Managing Financial Resources-Case Study of Starbucks

Managing Financial Resources-Case Study of Starbucks

Financial analysis refers to the process of evaluating the financial viability of a business to determine its profitability and suitability for continued investment. Typically, information obtained from the financial analysis is used to determine whether a business entity is financially stable, liquid or solvent enough to provide returns to the investors and to support corporate objectives (Walgenbach, Norman and Ernest 2003, p. 30). Important aspects of concern for financial analysis include the balance sheet, cash flow statement, and income statement. In addition to the review of these statements, another important area of financial analysis is extrapolation. This involves reviewing company’s past and present performance to estimate future performance. Extrapolation helps companies to predict future trends in their financial performance and take appropriate measures to avoid threats or take advantage of opportunities for improving financial performance.
Company Background
Starbucks Corporation is an American multinational company whose primary business involves manufacturing and marketing of specialty coffee and tea. The Corporation was founded in 1985 and is headquartered in Seattle (USA). Starbucks has divided its international operations into four segments based on the geographic region: the Americas which includes North and South America; China/Asia Pacific segment/ Europe, Middle East and Africa; and channel development.

In each of these market segments, Starbucks uses either company-operated stores or licensed stores. The mix of licensed versus company-operated stores varies widely depending on several factors such as the ability to access desired store locations, the complexity of the market, and the company’s ability to leverage available opportunities such as infrastructure (Birt, Keryn, Suzanne, Albie and Oliver 2015, p. 5-7).
Starbucks product mix includes high quality roasted and handpicked coffee and tea, selected fresh food items and some other items. Currently, Starbucks is the largest and most successful coffee house in the world. It operates over 19700 stores in 630 countries across the world. Its diverse portfolio includes well-known brands such as Torrefazione Italia Coffee, Starbucks Coffee, Evolution Fresh, Tazo Tea and Seattle’s Best Coffee among others. Starbucks mission is to inspire and nurture the human spirit by providing high-quality coffee. The company’s vision is to become a premier marketer of the finest coffee in the world while sticking to the uncompromising principle of quality (Kate 2007, p. 793).
Being the largest and most successful coffee house in the world, Starbucks’ corporate strategy is focused on consistent growth through expansion into new markets. Starbuck’s long-term objective of expanding globally is to increase its market share in a systematic manner by opening new stores in selected markets, and also by increasing sales revenue in existing markets. The company seeks to be the leading brand and retailer of special coffee in each of its target markets providing customers with unique customer experience (Argenti 2004, p. 28). In this regard, the company’s long-term strategy is based on consistent delivery of superior customer service experience and well-maintained coffee stores that reflect the expectations of the target customers in local markets. In so doing, the company endeavors to build a high degree of customer loyalty, which is the backbone of its growing profitability.

