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Running Head: STARBUCKS FINANCIAL ANALYSIS

Starbucks Financial Analysis Shelley Dyrda Southern New Hampshire University

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Starbucks Financial Analysis

2 Financial Analysis: Starbucks Corporation

The purpose of the following study is to analyze the competition and develop benchmarks for the purpose of improving profitability and expanding operations for the marginally successful, Midwest-based Coffee Connection. The most similar competitor to the Coffee Connection is the Starbucks Corporation, an American coffee company and coffeehouse chain that is based in Seattle, Washington and includes more than 25,000 shops in 75 countries (Hoovers, n.d.). Therefore, and in order to perform the analysis, there will be multiple tools used to analyze the performance of the Starbucks Corporation as well as research and observations pertaining to the success and challenges faced by Starbucks. The overall goal is to provide information to the Coffee Connection business leaders by creating more in-depth financial accounting statements and all the involved components in order to make better business decisions related to performance and financial health within the coffee shop industry. All in all, the result will aid in creating effective management and informed management decisions. In order to obtain this goal and reach the desired results, the following study will first focus on the analysis of the Starbucks Corporation’s financial condition by interpreting financial information used for informing business decisions. This includes any horizontal and vertical changes in Starbucks’ accounts receivables balances (via the balance sheet and income statement accounts), fixed assets, intangible assets, depreciation, amortization, and short and long-term debt for a two-year period (2014 – 2016). Additionally, the methods for accounting for receivables and evaluating uncollectible receivables and how they affect they ways in which information is communicated; the methods for fixed asset and intangible asset acquisitions as well as depreciation and amortization (and asset categorization) and how they affect the balance sheet, income statement, and statement of cash flows; and the debt financing that encompasses

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current and long-term liabilities and the issuance of bonds. Secondly, this study will analyze and discuss the financial performance of Starbucks using financial ratios. This encompasses liquidity, solvency, and profitability ratios and what each reveal about Starbucks, including the description of benchmarks, standard measurements, and all types of analyses used once the ratio amounts are known. Thirdly, this study will provide an overview of the importance of accounting regulations and reporting requirements in the preparation of financial reports and consideration of the governmental and GAAP reporting policies for what is mandated that is included in Starbucks’ financial statement. This includes required control procedures and reporting consisting of segment information, estimates and assumptions required, investments and fair value required, and leases required and the information disclosed about Starbucks’ regarding all of the above. All in all, the information revealed should provide the Coffee Connection with a learning experience about the overall financial health of a competing business as well as additional suggestions for financial improvements. Vertical and Horizontal Analysis: Starbucks Corporation Overall, Starbucks’ net revenues increased from 2014 to 2015 and from 2015 to 20161. Also, there was an increase between 2014 - 2016 in terms of cost of goods sold, which typically encompasses the cost of materials to produce product, occupancy costs, and involved labor costs2. Both of these factors are increasing which indicate that the overall performance of the company is most likely trending positively and sales objectives are being achieved. It also indicates that Starbucks is growing as a company because when a business is growing, the cost of goods sold is a normal occurrence (Adkins, n.d.). Although, it could be argued that Starbucks should strive for a decrease in the cost of goods sold since it will result “in a larger gross profit 1 See Appendix A – Net Revenue (row 8) 2 See Appendix A – Cost of sales (row 9)

