Costco Is a Mass Market Retailer, Focusing Essay

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Costco is a mass market retailer, focusing on a "warehouse club" business model. The company has a cost leadership strategy and this helps to characterize the firm's financial statements In terms of the critical ratios, the following table outlines the results for Costco for the 2012 and 2011 fiscal years:

Costco Financial Metrics

Liquidity Ratios

Formula

Current Ratio

current assets / current liabilities

Quick Ratio

(current assets - inventory) / current liabilities

Activity Ratios

Receivables turnover

Sales / Avg Accounts Receivable

Inventory turnover

COGS / Avg inventory

Debt Ratios

Debt ratio

Total liabilities / total assets

Long-Term debt to equity

Long-term debt / total equity

Profitability

Gross Margin

Gross profit / Revenue

Net Margin

Net profit / Revenue

Market ratios

P/E

Stock price / earnings

Price / Book

Price / shareholder's equity

These ratios tell the story of Costco. There are a number of aspects to this. The liquidity ratios highlight the degree to which the company can meet its financial obligations for the upcoming period. Firms that are in retail tend to have significant spreads between their current ratio and their quick ratio, because they have high inventory levels. Thus, the quick ratio is probably more important than the current ratio. The quick ratio for Costco is healthy, at 0.53. There is some concern that the trend is declining even while the current ratio is increasing, because that probably reflects inventory levels increasing. However, the inventory turnover ratio does not support that theory. However, it is good to know that Costco is a liquid company.

The activity ratios highlight how well the company is run. The receivables turnover and the inventory turnover figures are both healthy. The receivables turnover ratio is particularly healthy because it implies payment on sales in a little over 3 days. The inventory turnover ratio sits at just under a month, which is not great, but is expected for companies in retail.

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If Costco is purchasing goods on 30-day credit, for example, it is selling them and collecting that revenue by the time it has to pay its suppliers. In addition, management always wants to see turnover increase. While there has been a minor decrease in inventory turnover, this is offset by the increase in receivables turnover.

The next set of ratios are the debt ratios, which speak to the long-term solvency of the company. Costco has a low level of long-term debt relative to equity, and has low liabilities overall as a result. Thus, Costco is clearly well within the normal bounds of a solvent company and has little if any solvency risk. The profitability ratios are another type of ratio that can measure the health of the firm. Costco would be expected to have thin margins, because it is a low-cost retailer. The gross margin is around where you'd expect for a cost leader, and the net margin is as well. Firms with this strategy typically earn very tight margins and make profits based on very high volumes. Costco definitely takes this approach. It's 2% net margin is in line with other firms in the industry, include Wal-Mart.

The market ratios are another measure, this time relating the financial statement measures with the market response. These ratios are mostly useful if you accept the tenuous idea that markets are perfectly rational, which would at least imply the stock market price has real meaning. The market has actually priced the company, with its P/E being very stable for the past couple of years. The price/book ratio has increased in 2012, which reflects a modest increase in share price combined with a larger increase in the book value of the firm, something that derives from another year of profits and a decline in the debt ratio. The market does not see.....

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