Objective and Methodology
The objective of this paper is to analyze the financial performance of Starbucks Corp. To achieve this objective, different financial ratios such as profitability, liquidity, market value and debt management ratios for the financial year ending September 2016 have been calculated. The data used to conduct the financial analysis has been obtained from the company’s annual reports. To get a better picture of the company’s financial position, its performance in 2016 has been compared to the previous years. This comparison is necessary in order to determine how good or bad the world’s largest coffee house has been performing in recent years. Besides the financial data study, the research methodology consists of a detailed review of literature on the topic.
Overview of the Retail Coffee Industry
Starbucks operates primarily in the retail coffee industry. The industry has reached a mature stage with intense competition involving well-established and medium-sized players. Dunkin Brands and Starbucks hold a large market share (about two thirds), which gives them considerable influence to dictate market trends. Between 2007 and 2010, the global coffee retail industry experienced a major slowdown due to the economic crisis. Before the crisis, the industry had consistently recorded positive growth for almost two decades. Since 2010, the industry has shown positive growth patterns. The demand for products in the retail coffee industry is affected by various factors such as disposable income, health factors and the pricing of coffee in the international markets (Yu-Te, Chin-Mei and Hsiao-Chien 2012, p. 28-31).
Analysis of Starbucks’ Financial Performance
Income Statement
The income statement shows a company’s revenue and expenses during a specific accounting period. The statement shows the net profit or loss incurred by the company as a result of its operations. Typically, the income statement is divided into two major sections: operating income and non-operating income (Kieso, Weygandt and Warfield 2007, p. 28). Operating income shows information about expenses and revenues that are directly tied to the company’s core business operations. On the other hand, non-operating income discloses information about expenses and incomes not directly linked to the company’s regular operations (Chew and Parkinson 2013, p. 32). Starbucks total income has grown steadily over the years. In 2013, the company’s revenue was $14.87 billion (Starbucks 2013). It increased to $16.45 billion in 2014 and then $19.16 billion in 2015. In 2016, Starbucks income hit a record of $21.32 billion. During the financial year ending September 2016, revenue from Starbucks operated stores accounted for almost 80% of the company’s revenue. The steady growth in Starbucks income (revenue) shows that the company has been performing well in terms of sales and expense management. The revenue is projected to continue growing in the short term (2016-2020), although this will depend on external factors such as global coffee prices (Starbucks 2016).
Price to Earnings Ratio
Price to earnings ratio (P/E ratio) is a tool for valuing the financial performance of a company that compares current market prices of shares to the earnings per share (Horngren, Srikant and Rajan 2003, p. 4). Starbucks P/E ratio is currently 30.87. This ratio compares favorably with the industry average and the company’s performance during the previous years.
Price to Sales Ratio
Price to sales ratio is a financial valuation that compares the stock price of a company to its revenues. This ratio is an indicator of the value placed on the company’s sales revenue. As such, a high and growing price to sales ratio gives a good indication that a company is performing well in terms of revenue growth (Blocher and Juras 2016, p. 8). Currently, Starbucks price to sales ratio is 3.78. In the past three years, the company has maintained a positive movement in price to sales ratio. An indication that the company’s sales performance is good (Starbucks 2014).
Profitability Ratios
Profitability ratios are a group of financial metrics used to gauge the ability of a company to convert capital into profits while minimizing expenses and other costs incurred to support business operations (William, Shannon and Maher 2005, p. 64). Shareholders, potential investors, and creditors use information obtained from profitability ratios to assess a company’s return on investments based on the amount of resources and assets available. The table below gives a summary of Starbucks profitability ratios in 2016.

Source: Starbucks 2016
Gross margin is the most important profitability ratio. It measures the efficiency of a company’s pricing strategy and is calculated by dividing operating income during a given year by net sales during the same year (Clinton and Merwe 2006, p. 26). As shown in the table above, Starbucks gross margin was 24.62 in 2016. The company has consistently maintained a high gross margin throughout the years. Return on equity compares a company’s income (revenue) to shareholder’s equity. This ratio serves as a measure of the company’s efficiency in utilizing resources to achieve income. Starbucks return on equity is currently 48.16% which is quite higher than the 10% recommended. The high return on equity is important in attracting potential investors because it shows that the company has the capacity to turn capital into profitable returns for shareholders. It can be noted that Starbucks has maintained healthy profitability ratios during the past few years preceding 2016. This can be evidenced by the company’s above industry average return on invested capital.
Capital Structure
Starbucks capital structure consists of equity and debt. Equity financing refers to the use of capital obtained through the issuance of shares to the public. On the other hand, debt financing refers to the use of capital obtained through loans and bonds (Tracy, 2004, p. 22). Over the years, Starbucks has used a combination of debt and equity to support its business operations. The table below shows the company’s capital structure in 2016.