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and an increase in net operating profit” (para. 5). Moreover, in performing a horizontal analysis, which can indicate changes over time in financial line items and the direction a business is taking, it reveals that Starbucks had a slight increase (6.93%) in accounts receivable from 2015 to 20163 (Harrison, Baylor, Horngren, & Thomas, 2014). Additionally, and in conducting a vertical analysis, which reveals a relationship of a financial statement to its base and allows for studies in key financial statistics, it highlights that fact that accounts receivable made up 5.79% and 5.37% of the total assets in 2015 and 20164 (p. 749 & 780). While accounts receivables may account for a lower percent in terms of all assets, it seems to have been consistent in the past two years—indicating no unusual activity in this area. While this may be the case, there is a potential possibility for a trending increase in the near future, as indicated by the 2015 to 2016 figures. One can also conclude a possible relationship between accounts receivable and net revenues (p. 690-691). As net revenue rose, accounts receivable did as well, indicating a correlation. This is when “trend line analysis” is useful – for comparing bad debts to sales over a period of time (“Accounting Receivable Analysis,” n.d.). It can be argued that if “there is a strong recurring trend in this percentage, management may want to take action” (para. 4). If Starbucks does continue to trend upward in terms of bad debt, “management may want to authorize tighter credit terms to customers” (para. 4). Accordingly, Starbucks’ “allowance for doubtful accounts is calculated based on historical experience, customer credit risk and application of the specific identification method” (“Starbucks Fiscal,” p.54). And “As of October 2, 2016 and September 27, 2015, Starbucks’ allowance for doubtful accounts was $9.4 million and $10.8 million” (p.

3 See Appendix B – Accounts Receivable (row 7) 4 See Appendix B – Accounts Receivable (row 7)

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54). This financial information is conveyed in the Starbucks Fiscal 2016 Annual Report where the allowance for doubtful accounts is divided by the gross accounts receivable5. In examining a horizontal analysis of the changes in Starbucks’ fixed assets, intangible assets, depreciation, and amortization over time (2015 – 2016), the results reveal an increase of 10.90% in fixed assets (property, plant, and equipment, etc.), an increase of 9.15% in goodwill, increase of and an increase in depreciation and amortization of 10.31% in 2016, 24.71% in 2015, and a slight decrease of -0.79% in other intangible assets (trade names, trademarks, patents, etc.)6. In examining the same as above in terms of a vertical analysis, the fixed assets make up a total of about 32% of total assets and appear to be consistent overtime7. Within the same time period, other intangible assets make up 4.19% and 3.60%, goodwill accounts for 12.69% and 12%, and depreciation and amortization account for 7.52% and 7.19%8. All of the factors and figures above have remained within the same range within the past few years and therefore do not reveal unusual activity that is troubling or worth investigating. There may be an increase in fixed assets, but as the company may be growing, more equipment, furniture, improvements, etc. may be needed. These fixed assets may make up a large portion of the total assets, but they are vital to the business operations and cannot always be easily liquidated (“Property, Plant,” n.d.). Land, on the other hand, is not amortized as its value can increase—it remains the same over time on the balance sheet (para. 3). According to the Starbucks Fiscal 2016 Annual Report, everything under the property, plant, and equipment, etc. category have carrying amounts as the balance sheet date of long-lived, depreciable assets or physical assets or tangible assets (“Starbucks Fiscal,” p. 54 & 71). All of the assets under this category demonstrate increases on 5 See Appendix D Source: https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Financial-Reporting-Quality/BadDebts#Allowance-for-Doubtful-Accounts-Receivable

6 See Appendix B – (row 13, 16, 17), Appendix C 7 See Appendix B – (row 13) 8 See Appendix B (row 13, 16, 17) and Appendix C

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the balance sheet. “Property, plant and equipment assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities” (p.54). The cash flows does reveal an increase in operating costs and depreciation and amortization from 2014 – 20169. While depreciated expenses related to production and distribution facilities are reflected on the statement of earnings (p. 54). As for intangible assets and goodwill, all increased in 2015 to 2016 and carry amounts as part of the balance sheet data, net of accumulated amortization and impairment and/or impairment charges. In examining a horizontal analysis of changes in Starbucks’ short-term debt, which consists of the current liabilities, and long-term debt, it reveals a short-term debt increase of 24.64% from 2015 – 2016 and a long-term increase of 36.41%10. As for a vertical analysis, the short-term debt accounted for 31.73% of the total liabilities in 2016, which is also an increase from the previous year. The long-term debt, which accounted 22.35% of the total liabilities in 2016, also increased per the previous year11. Short-term debt can be an important factor in determining the company’s performance since the debt is larger than the cash and cash equivalent account (“Short Term Debt,” n.d.). This may be an indicator in terms of a cash shortage and therefore there are a lack of funds to pay off the debt (para. 2). Since there are many increases of debt, the analysis can serve as a possible alert for a course of action to be taken. As for financing activities, the statement of cash flows show that the proceeds of longterm debt have increased from 2014 to 2016. Additionally, the total accrued liabilities have increased from 2015 to 2016. This could possibly mean that since the balance is high and if each liability remains outstanding for a long time, this can create more cash flow. Starbucks also utilizes short-term and long-term debt financing and this includes interest rate hedges to manage 9 Starbucks Fiscal 2016 Annual Report p. 48 10 See Appendix B (row 36 & 37) 11 See 10

