Ratio Analysis of Starbucks – Milestone 2
Crystal Scottborgh
Southern New Hampshire University
MBA 503-Q3797
Professor Frey
April 4, 2021 (submitted April 9, 2021)
Using Ratio Analysis when looking at a company’s Financials allows one to properly determine the financial health of a company. It can help investors determine whether they want to invest in the company, or if already invested, whether they want to pull their money out of a poorly performing company. In addition, Ratio analysis uses different accounts in a company and compares trends over different time periods (current or historical) to determine the areas in which the company’s performance is excelling or failing. Because of the COVID-19 Pandemic, many companies have suffered in sales in 2020 and therefore the values from 2020, compared to prior year, 2019, have dropped for the most part. To determine the financial health of a company, there are three different ratios which are used to make this calculation. Three ratio categories that are commonly used include Liquidity Ratios, Solvency Ratios, and Profitability Ratios.
Liquidity Ratios use a company’s current cash figure to the operational obligations of the company to test the financial health of the company (Demonstrating Value, 2013). Two Liquidity Ratios include the Current Ratio and the Cash Ratio.
The Current Ratio equates to the Current Assets of a company (cash, cash equivalents, accounts receivable, stock inventory, marketable securities, and prepaid liabilities) divided by the Current Liabilities of a company (loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses). Both items are current, meaning short-term which usually refers to a period of less than a year. The current ratio measures a company’s ability to meet short term obligations with its short-term assets. The “preferred” current ratio of a company is between 1.2 and 2.0 (Demonstrating Value, 2013). This is because if a company’s current ratio is less than 1, the company is not producing enough income and may have to liquidate. If the current ratio is too high, that means there is an excess amount of cash or inventory and the company will have to revisit what it is spending its money on and potentially invest more capital elsewhere, and with inventory it may need to purchase less inventory.
According to the values reported on the Starbucks 2020 Annual 10K Report, the current Ratio is 1.06*. According to Demonstrating Value, this is a healthy current ratio. It shows that Starbucks can meet its short-term obligations with its short-term assets. This also shows that Starbucks is properly investing its capital and not purchasing excess inventory that could be a waste for the company. According to the 1.06 current ratio value, I would conclude Starbucks is financially healthy for the short term. Comparing the current ratio,1.06, in 2020, the 2019 Current Ratio for Starbucks was 0.92 or 92%*, based off the numbers reported on Starbucks’ 2019 Annual 10 K report. Therefore, Starbucks Current Ratio improved from 2019 and one could say Starbucks’ financial health is improving. However, to further test the theory of Starbucks’ ability to meet short term obligations, I would measure its Cash Ratio too.
The Cash Ratio uses only cash and cash equivalents to test whether a company can satisfy its short-term obligations. Because no other assets are considered, this ratio is very specific and only focuses on a company’s most liquid resources. If a cash ratio is greater than one it shows that the company can satisfy its short-term debt with its most liquid assets (Kenton, 2021). Much like the Current ratio, if the cash ratio is too high it shows that the company is poorly spending its capital. If the cash ratio is less than one there are more current liabilities than there is cash on hand for the company to use to pay these liabilities (Kenton, 2021). But if the company manages their cash, investments, and inventory well, because only the most liquid assets are measured, it may not be something one needs to panic about. The Cash Ratio equates to the sum of the cash, cash equivalents and short-term investments of a company divided by the company’s current liabilities. According to the values reported on the Starbucks 2020 Annual 10 K Report, the Cash Ratio is 0.63 or 63%*. Although Starbucks’ cash ratio fell below 1, because of Starbucks’ current ratio value, as an investor I would not be too worried about whether Starbucks could take care of its short-term obligations. Being that inventories and other assets are not considered in the cash ratio it is not necessarily a true determinant in whether Starbucks could pay off its short-term obligations should they have to. The importance of calculating more than one liquidity ratio lies in the fact that you can get a more accurate representation of whether a company can pay off the short-term obligations with its current assets. Not only are liquidity ratios used to determine a company’s financial health, but solvency ratios are used as well.
Solvency Ratios are also known as leverage ratios. These types of ratios are used to determine a company’s ability to pay off long term debt based on its cash flow (Hayes, 2021). Moreover, solvency ratios measure the company’s capacity to pay off all its debt, not just short-term debt which liquidity ratios are used for. Two solvency ratios are the Debt Ratio and the Equity Ratio.
The Debt Ratio equates to a company’s total liabilities divided by the total assets of the company. The debt ratio will show the company’s ability to pay off its long-term debt with all its assets. The higher the ratio of the company, the more the company is funded by debt (Hayes, 2021). One can safely say, if the company is funded by debt more than it is funded by its assets it is not performing well financially. According to the Starbucks 2020 Annual 10 K Report, Starbucks’ debt ratio is 1.27*. Because this number is just barely above 1, one can conclude Starbucks is very capable of paying off its long-term debt with its total assets and still be in a comfortable position. In comparison to Starbucks’ debt ratio value in 2019 which was 1.32, one can say Starbucks’ is fundamentally in the same position as it was in 2019. If confirmation of this theory was necessary, one can also try to use a different solvency ratio to see if the same assumption can be made. In this case the Equity ratio will be used to test the theory.
