Costco Wholesale Company’s Financial Analysis

Executive Summary

Finance includes activities on money, credit, banking and investments. Fundamentally, it involves the process of acquiring and management of money. The concept of financial analysis is significant to any business whether small or big. Having an understanding of the fundamentals of finance is essential in making decisions in a company. Medium and large companies usually employ financial analysts that include accountants to have a responsibility of managing financial matters of the company. The small business owners conduct their financial analysis on their own as they may not be able to pay a financial expert.

When a business has the expertise in its financial management, it gets the following benefits; the first one is it gets effective investment decisions. Coming up with effective investment ventures for a business can only happen when the business uses the financial formulas to determine the appropriate investments. Bonds and stocks are a common investment of many businesses. The essential finance formulas include capital assets pricing model and return on investments.

The second benefit is that the business is able to get a full analysis of the financing options to acquire the right purchasing options or the new growth opportunities. The key finance formulas used to determine the debt or equity and getting external funds includes the capital structure analysis and weighted average. The principles of finance measure the debt basing on loan terms, interest rates, and the repayment method.

Cash management is another vital principle in business finance, a business is able to know how much it generates by analysis of its statement of cash flows. From the statement, the company is able to understand the cash inflows and outflows on investments and financial operations. The net present value formula is used in assessing the amount of cash inflow that the company expects compared to its current cash outflows. One significant way of examining a healthy business by looking at the cashflow statement. Cash inflow is money coming into the business, from investments or sale, while the cash outflow illustrates money leaving the company. A business is therefore in a healthy state when its cash inflows are greater than its outflows.

A lower cash inflow in a company can be risky as it can make the company bankrupt. Evaluations of the balance of a company aids in identifications of the business strengths and weakness that gives essential information vital in making projections and financial estimations on how well the business can fare in the future. The report will examine the analysis of Costco Wholesale company finance for the past three years. The cash flow and cash inflows will be focused in the analysis, moreover the company’s budgeting techniques will be illustrated and its investments.

Company background

Costco company is a multibillion international retailer having its business activities in eight countries. It operates international chain of warehouses which carry quality and branded merchandise at lower price. The design of the wholesale provide help to the small and the medium size enterprises reduce their purchasing costs for their resale. Moreover, individuals also can purchase goods from the warehouse for their own personal use (Rahman, 2020). The company offers exclusive products categories under one roof. It is known for carrying out the top-quality products globally with 100% satisfaction rate to their customers.

Costco first opened its operations in 1976 under Price Club. It initially served the small businesses and grew with time to serving non-business members. Due to this change it witnessed a significant growth and in 1983 it operated under Costsco as its name. The company saw a rise in its sale from zero to about $3 billion in a spun of less than six years which made it the first company to record such sales (Costco, 2021). The corporate name Costco Companies was adopted fully in 1997 and by the 21^st century it operated stores in the US, Mexico, Canada, Australia, Europe and Australia (Costco, 2021). The company was praised for its act of providing employees with a higher wage and more better benefits.

The operating principle has always been keeping of low costs and passing savings to the members. Costco has grown in its recent years with its global sales exceeding $64 billion and it has largely brought a transformation in the retail world (Rahman, 2020). With the continuous evolution of the company, it has enabled it to stay true to its qualities and attracted millions of loyal global members worldwide. With the company’s commitment to quality, it carries about 4000 stock keeping units (Costco, 2021).

Costco offer best values to customers through wisely selecting its goods based on brands, quality and prices. It currently offers an extensive range of stock with the convince of various departments and a special customer service. With several locations internationally, the company is dedicated to provide their customers a pleasurable shopping experience.

Cash inflow and cash outflow

Cash inflow is the money the company receives from the operating activities. The items included in the cash inflow includes the following;

• Cash receipt from sales.
• Cash receipts from refund from suppliers.
• Cash receipt from licenses.
• Cash receipt from the collection of receivables.

Cash outflow is the amount of cash disbursed by the business; these are money leaving the business. Examples of cash out flow includes;

• Cash refunds to the customers.
• Cash payments of taxes.
• Payments of employees.
• Payment to suppliers.
• Payment of interest to the creditors.