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all interest expense related to the existing fixed rate debt (“Starbucks Fiscal,” p. 41). The interests have shown increases as well. A component of long-term debt, including the interest rates is the issuance of bonds (p. 71). According to the Starbucks Fiscal 2016 Annual Report, Starbucks has issued bonds in 2016 and will continue to do until 2045 (that mostly encompass an increasing interest rate and long-debt maturities) (p. 74). When a company typically issues a bond, they will receive cash and report it in the cash inflow for that year, record it as a corresponding liability, and will pay interest until the bond is repaid (Cromwell, n.d. & “Issuance of Bonds,” n.d.). Since the interest rates and market are the same, Starbucks bonds will most likely be sold at face value (“Issuance of Bonds,” para. 6). Key Financial Statement Ratios and the Starbucks Corporation Financial ratios are used to express a relationship between financial statement items, provide historical data that management, at a company such as Starbucks, can use to identify strengths and weaknesses, and to estimate a company’s future financial performance (Basu, n.d.). There are three broad categories of financial ratios: liquidity, solvency, and profitability. Liquidity “measures how quickly an item can be converted to cash” (Harrison, Baylor, Horngren, & Thomas, 2014). It is typically managers, stockholders, and creditors who care about the liquidity of a company’s assets (p. 271). Assets are mainly found on the balance sheet in the order of a liability (p. 431). And long-term investments are typically less liquid than short-term due to the fact that a company neither intends “nor has the ability to liquidate them within the current year or operating cycle” (p. 431). A liquidity ratio that is common is the current ratio, which is the ratio of current assets to current liabilities (Basu, para. 2). The current ratio is calculated by dividing current assets by the total current liabilities. “Acceptable current ratios vary from industry to industry and are

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generally between 1.5% and 3% for healthy businesses. If a company's current ratio is in this range, then it generally indicates good short-term financial strength” (“Current Ratio,” n.d.). If the value of the current ratio is considerably high, then it could indicate that a business may not be using its current assets efficiently—it serves as a warning to problems in managing working capital (para. 4). On the other hand, and when the ratio is low (current liabilities exceed current assets), it could indicate that a company may be having difficulties meeting its short-term obligations/current liabilities (para. 5). For example, and in terms of Starbucks, this could reveal their ability to pay off its short-term bills. A high ratio would indicate a “safety,” which increases their flexibility because some of the inventory and balances on the receivables may not be able to be converted easily to cash (Baus, para. 2). In 2015 and 2016, Starbucks’ current ratios were about 1.09 and 1.0312. Both years seem to have ended with similar results and were close to the industry average of 1.1413. The current ratio is slightly larger than 1 and Starbucks should continue to strive for one that is higher to provide additional “padding” against unforeseeable events/incidental expenses that may arise. The ratio is within the “healthy” range and therefore is an indicator of good short-term financial strength. Starbucks is most likely using their current assets efficiently. The quick ratio or acid test ratio is a liquidity ratio that reveals how well a company can quickly convert its assets into cash to pay off current liabilities (Harrison, Baylor, Horngren, & Thomas, p. 271). “The quick ratio is used to identify problems that a company may have paying off its current liabilities”—when a company has assets but cannot convert any of them to cash to pay debts (Arbuckle, n.d.). The quick ratios for Starbucks in 2015 and 2016 were .64 and .67—

