What can the historical income statements (case Exhibit 1) and balance sheets (case Exhibit 2) tell you about the financial health and condition of Krispy Kreme Doughnuts, Inc.? The income statement and balance sheet provides an overview of the company’s expenditures, future debt constraints, and how the company has done in previous years allowing investors and other relevant parties to make future predictions for investment purposes. Details of the income statement provide insight into Krispy Kreme Doughnut’s current state as well as their future as a company and the balance sheet is more like a snapshot of their assets and liabilities.
Reviewing the income statement, the first thing that became apparent was the rise in total revenue as well as operating expenses. The revenues grew from $220MM to about $666MM and net income skyrocketed from about $6MM to $57MM. The operations expenses also increased significantly, over 100%, from $190MM to $507MM. These increases promote that the organization is in good operating health and is likely attributed due to factors such as acquisitions of a new brand that is already established (Mountain Mills) or their expansion of the Krispy Kreme stores nationwide as well as entering the global market.
However it is probable as well that it is a combination of profitable new stores in financially sound sectors and the rebound of the Mountain Mills brand. While income from operations reports as a large increase year over year, which is positive, there are some signs of negative growth for the income from interest is significantly low. This provides evidence that they called in some of their accounts receivable or some franchise stores likely closed.
Looking at the company’s interest income from the FY2001 through FY2003, the interest income was reported significantly higher due primarily to their aggressive accounting methods, which made the firm appear much healthier to external parties than the company actually was. Additionally, the company continued to report an increasing net income between the FY2001 and FY2004, growing by nearly 104%. Overall however the historical income statements show Krispy Kreme having rapid improvement and that business was profitable. The balance sheets of Krispy Kreme look very similar to their income tatement(s). The majority of line items have experienced great growth. On the asset side of the balance sheet, the total assets increased year over year and by over 600% within the four year time-span. The company also eliminated their long-term investments in FY2004 and increased their intangible assets from $0 to $176MM. The dramatic increase of intangible assets was due to their aggressive accounting treatment for franchise acquisitions. Reviewing the liabilities and equities side of the balance sheet, a concerning detail is easily noticed in regards to revolving lines of credit.
In a span of four years, it went from $0 to $7. 3MM and then jumped significantly to $87MM in just one year. This is particularly concerning and should cause areas of concern for revolving lines of credit are typically used to provide liquidity for a company’s day-to-day operations. How can financial ratios extend your understanding of financial statements? What questions do the time series of ratios in case Exhibit 7 raise? What questions do the ratios on peer firms in case Exhibits 8 and 9 raise?
Through the use of financial ratios, one is able to understand a company’s short-term and long-term solvency, their asset management or turnover activity, as well as their profitability measures and market value. In addition, financial ratios can also be used as a quick comparison to other companies and to the same company over time. The liquidity ratios of Krispy Kreme doughnuts shed light on the short-term solvency of the company or the ability of the company to cover its short-term bills without running into any undue stress on the company. Krispy Kreme Doughnuts liquidity ratios increased dramatically over the last few years.
In January of 2000, Krispy Kreme reported a current ratio of 1. 39 or 41,038CA/29,586CL. The current ratio 1. 39>1 indicates the company has high liquidity and is able to immediately pay off short-term liabilities. Over the next four years the company’s current ratio continues to increase, as does the company’s quick ratio. The quick ratio allows creditors to compare the current assets minus inventory, which is often the least liquid asset, over current liabilities. As a whole, the company appears to be handling the short-term bills efficiently and maintaining a fairly healthy liquidity of assets.
This is likely due to the increase in assets (stores, equipment, inventory, etc). The increased liquidity ratios seem much healthier than the other firms. |Current Ratios at End of FY2003 | |Krispy Kreme |McDonald’s |Dominos |Starbucks |Wendy’s |Sonic | |3. 25 |0. 76 |0. 99 |1. 52 |0. 88 |0. 92 | The leverage ratios allow for us to better compare Krispy Kreme Doughnut’s performance versus other competitors and through time. Organization’s capital structure is dependent on its industry. Therefore in comparing debt ratios, we must compare to industry averages. Krispy Kreme Doughnut’s Debt to Equity ratio is among the lowest, ranking third (11. 6%) compared to its competitors. |Debt Ratios at End of FY2003 | |Krispy Kreme |McDonald’s |Dominos |Starbucks |Wendy’s |Sonic | |11. 26 |77. 97 | (131. 07) |0. 21 |39. 39 |62. 53 | This low debt to equity ratio shows that Krispy Kreme is covered to pay long-term liabilities with its equity. Additionally, a low debt to equity ratio increases tax savings while minimizing the default risk. The times interest earned ratio was 124. 29 in 2002 and had fallen to 23. 15 by 2004. This indicates that interest payments were catching up to the earnings and that Krispy Kreme Doughnuts was on the path to having trouble paying off their debts.
