So we can see that Costco‟s operating profit margin was
fluctuating from year to year.
Return on Asset (ROA)
Return on Asset (ROA) an indicator of how profitable a company is relative to
its total assets. It gives an idea as to how efficient management is at using its
assets to generate earnings. It is calculated by dividing a company's annual
earnings by its total assets, ROA is displayed as a percentage. Sometimes
this is referred to as "return on investment". The ROA after interest and taxes
are computed as follows:
Return on Asset (ROA) = Net Income / Total Assets
The following table shows the Return on Asset (ROA) data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 5.5% 6.2% 4.9% 5.4%
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Explanation: ROA measures the overall effectiveness of management in
generating profits with its available assets. Here, we see that Costco‟s had
ROA of 5.5% in 2007, which plummeted to 6.2% in 2008. It further went down
to 4.9% in 2009 but rose a little bit in 2010 by a mere 5.4%.
Return on Equity (ROE)
Return on Equity (ROE) is the amount of net income returned as a percentage
of shareholders equity. It measures a company's profitability by revealing how
much profit a company generates with the money shareholders have invested.
The return on equity (ROE) is measured as follows:
Return on Equity (ROE) = Net income available for common
stockholders’ / Common Equity
The following table shows the Return on Equity (ROE) data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale 12% 14% 11% 12%
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Explanation: ROE measures the return earned on the common stockholders‟
investment in the firm. In 2007, ROE of Costco‟s was 12%, it rose to 14% in
2008. However, ROE fell to 11% in 2009 and rose a bit in 2010, by 12%. This
was because Costco‟s net income fell significantly in 2009 compared to net
income of 2008.
Overall comment on Profitability Ratio
Compared to WAL-MART4 Costco‟s management is not efficient at using its
asset to generate earnings. ROE indicates that costco is less capable of
generating cash internally.
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2.3.5 MARKET VALUE RATIO
MARKET VALUE RATIO
The Market Value Ratios represent a group of ratios that relates the firm‟s
stock price to its earnings and book value per share. These ratios give
management an indication of what investors think of the company‟s past
performance and future prospect. If the firm‟s liquidity, asset management,
debt management, and profitability ratios are all good then market value ratios
will be high which will lead to an increase in the stock price of the company.
A set of ratios that relate the firm‟s stock price to its earnings and book value
per share, two ratios like price earnings ratio and market book value ratio
these gives management an indication of what investors think of the
company‟s past performance and future prospects. If the firm‟s liquidity, asset
management, debt management and profitability ratios are all good then its
market value ratios will be high and its stock price will also be higher than its
book value per share and vice versa.
Price-earnings Ratio or Earnings Multiple
This is the ratio of the price per share to earnings per share. It shows how
much investors are willing to pay per dollar of reported profit. It is calculated
as follows:
P/E Ratio = Market Price per Share/ Earnings per Share
The following table shows the P/E Ratio data of COSTCO
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Year 2007 2008 2009 2010
Costco Wholesale 28.05X 18.1X 24.00X 23.8X
Explanation: The P/E ratio measures the amount that investors are willing to
pay for each dollar of a firm‟s earnings. But Costco‟s P/E ratio decreased from
28.5X in 2007 to 23.8X in 2010. This was due an increase in the earnings per
share of Costco. However, in 2009 price of Costco‟s share fell due to
comparatively poor performance and as a result EPS also fell and so the P/E
ratio fell to 24.0X and 23.8X in 2010.
Earnings per Share
The ratio between the net profit & total number of outstanding shares is given
by Earnings per Share (EPS). It is an indicator of the overall operational
profitability of the company, as well as the performance. EPS can be used as
a barometer for measuring the firms potential for generating future cash flows.
Earning per Share (EPS) = Net Income Available for Common
Stockholders’/Number of Common Shares outstanding
The following table shows the EPS ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale $2.37 $2.89 $2.47 $2.92
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Explanation: Earnings per Share for Costco were higher in the year 2008 and
2010 which is due to the higher net income generated by the company.
However, in 2007 the company‟s Earnings per Share ratio fell sharply to $2.37
and again in 2009 to $2.47 due to lower net income available for common
shareholders.
Book Value per Share
Book Value per Share or BVPS is the ratio between the common equity/net
worth and the number of common shares outstanding (amount).
Book Value per Share = Common Equity or Net Worth / Number of
Common Shares Outstanding
The following table shows the Book Value per Share ratio data of COSTCO-
Year 2007 2008 2009 2010
Costco Wholesale $19.73 $21.25 $22.98 $24.98
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Explanation: From the above data given, we can see that Book Value per
Share of Costco increased consistently since 2007. Book Value per Share
was $19.73 in 2007, and till 2010 it is $24.98. This is due to Costco‟s
consistent performance in the business.
Overall comment on Market Value Ratio
In terms of EPS it can be said that WAL-MART5 had performed better than
Costco.
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3.1 RECOMMENDATION & CONCLUSION
Costco will remain a key player in the retail market today. As it
continues its growth, Costco will need to identify strategic opportunities to
advance their company. Looking toward the future, management needs to
take advantage of growing market areas while also taking advantage of
existing markets to take a larger market share. Costco must also take risk to
enter these new markets before the competition does. There are few new
competitors entering the retail market of Costco since the barriers to entry are
so great, but it still has great competition of Wal-Mart, WinCo, and Fred
Meyers. Therefore management needs to be very proactive in the marketing
of Costco, making sure to do its research into new markets. Since Costco is
very financially sound, it is best to take advantage of research and
development to make them a better company, especially while the company
has the means to do it. Factors to look for are where are the competition
going, what are the international laws and requirements to enter a new
market, and what are not just the financial benefits, but also the other benefits
of expanding their business.
The Costco Corporation is very strong, and continues that way. One
of its main strengths is that it is a very liquid company. It has billions in cash
and cash equivalents that allows it to finance future growth. Another financial
strength is that Costco has high investments into fixed assets, so that if
crunch time came, it could make those fixed assets liquid to cover liabilities.
Having a very liquid company that can invest into its future is a sign of strong
financial performance.
The main weakness of Costco is that it also a surplus of cash on hand.
It could be aggressively using the retained earnings and cash to finance
greater growth, and to be invested in more long term investments.
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Costco has kept a sound financial plan over the last five years and its
management‟s intentions to keep Costco on top of the market. As we come
into the future of the retail market, Costco shows promises of strong growth
and a greater market share.
3.2 BIBLIOGRAPHY
1. Annual Report of 2007-2010.
2. Besley & Brigham, „Essentials of Managerial Finance‟, 14th
Edition, Besley & Brigham.
3. http://www.advfn.com/p.php?pid=financials&btn=s_ok&mode=an
nual_reports&symbol=NYSE:WMT&start_date=13
4. http://quicktake.morningstar.com/stocknet/efficiencyratios10.asp
x?symbol=wmt
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APPENDIX
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