12 See Appendix E 13 2015 industry comparison - Source: https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Long-Term-Trends/CurrentRatio#Comparison-to-Industry

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indicating a ratio below 114. However, a quick ratio of 1 or above is considered to be more than satisfactory (para. 4). When a ratio is at 1, it most likely means the quick assets are equal to the current liabilities (para. 4). Therefore, a company will not have trouble paying its short-term debts (para. 4). It is probably best for Starbucks to achieve a higher ratio (above 1). Additionally, the industry average falls at about .5515. This fact indicates that there are companies in the same industry that may have twice as much in current liabilities as quick assets and have trouble paying current liabilities (para. 4). Accordingly, asset management ratios are important to analyzing how effectively a business is managing its assets to produce necessary sales (Peavler, 2017). “Asset management ratios are also called turnover ratios or efficiency ratios” (para. 1). The inventory turnover ratio is one of the most important asset management ratios (para. 3). This number will reveal the number of times inventory is sold and restocked each year (para. 4). For Starbucks, the inventory turned over about 6 times in 2015 and 201616, which is lower than the industry average of roughly 817. This could indicate that Starbucks may have a low turnover rate two years in a row and therefore may not be selling products efficiently. This could be the result of expired or perished products or purchasing too much inventory for demand (Kokemuller, n.d.). The receivable turnover is a ratio that provides a business owner the state of the accounts receivable (Peavler, para. 13). In other words, how many times each year a business cleans up or collects their accounts receivable (para. 13). “The higher the receivables turnover, the better as it means you are collecting your credit accounts on a timely basis. If your receivables turnover is low, you need to take a look at your credit and collection policy and be sure they are on target” 14 See Appendix E 15 Industry MRQ - Source: http://csimarket.com/stocks/SBUX-Financial-Strength-Comparisons.html 16 See Appendix E 17 2015 Industry comparison - Source: https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Ratios/Short-term-OperatingActivity#Inventory-Turnover

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(para. 14). For 2015 and 2016, the accounts receivable ratios for Starbucks were 26.65 and 27.7318, which are higher than the industry average of 22.4219 therefore pointing to a higher receivable turnover. Therefore, Starbucks is collecting their credit accounts on a timely basis. Furthermore, solvency is the ability for a company like Starbucks to meet long-term financial obligations and assesses a company’s ability to continue into the future (Basu, para 2). Solvency also relates to the ability of paying long-term debts and those connected to interest. To be solvent, the value of the assets must be greater than the sum of its debt. It therefore becomes a measure of financial stability (para. 3). “The debt-to-asset ratio is the ratio of total debt to total assets” (para. 3). This can be used, for instance, to show how a company like Starbucks has maybe taken on too much debt, and “used to measure an enterprise’s ability to meet its debt and other obligations…whether a company’s cash flow is sufficient to meet its short-term and longterm liabilities” (para. 5). Of course, the lower the solvency ratio, the greater a company will default on their debt (para. 5). Debts to assets, which is a solvency ratio, measures the percentage of a company’s assets that have been financed with debt (Investopedia staff, 2016). “A higher ratio indicates a greater degree of leverage, and consequently, financial risk” (para. 7). Respectively, the debt to asset ratios for Starbucks in 2015 and 2016 were .19 and .2220. Accordingly, the industry average is approximately .5321 and therefore, Starbucks’ debt to asset ratio comes in on the high side in comparison to other establishments within the same industry. Being considerably high within the industry, this could possibly mean greater risk that cash flows from operations will be insufficient to cover interest and principle payments. The debt to assets ratio has also increased 18 See Appendix E 19 2015 Industry comparsion - Source: https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/Ratios/Short-term-OperatingActivity#Receivables-Turnover

20 See Appendix E 21 Industry average debt to assets - Source: http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=sbux

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slightly from 2015 to 2016 and Starbucks should watch this as only time will tell if the situation will deteriorate in the future. The debt to equity ratio indicates the degree of financial leverage that encompasses both short and long term debt (para. 6). A rising debt to equity ratio also indicates higher interest expenses and it may affect credit rating, which ...