Activity ratios help one to understand the asset management of the organization. The inventory turnover for Krispy Kreme Doughnuts is much lower when compared to the peer firm average. Krispy Kreme Doughnuts reports an average inventory turnover ratio of roughly 18. 6, which indicates a relatively low turnover rate per year. Additionally, it takes Krispy Kreme Doughnuts around 19. 6 days to sell off its entire inventory. When reviewing Krispy Kreme Doughnut’s receivables average turnover, it reports an average ratio of 10. 9 and roughly 34 days to collect on any credit sales. Comparing these ratios to other companies in the industry, Krispy Kreme Doughnuts is again on the low end of the spectrum. Having a low average collection period is ideal; this gives Krispy Kreme better liquidity, being able to turn their accounts receivable into cash quickly. When calculating the asset turnover, the ratio dropped from 2. 10 in FY2000 to 1. 01 by FY2004. This signified that sales generated from total assets were decreasing and likely attributed to Krispy Kreme’s asset accumulation.
Lastly, looking at Krispy Kreme Doughnut’s profitability ratios, it can be seen that the company maintains a fairly steady ROA and ROE over the years and continues to increase operating profit margin slighting between FY2000 and FY2004. Compared to their competitors in FY2003, it seems Krispy Kreme relies less on short-term debt. The leverage ratios suggest Krispy Kreme has much less long-term debt obligations than their competitors as well. Krispy Kreme has a lower inventory turnover ratio than its competition, which may suggest that the large amounts of assets could be attributed to high inventory.
Their return on assets is in the middle and the return on equity is low compared to the others. This could be an indication that Krispy Kreme is not spending shareholder’s dollars appropriately and is not able to control its costs and expenses efficiently Is Krispy Kreme financially healthy at year-end 2004? Based on the firm’s Price/Earnings Ratio, the growth prospects and expectations in the market continue to decline from 2001 to 2004. In 2001, Krispy Kreme exhibited a Price/Earnings Ratio of 6%, which decreased to 3. 87% by 2004. In the industry, Krispy Kreme Doughnuts reports one of the higher net profit margins amongst operating peers.
This indicates that the company has a good handle controlling their costs at this time. Also comparing Krispy Kreme’s profit margin ratio, they have one of the higher percentages thus further substantiating control. Looking at the total asset turnover ratio, Krispy Kreme Doughnuts has a 1. 01 which being greater than 1, informs us that Krispy Kreme manages their assets efficiently. Furthermore comparing their ratio to others in the industry, they are above many of them – i. e. McDonalds total asset turnover is . 69, which informs us that they do not have a proper handle on their assets.
Despite the company’s appearance of financial stability, Krispy Kreme has taken an aggressive approach to their overall financial reporting strategy, which raised some suspicions amongst creditors and financial analysts. Through reporting the franchise acquisitions as interest income, Krispy Kreme was able to immediately inflate profit while booking costs as intangible assets. This reporting strategy created the illusion that Krispy Kreme Doughnuts was much more financially healthy than it was in reality. In January 2000, Krispy Kreme reported interest income as 4. 9% of their net income.
However, in 2001 the company’s interest income as a percentage of net income increased to 15%. So while the balance sheet provides indication that Krispy Kreme Doughnuts is a financially healthy company, it is misleading due to the intangible assets and covers the fact that Krispy Kreme is not in a financially healthy state. In light of your answer to question 3, what accounts for the firm’s share price decline (between 2003 and 2004)? Based on Exhibit 1, the share price for Krispy Kreme is not declining from 2003 to 2004, however the earnings per share is declining.
The decline in earnings per share is based primarily on the increasing net income of the company. The adjustment toward real market value of the firm is also a factor. The $716MM of intangibles on the balance sheet is a serious problem. To put it in perspective, this amount is greater than accumulating the net income of the previous five years. Lastly, the financial reporting liberties Krispy Kreme took, which led to a formal investigation, also served as a primary driver for the share price decline. Additionally, future cash flows and the growth were contributors as well and the company’s strategy in both of these was not well managed.
The company grew too quickly and saturated the market, diffusing the product market ability and when expansion plans had been eliminated, the company lost the majority of its capita. Combined with internal mismanagement and a formal investigation launched with analysts revealing poor capital spending, the market response to Krispy Kreme drastically decreased. What is the source of intrinsic investment value in the company? Does this source appear on the financial statements? Intrinsic value is the actual value of the company or an asset based on an underlying perception of its true value including all aspects of the usiness in both tangible and intangible factors. This value may or may not be the same as the current market value. The intrinsic investment value of Krispy Kreme appears to be based on the growth opportunity. Due to the high expectations of growth and results from Wall Street, Krispy Kreme was pressured to keep releasing great numbers and report their profitability. This caused them to use very aggressive accounting procedures for acquisition, which contributed to a large, unforeseen loss. Instead of being satisfied with steady growth, they tried to get too big too fast and oversaturated the market.