Ratio Analysis
The accounting data helps to know the performance of the organization. Accounting is
the means by which information about an enterprise is communicated and, thus, is
sometimes called the language of business. We can use the ratios to evaluate the
performance of the Starbucks.
A ratio is nothing more than a simple division of two numbers. Often numbers by
themselves do not convey anything until they are related. It needs a contextual
reference. In financial analysis, we need qualitative information and try to read between
the numbers. We have to ask all the right questions. Over the years, there are some
ratios, which have become more popular and handy for rule of thumb analysis of
financial statements. Our purpose in this note is not deride them but to advice the
reader to use them properly to derive the correct results. Ratio analysis can also help us
to check whether a business is doing better this year than it was last year; and it can tell
us if our business is doing better or worse than other businesses doing and selling the
same things. In other words it helps in inter firm and intra firm comparison.
Liquidity Analysis
Liquidity is a company’s ability to meet its maturing short-term obligations. Liquidity is
important for conducting business activity especially in times of adversity such as when
operating losses occur due to economic conditions or drastic price increases of raw
materials or parts. Liquidity must be sufficient to cushion such losses.
Some ratios of liquidity:
Current Ratio. The current ratio is another way to express the relationship between
current assets and current liabilities. A current ratio of less than 1:1 is usually
unacceptable since in that case current liabilities would exceed current assets—a
warning that there may soon be a cash flow problem. A general rule of thumb calls for a
current ratio of 2:1. For example, Starbucks had an average current ratio of .79 in 2006
and is comparable to the industry, so its liquidity position seems to be stronger but if we
see the quick ratio, is not up to mark. It’s less than industry average. Thus near term
liquidity of Starbucks is less than adequate.
Asset Utilization
Asset utilization ratios such as total asset turnover measure the speed at which a
company turns over long-term assets, important for weighing and evaluating the
operating performance of a company. The value becomes useful and quantifiable when
measured only in relation to others in the same industry. This ratio measures how
productive the assets are in terms of generating sales for the company. Some asset
utilization ratios are:
Days sales outstanding
This is a measure of how quickly accounts receivables are turned into cash. This ratio is
used to evaluate credit management and account collection practices. A decrease in
days sales outstanding is considered favorable. Starbucks days’ sales outstanding is
slightly higher than the industry. But still, this is good.
Inventory turnover ratio
The inventory turnover ratio measures how quickly inventory is converted into sales.
This ratio is used to evaluate inventory management. An increase in the inventory
turnover (and a decrease in the average sale period) would usually be considered
favorable. Starbucks inventory turnover ratio is slightly lower than the industry - but its
still good.
Other turnover ratios
Starbuck’s asset turnover ratio is comparable to the industry.
Debt Management ratios
This group of ratios, the solvency ratios, measures the company’s ability to meet its
long-term obligations as they become due. Creditors prefer to see a low debt ratio
because there is a greater cushion for creditor losses if the firm goes bankrupt. The
long-term creditor is concerned with both the near-term and the long-term ability of a
firm to meet its commitments. Long-term creditors are usually protected to some degree
by restrictive covenants, or rules, in loan agreements that restrict the firm’s ability to
take actions that are not in the best interests of the creditors. It appears that the
Starbucks solvency position is relatively as it has low debt ratio of .5 and higher interest
coverage ratio of more than 100 times. This is also higher than the industry average.
Profitability
Profitability ratios try to measure how profitable the firm is. Note that their success in
this endeavor depends on how accurately the financial statements reflect reality. They
include the profit margin on sales, basic earning power, return on total assets (ROA)
and return on common equity (ROE).
Profit Margin on Sales = Net Income available to Common Shareholders / Sales
Return on Assets = Net Income available to Common Shareholders / Total Assets
Return on Equity = Net Income available to Common Shareholders / Common Equity
The profitability ratios, indicates a company’s financial health and how effectively the
firm is being managed to earn a satisfactory profit and return on investment. Starbucks’
net profitability has declined lately and is considered poor. Similarly, its return on asset
needs improvement. However, the company’s return on equity is higher as compared to
the desired level - which is very good.
Other ratios
Price-Earnings Ratio
The relationship between the market price of a share of stock and the stock’s current
earnings per share is often stated in terms of a price-earnings ratio. This ratio tends to
be high in firms that have good future growth prospects. The price-earnings ratio is
widely used by investors as a general guideline in gauging stock values. If the ratio is
unusually high or low for a firm in relation to its industry, an analyst is likely to suspect
that the stock is overvalued or undervalued.
Starbucks is one of the most successful organizations in the world due to its strategy,
which is in harmony with the prevailing culture. It has adapted to the culture of
globalization and pop culture. It has featured in various cinemas and TV shows.
Thus, Starbucks is dynamic in their approach to adapt the cultural change. However,
they have their share of critics too. Several online activism groups maintain websites
criticizing the company's fair-trade policies, labor relations, and environmental impact,
and holding it as a prime example of what they see as U.S. cultural and economic
imperialism.
Strengths and weaknesses:
Strengths
• Adequate solvency
• High Return on equity
Weakness
• Low net margin ratio
• Low return on assets
• Low inventory turnover ratio
• High Price to Earning ratio