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Essay: The History and Financial Evaluation of Costco Wholesale Corporation

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  • Published: 1 April 2019*
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Part 1

The company I chose is Costco Wholesale Corporation. Costco’s city of incorporation is Issaquah, Washington. I am not going to lie, I definitely thought that the city of incorporation would be Kirkland Washington.

Costco is in the business of selling products to customers. The thing that sets Costco apart from other large stores is the Costco sells most of its items in bulk. Costco’s target audience includes families and businesses (Best). With everything from toothpaste to office chairs, Costco’s got you covered.  

Costco actually has a very interesting history. First came Price Club in 1976 and then came Costco in 1983. In 1993 the two stores merged and went by the name of PriceCostco, but in 1997 the company name went back to Costco (Costco Wholesale Corporation)

Costco’s top three competitors are The Kroger Co, BJ’s Wholesale Club Holdings, Inc., and Sam’s West, Inc. W. Craig Jelinek is Costco Wholesale Corporation’s CEO (D&B Hoovers).

Part 2

I wish I had a personal connection to Costco. From what I know about the company, it treats it’s employees very well and is considered a great place to work. I also really appreciate that they don’t use plastic bags. They do this to cut costs, but by reusing the boxes that the merchandise came in, they really help the environment.

I am a customer of the company. My family does not go to Costco as often as others, but we love it just as much. We get products like toilet paper, socks, toothpaste, and sunscreen there. I would say that we go to Costco about once every 6-8 weeks. But trust me we go on plenty of pizza runs and occasionally purchase large electronics in addition to our regular Costco shopping.

I think this Company would be a good investment because “more than 81 million people pay $55 for annual memberships for the privilege of shopping at Costco, with fewer than 10% each year deciding the experience isn’t worth the price of membership. (Best)” If that doesn’t show customer satisfaction then I don’t know what would. Costco also implements cost saving techniques. I mentioned the lack of plastic bags, but they also don’t fully unpackage the products before putting items on the floor. This helps them save money because nobody has to unpackage the items and keep their prices low, which means that they keep their customers.

Part 3

Evaluating the ability to pay current liabilities

Costco’s 2017 working capital was (178,000) and its 2016 working capital was (357,000). The working capital calculation measures how well the company can pay off current liabilities with current assets. Costco’s working capital was negative both years which means that the company had more current liabilities than current assets. That means that the company cannot pay off current liabilities with current assets (Mattison, Matsumura and Miller-Nobles). Luckily, the working capital had a positive jump of 179,000 between 2016 and 2017.

Costco’s 2017 current ratio was .99 and its 2016 current ratio was .98. The current ratio is similar to working capital because it also measures how well the company can pay off current liabilities with current assets. 1.50 is considered a good current ratio and unfortunately Costco was pretty far below (Mattison, Matsumura and Miller-Nobles). Once again though the current ratio did increase, by .01, between 2016 to 2017 which is a positive.

Costco’s 2017 cash ratio was .26 and its 2016 cash ratio was .22. The cash ratio is slightly different than working capital and the current ratio. Instead of measuring the company’s ability to pay off current liabilities with current assets, the cash ratio measures how well the company can pay of current liabilities with cash and cash equivalents. Having a cash ratio below 1 is a good sign, because if the ratio is too high then you are probably have too much cash lying around. However, cash ratios of .26 and .22 are considered very low. This ratio shows that the company isn’t able to pay off their current liabilities (Mattison, Matsumura and Miller-Nobles).

Costco’s 2017 acid-test ratio was .41and its 2016 acid test ratio was .38. The acid test ratio is used to find out if the company can pay off all of its current liabilities if they had to pay them off immediately. Usually you want the acid-test ratio to be between .90 and 1 (Mattison, Matsumura and Miller-Nobles). Unfortunately, Costco did not pass the acid test because the ratios are far below where they should be. The 2017 ratio is off by .49 and the 2016 ratio is off by .52. Once again, the acid-test ratio improved between 2016 and 2017, by .03, which shows improvement.

Overall, the above calculations show that Costco really cannot pay off current liabilities.