The Equity Ratio determines how much a company is funded by equity as opposed to debt. The higher the value, the healthier a company is. The lower the value, the more debt a company has (Hayes, 2021). The equity ratio equates to the total equity of the company divided by the total assets of the company. According to Starbucks’ 2020 Annual 10 K, the equity ratio value is 26.6%*. According to Hayes, the closer the equity ratio value is to 100%, the more equity as opposed to debt finances the company. However, because Starbucks is one of the dominating companies in its industry and Starbucks is a large competitor, I would compare its equity ratio value to another company’s value in the same industry and see how Starbucks compares. The 2019 Equity Ratio value was 32.4%. It was slightly higher in 2019, than in 2020. One can assume the pandemic caused Starbucks to rely on using debt to help fund some of its finances. Being that the Debt Ratio has already been calculated, as well as the Current Ratio, and the Cash Ratio and the values have shown pretty good financial health, I could safely assume Starbucks is a financially healthy company. If these ratios were not enough for investors, I could also use Profitability Ratios to help determine its financial health as well.
Profitability Ratios are used to determine how a company earns profits from its sales and generates value for its shareholders (Hayes, 2021). Although higher ratios put the company in a healthier financial standing, the value is more useful if used in a comparison to prior years and/or the value being compared to another company in the same industry. Two profitability ratios that are commonly used include the Return on Assets Ratio, and the Operating Margin Ratio.
The Return on Assets (ROA) Ratio measures the net income divided by the total assets of the company. The ROA ratio will show how “effective a company is [moving] its assets to generate sales and profit from the company” (Hayes, 2021). The higher the value of the ROA ratio, the more financially healthy a company looks. Based on Starbucks’ 2020 Annual 10 K, the ROA was 4%. In 2019, Starbucks ROA was 23.2%. According to the 2020 Annual 10 K, the total current assets have increased causing the total assets to drastically increase and therefore making the ROA lower than the prior year. If I were to solely look at the ROA profitability ratio, I would assume Starbucks is not performing as well as it has in the past. But to confirm, I would test the operating income profitability ratio.
The operating margin ratio is used to determine “how much profit a company makes on a dollar of sales after paying for variable costs of production” (Hayes, 2021). Again, with this ratio, the higher the value of the operating margin, the more efficient the company would seem from a financial health standpoint. The operating margin ratio is calculated by taking the operating income and dividing it by the company’s net sales. According to Starbucks’ Annual 2020 10 K report, Starbucks’ operating margin is 6.6%*. This value has dropped from 15.4%* in 2019. This drop could be because of the decreased sales most likely to the effects of the COVID 19 pandemic and having less orders being fulfilled during this time. Because the workforce is starting to return to work, one can assume the values for the ROA and the Operating Margin will increase now that more sales will probably start to come in for Starbucks.
In Conclusion, using all these different ratios can allow one to determine the financial health of the company based on different aspects. The liquidity ratios allow one to determine how well a company is doing currently to meet its short-term obligations. The solvency ratios allow one to measure how well a company is doing compared to the debt it is acquiring. Finally, profitability ratios focus on the profits generated from sales made by the company. When using all the ratios one can make an educated assessment on the financial standing of the company. With all my findings, I would conclude that overall Starbucks is a financially healthy company. However, because of the COVID-19 pandemic, I would argue its health has been negatively impacted. But comparing Starbucks’ 2019 values to its values after the onset of the pandemic (in 2020), I can predict Starbucks will do better in 2021 as it recovers from the hits it took to its revenue after the pandemic.
References
Demonstrating Value, Financial ratio analysis. (2013, December). Retrieved April 06, 2021,
from https://www.demonstratingvalue.org/resources/financial-ratio-analysis#Intro
Hayes, A. (2021, April 6). Solvency Ratio. Investopedia.
https://www.investopedia.com/terms/s/solvencyratio.
Kenton, W. (2021, March 20). Understanding the Cash Ratio. Investopedia.
https://www.investopedia.com/terms/c/cash-ratio.
Starbucks. (2020, October 29). Starbucks Reports Q4 Fiscal 2020 Results Press Release.
Retrieved April 06,2021 from https://investor.starbucks.com/press-releases/Q4 2020
Starbucks. Starbucks Corporation 2019 Form 10-K. Retrieved from
https://starbucks.com/financials/2019-Annual-Report.pdf
Starbucks. Starbucks Corporation 2020 Form 10-K. Retrieved April 06, 2021, from
https://starbucks.com/financials/2020/Annual-Report.pdf
Wall Street Journal. (n.d.). SBUX | Starbucks CORP. annual income statement – WSJ. Retrieved
April 06, 2021, from https://www.wsj.com/market-data/SBUX/financials/annual.
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