Source: Starbucks 2016
As shown in the table above, Starbucks relies more on equity financing than debt financing. As of September 2016, the company’s debt ratio was 38.38% while equity ratio was 61.62%. This ratio has been decreasing over the past three years, meaning that the company is keen to reduce its reliance on debts as a source of financing. A decreasing debt ratio indicates low risks associated with the company’s financing. In particular, it shows that the company’s financial position is healthy and that it can attract creditors (Ehardt and Brigham 2008, p. 21).
Factors affecting Starbucks Financial Viability
Coffee Supply
Although Starbucks specializes in different types of beverages and food products, coffee is the primary focus of its business. Accordingly, trends in the global prices and supply of coffee is an important factor that influences Starbucks financial viability. In accordance with the company’s corporate objectives, Starbucks stores are committed to selling finest and high-quality coffee beverages and bean coffees (Baldwin 2015, p. 16). To ensure a high degree of compliance with its rigorous quality standards, Starbucks controls all aspects of its businesses processes such as coffee purchasing, roasting, distribution and packaging of the coffee used in its business operations. In order to avoid risks of undersupply of coffee and diverse movements in prices, the company purchases green coffee from different coffee producing regions of the world and custom roasts it to its standards. The strategy of buying from multiple regions at the same time ensure that the company is able to have a constant supply of coffee all year long and that unforeseeable issues such as political instability do not affect its business.
The price of coffee in the international markets is subject to drastic volatility. While a great share of coffee is traded in the commodity market, Arabica coffee (which is the quality sought by Starbucks) is traded on negotiated basis at premium prices. Both the commodity and premium prices of coffee depend on several factors including market forces of supply and demand at the time of purchase (Baumol and Alan 2006, p. 46). Across the world, the supply of coffee is affected by several factors such as natural disasters, crop diseases, weather, and change in the cost of production and farm inputs, and economic and political conditions in the country of origin. All these factors affect pricing and hence the revenues that leading coffee houses like Starbucks make. Pricing is also affected by other factors such as commodity index funds and hedge funds.
In addition, supply and pricing of coffee in the international markets is greatly affected by the actions of certain organizations such as environmental lobby groups and labor organizations. Adverse actions by these organizations may have huge impacts on coffee prices and ultimately the profitability of Starbucks. It can be noted that Starbucks buys its coffee through the fixed price commitments (Craig and Zeynep 2007, p. 624). This means that the quality, quantity, price and delivery period are agreed upon in advance with the aim of securing an adequate supply of quality coffee. Price fixation depends on prevailing market conditions. In general, Starbucks depends on maintaining strong relationships with producers of coffee outside, exporters, and third-party trading companies for constant supply of green coffee beans. By strengthening relationships with these parties, Starbucks expects to reduce the risk of non-delivery of coffee.
As part of its efforts to secure the future supply of coffee and maintain its leadership position in the industry, Starbucks operates several farmer support centers in the world. The company employs agronomists and other experts who work at these centers to advise coffee growers on best practices in the production of high-quality coffee. Besides coffee, Starbucks purchases significant amounts of tea and dairy products to supplement the operations of its stores. The company has maintained strong relationships with the suppliers of these products to minimize risks of non-delivery.
The Competitive Landscape
Starbucks competitors in the coffee category are quick service restaurants as well as specialty coffee shops. In almost all markets where Starbucks operates, there are tens of established competitors in the specialty coffee business. Java House and McDonald’s are among the largest competitors for Starbucks (Schultz 2011, p. 7). The company also competes with other companies in the distribution and marketing of roasted coffee. Just like Starbucks, its competitor’s customers choose retailers based on product quality, price, convenience and quality of service. Besides competing in terms of product offerings, Starbucks also competes in terms of qualified personnel and prime store locations. The company’s profits are directly related to the locations of its stores. It is for this reason that most of Starbucks stores are located in busy streets where customer traffic is high. This factor drives the company’s sales and profitability.
In order to maintain high levels of financial performance and overcome competitors, Starbucks is committed to upholding its corporate social obligations in the communities where it operates. To this end, the company’s focus is on ethical sourcing of raw materials, minimization of environmental impact and contributing to the empowerment of local communities. Essentially, Starbucks endeavors to be a good corporate citizen and to leverage on that reputation to achieve unprecedented levels of financial growth.