For a business to effectively operate it has to generate positive cash flow and the one that records negative depicts that the business is poorly managed. The company management have to understand the cash inflow and outflow of the business to know the performance of the company at every point in time. The following diagram illustrates the cash inflow and outflow of Costco from 2018 to 2020.

figure 1(Source Costco website). Values are in Million Dollars.

Costco expenditures from 2018 to 2020.

figure 2 (Source Cotsco website). All values are in USD.

Calculation of capital budgeting techniques

Capital budgeting can be defined as the process of evaluating an investment and expenses to obtain the best returns on an investment (Alles et al.2021). Businesses usually face the challenges of choosing between two projects or buy versus replace options. Any organization would like to invest in a profit-making investment but due to the limitations of capital the business has to make a decision of selection a particular project. Capital budgeting affects our daily lives and the following are the objectives of capital budgeting;

• It helps in selecting profitable projects; Business faces many profitable projects to invest on frequently but because of the limited capital, a business has to have the right selection of a profitable businesses in increasing wealth of shareholders.
• Finding the right funding sources; This is another important objective of capital budgeting, making a determination of the quantum of funds and the right sources of procuring them is vital to the business. Knowing the balance between the returns on investment and the cost of borrowing is a key goal of capital budgeting.
• It helps in capital control; Capital control is an objective of capital budgeting and having an appropriate expenditure for a certain project is key in capital budgeting and a control of the capital costs is an essential thing for any business.

Capital budgeting techniques

There are various capital budgeting techniques that a business can use based on its cash inflows and outflows. The following are some of the techniques applied by Costco in its capital budgeting;

Payback period method

This refers to the period of time to be taken in recovering the cost of an investment. It is time that a certain investment takes to generate its initial investments (Alles et al.2021). This technique finds a computation of a time period needed in earning the initial investments of the project. The project having the shortest duration is one that is opted.

The formular used in calculation of the payback period is greatly depended on if the periodic cash inflows of an investment are even or odd. For even payback time the following formular is used;

Payback Period =Initial Investment ÷Net Cash Flow per Period

For example, if Costco plans to start an investment that needs an initial capital of $100 million. With an expectation that the project generates $30 million annually in the net cash inflow for the next 5 years then the payback period can be calculated as follows;

Initial Investment= $100

Net Cash Flow per year=$30

Payback period =$100 ÷$30=3.3years.

The shorter the payback period of the investment of the project the lower thew risk involved. The decision is to make an investment on a project that has the shortest payback period. For this case Costco can proceed and make an investment on the project. A decision to accept or to reject a certain project entirely depends on the risk appetite of the company management (Alles et al.2021). Mangers of the business have to set their acceptable payback period of each investment. For the low return investments, the mangers accept the project if it has a low risk and the payback therefore has to be shorter.

The advantages of payback period

1. It is simple in its computation.
2. For the business that face problems on liquidity, it will provide a good ranking of their investments on which will return capital back early.
3. It can be used in the measurement of risk inheritance in a project, payback period illustrates an indication on the certainty of thew project cash flow.

Disadvantages of the payback period

1. It does put into consideration the money value that can lead to making of wrong decisions. Discounted payback is the variation technique that tries to address this disadvantage.
2. It does not put cash flow into account that happens after payback. It means that a certain investment with a decent cash inflow can be ignored after the payback period.

Accounting rate of return (ARR)

This is another capital budgeting technique that is used in making decisions in Costco Company. It can be defined as a percentage rate of return expected from a project compared to its initial investment cost (Alles et al.2021). ARR is one of the best capital budgeting method that is used in calculating the profitability of an investment and making the determine on the type of project to invest on. This technique can hugely help the business in making the determination on the right decisions going ahead.

The formular for calculating ARR is;

ARR=Average Annual Profit / Average Investment

For instance, if Costco Wholesale wants to invest in a new set of vehicles to grow their business. The cost of the vehicles estimated at $1000,000 and this will increase the revenue of the company by $250,000 and an increase on the expense by $50,000. The new vehicles are expected to have a shelf life of 20 years and without any salvage value.

ARR is then calculated as follows;

• ARR=Average Annual Profit ÷Average Investment
• Annual profit =$250,000-$50,000=$200,000
• Depreciation expense=$1000,000/20=$50,000
• True Average annual profit=$200,000-$50,000=$150,000
• ARR=$150,000/$250,000=0.6=60%

Therefore, from this type of investment by Costco, it can be determined that for each dollar that the company will make investment, it will receive 60% in return. This is a good investment option and if it is the only available invest then the company can opt to investing in it.