Evaluating the ability to sell merchandise and collect receivables

Costco’s 2017 inventory turnover ratio was 11.9 times a year and its 2016 inventory turnover ratio was 10.96 time a year. Inventory turnover in the retail sector is usually about 9.78 (CSIMarket). Costco technically sells wholesale, but since it is different than most wholesalers in that it sells directly to customers instead of a middle man, we can effectively compare it to the inventory turnover of the retail sector. Inventory turnover measures the number of times Costco sells its average level of merchandise inventory during a period. Costco’s inventory turnover was 2.12 points above average in 2017 and was 1.18 points above average in 2016. Since inventory turnover was above average it shows that Costco does not have a problem with selling merchandise inventory (Mattison, Matsumura and Miller-Nobles).

Costco’s 2017 days’ sales in inventory was 30.67 days and in 2016 it was 33.3 days. The days’ sales in inventory “measures the average number of days that inventory is held by a company (Mattison, Matsumura and Miller-Nobles).” Most companies “only buy enough inventories to sell within the next 90 days (My Accounting Course).” That means that Costco is doing great because it is selling through its in inventory in less than half the time. This makes complete sense to me because a lot of times when you find something at Costco it is important to buy it right then and there. If you come back in a few weeks there is a good chance that it will be gone.

Costco’s 2017 gross profit percentage was 11.33% and in 2016 it was 11.35%. The gross profit percentage “measures the profitability of each sales dollar above the cost of goods sold (Mattison, Matsumura and Miller-Nobles).” In the retail world gross profit is usually between 20% and 30% (Browne). In both 2017 and 2016 the gross profit percentage is about 9% lower than the industry average. The fact that the gross profit percentage decreased by .02% between 2016 and 2017 is not a great sign. It shows that Costco did not earn enough gross profit on merchandise inventory “to cover the remaining operating expenses and to earn net income” in 2016 and it got even worse in 2017 (Mattison, Matsumura and Miller-Nobles).

Overall, Costco has no problem selling through its merchandise however, the company needs to work on gaining more gross profit on merchandise inventory.

Evaluating the ability to pay long-term debt

Costco’s 2017 debt ratio was 69.52% and its 2016 debt ratio was 62.81%. The debt ratio “shows the proportion of assets financed with debt.” For most companies the debt ratio is between 57% and 67%. That means that in 2016 Costco’s debt ratio was considered low risk. However, in 2017 the debt ratio was 2.52% over average. That does not necessarily show high risk, but it definitely shows higher risk in comparison to 2016. Having higher risk means the company may not be able to successfully pay off their debts (Mattison, Matsumura and Miller-Nobles).

Costco’s 2017 debt to equity ratio was 2.28 and in 2016 it was 1.69. This ratio “shows the proportion of total liabilities relative to total equity.” A good debt to equity ratio for the retail industry is about 1.12 (CSI Market). In comparison, Costco’s debt to equity ratio is not looking too good. Their high debt to equity ratio means that they are “financing more assets with debt than with equity.” The higher the ratio is over 1 the higher the risk. In 2017, the debt to equity ratio was 1.28 over 1 (Mattison, Matsumura and Miller-Nobles). And the debt to equity ratio increased by .59 between 2016 and 2017 which also shows high risk.

Costco’s 2017 times-interest-earned ratio was 1.029 and in 2016 the ratio was 1.027. The ratio evaluates Costco’s ability to pay interest expense. This ratio would help show banks that the business is reliable and can pay back the interest on loans. Usually, businesses fall between 2 and 3. Having a low ratio means that Costco has trouble paying interest expense (Mattison, Matsumura and Miller-Nobles). The ratio increases by .002 over 2016 and 2017 which shows very little improvement.

Overall, Costco’s ratios show that the company struggles to pay back long-term-debt.

Evaluating profitability

Costco’s 2017 profit margin ratio was 2.12% and the 2016 ratio was 2.02%. This ratio “shows how much net income a business earns on every $1 of sales.” I was not able to find the average profit margin ratio for the retail industry, but in my opinion this is a good ratio. The ratio increased by .1% between 2016 and 2017. This increase is considered an improvement because the higher the ratio the more net income the business earns (Mattison, Matsumura and Miller-Nobles).

Costco’s 2017 asset turnover ratio was 3.63 and the 2016 ratio was 3.34. This ratio “measures the amount of net sales generated for each average dollar of total assets invested.” In retail, the asset turnover ratio is usually about 2.36 (CIS Market). In comparison, Costco has a high asset turnover ratio. That means that the company is producing more “net sales for each average dollar of total assets invested.”

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