Short-Term Risk Factors
Although Starbucks is performing well in its domestic and international market segments, the company’s operations are exposed to a number of risk factors that may adversely and materially affect its business and financial performance in the short-term. A key risk factor is adverse changes in macroeconomic conditions in the United States or international markets. As a retailer, Starbucks relies heavily on customers’ discretionary spending for its sales revenue and profitability. During the 2007-2010 global economic crisis, Starbucks’ financial results dropped drastically. The crisis caused a sharp fall in disposable incomes, thereby crippling the ability of consumers to purchase the company’s products. Although the world has since recovered from the crisis, the aftershocks of the crisis can still be felt as evidenced by the fact that many countries including the United States are still grappling with severe recessions. If the situation is sustained in the short-term, consumers will have less money to spend. Consequently, customers may reduce the volume of their purchases from Starbucks or even switch to competitors low-priced substitutes. This will affect Starbucks’ financial performance (Strehle and Cruickshank 2004, p. 34-36).
The second risk factor relates to incidents involving food tampering, contamination, food-borne diseases and mislabeling. Such incidents, as well as adverse medical opinions, could harm Starbucks businesses and ultimately financial performance. According to Lindsey (2003, p. 65), reports and instances (whether true or not) about food quality have the undesired effect of injuring the reputations of companies in the grocery, restaurants and food processing industries. In the past, several companies in the food sector have incurred huge costs in terms of litigations, liability claims, and damages for similar incidents. Starbucks is keen to ensure that its businesses operations are not linked to any reports about the use of contaminated water, food contamination and tampering and safety issues. Essentially, clean water is critical to the company’s preparation of beverages and other foods.
The third risk factor is that the company is heavily dependent on the use of information technology to support its operations. For this reason, any material failure, security breaches, interruption or inadequacy of the technologies used by the company could severely harm the ability to operate and realize the stated financial objectives (Strong 2009, p. 46). The company uses various information technology systems across its operations such as point of sale processing, administrative functions, supply chain management and payment processing. The company’s ability to manage its businesses effectively depends on the capacity, reliability, and integrity of the various technological systems it uses. Although the company has put adequate security measures in place, it may not be able to prevent some aspects of failure especially those caused by catastrophic events, power outages, and system upgrade. Such failures can be too costly for the company.
Lastly, Starbucks is highly dependent on the financial performance of its American segment. Between 2010 and 2016, the American segment accounted for nearly 70% of the company’s consolidated net revenues. The greatest financial risk here is that if revenue from the American segment declines or slows, the other segments may not be able to make up for the losses. In effect, the company’s overall financial results could suffer massively. Since the Americas market is relatively mature (especially Canada and the United States) any slowdown could result in the lack of resources for funding expansion into other markets (Howard 2012, p. 72).
Conclusion
Analysis of Starbucks’ financial results for the 2015 fiscal year, as well as, the previous years demonstrate sustained determination by the company’s management to make sound business decisions. Overall, the company’s net revenue has been growing consistently, with all segments recording steady increase in revenue and operating margins. The American market is by far the largest and best-performing segment in terms of sales revenue and growth. Accordingly, Starbucks has committed substantial resources to support its business operations across the American continent. The company is also looking for opportunities in other parts of the world, especially in Europe and Asia. These two regions have shown strong potentials for increased profitability.
Looking forward, Starbucks expects to continue recording high levels of revenue growth in the short-term. It will achieve this by sticking to its core values of product quality and customer service excellence, and by opening new stores across the world. The company also looks to leverage investment in new platforms such as mobile orders. Competition, fluctuations in prices and supply of raw materials and technological changes are some of the most important factors that may affect Starbucks financial viability. The company is actively monitoring the market to ensure that external factors do not cause adverse effects on its business operations.

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