Each business always looks for more investment opportunities to grow their profitability (Sarwary, 2019). Calculation of return on investment helps in examining whether a project is worth investing.

Advantages of ARR capital budgeting technique

1. Its computation is simple and easy to understand.
2. The method is based on the accounting profit therefore it measures the investment profitability.
3. This method is based on the accounting details it does not require special reports in making its calculations.

Disadvantages of ARR

1. It ignores the investment cash flow.
2. Ignores the time value of a capital.
3. ARR does not bring into consideration the terminal value of an investment.

Calculations of Costco return on investment

ROI= Profit/ Cost of Investment ×100%

In 2018 Costco Investment cost was $1.06B and its Cash flow from investment was recorded at $2.95B therefore the ROI for 2018 is calculated as follows;

Profit =$2.95B-$1.06=$1.89B

Cost of Investment=$1.06B

ROI=$1.89B/$1.06B×100%

2018 ROI=65.17%

In 2019 Costco company invested a total of $1.09B and its Cash flow from the net investment was recorded at $2.87B;

ROI in 2019 can therefore be calculated as follows;

Profit=$2.87B-$1.09B=$1.78B

COI=$1.09B

ROI=$1.78B/$1.09B ×100% =163.30%

In 2020 Costco Invested $1.63B and its earned $3.89B at the end of the year.

ROI=$3.89B-$1.63B =$2.26B profit

COI=$1.63B

ROI=$2.26B/$1.63×100% =138.65%

In the last 3 years Costco invested a total of $3.78B and earned a Cash inflow of $9.71B

ROI in the past 3 years=$9.71B-$3.78B = $5.93B

ROI=$5.93B/$3.78B×100% =156.88%

Expected challenges

Each business faces a significant number of challenges in its operations and each opportunity and problem require different solutions. The following are the expected challenges faced by Costco;

1. The changing customer preferences is a risk faced by the company since its model entirely depends on the high-volume sales.
2. The company has been slow in the adoption of online shopping which has been the preference of many customers.
3. The biggest problem also is that the company hugely depends on the repeat purchasing from its memberships. The model works well in situation that their members comes back but in situation that they opt to move to their competitors it pose a challenge to the company.

Recommendations

It is vital for Costco Wholesale company to use the Social media to reach out to younger generation as their customers. The organization needs to properly opt to a social media platform to help them out in marketing their business activities. It is significant for managers of the company to keep an eye on the current trends on social media and incorporate the latest technologies to effectively continue attracting more customers. When the company opt to making an investment, it is essential that it put into considerations all the necessary risks and not make wrong investment choices.

Findings

Costco earnings shows that it has been witnessing increase in sales by an estimate of about 21% annually. In 2019 the company witnessed an increase in annual earnings to $8.20 B and a rise of 20% in 2020 to $9.85B (Costco, 2021). Selling of members earns Costco a lot of money and it enables the company to have loyal customers. The business model of giving advantage to their members helps bring back the customers to get their membership benefits. The company charges their members an annual fee an offer them shopping privileges in their stores, the profitability of the business has continuously stayed consistent (Rahman, 2020). The company’s capability to bring customers without spending much on promotion is an attribute that enables this company be among the top retailers in the world.

Conclusion

In conclusion, Costco owes its success to its unique business model. The company has made progress and connected with several families across the world through offering goods with lower prices. It has also seen a rise in the number of loyal members through its membership program. With the increase in technology, the digital era has seen the company transition to improving its digital presence by offering services online. Moreover, from this study it can be clearly noted that the company has financial strengths which has enabled it to remain competitive in its operation.

References

Alles, L., Jayathilaka, R., Kumari, N., Malalathunga, T., Obeyesekera, H., & Sharmila, S. (2021). An investigation of the usage of capital budgeting techniques by small and medium enterprises. Quality & Quantity.

Costco Wholesale Corporation. (2021). Web.

Rahman, M. H. (2020). Financial Analysis of Costco Wholesale Corporation: Exploring The Strengths And Weaknesses.

Sarwary, Z. (2019). Capital budgeting techniques in SMEs: A literature review. Journal of Accounting and Finance.