For a corporation to succeed, the management needs to have sufficient knowledge on financial concepts. Companies that apply these concepts manage to outdo their competitors as illustrated by Costco Corporation. Costco Wholesale Corporation runs 592 warehouses across the globe (Brigham & Houston, 2009).
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They sell various product brands together with the company’s own Kirkland Signature brand, which they sell at a discount to some individuals and businesses. It is the biggest and the most financially successful corporation in the industry.
It success is attributable to proper management since it carries its operations in large economic scales. Costco possesses a reasonable market share among its competitors because it implements the right accounting concepts, which include appropriate financial ratios, proper management of cash flows, and effective capital budgeting techniques.
Costco uses all the accounting ratios that help in evaluating the performance of the company for a specific period and those that compare its performance against their competitors. Efficiency ratios are used to determine the effectiveness in using company assets and management of liabilities. Currently, Costco efficiency ratio is at 1. 05 which is positive rate for meeting current liabilities.
Liquidity ratios determine the ability of a company to meet the obligations within set deadline. Costco’s liquidity ratio as given by Acid test ratio stands at 0.47. Although this ratio indicates the ability to convert asset into cash, it needs improvement to be proportionate to real estate possessed. Leverage ratios relate to debts of the company that is reflected in the balance sheet.
Profitability ratios measure on the effectiveness of business operations by determining how the company is running ascertaining whether it is improving or declining as compared to other forms in the industry. These ratios are given by comparing the sales and anticipated profits calculated using margin and mark-up. The company’s mark-up is at 15%, which facilitates low cost of the products thus increased sales and profitability.
Costco management controls the movement of fund in and out of the business accordingly. To achieve this, they ensure that there are more funds moving in the business through sales and debtors than the funding moving out of the business through purchases and creditors. They develop means of speeding up receipts from receivable and suggest ways to access payment through banks at customer’s authorization.
They also tighten credit requirement to discourage credit sale, and advertise aggressively to increase sales. The management analyzes and manages cash flows at reasonable intervals. This analysis facilitates the company to have enough cash in the current period to cover financial obligations for the next period (Brigham & Houston, 2009).
They utilize accounting software packages and other websites offering free templates that help in producing cash flow statement. This is essential for the company to understand the amounts flowing in and out of the business and make necessary provisions to cover for deficits.
Capital budgeting is a process that helps the management choose between alternative investment opportunities and allocate available resources to the most viable projects. Businesses have alternatives for investing the scare resources. The managers have the responsibility to choose the most viable investment that will increase the shareholders’ wealth.
They should invest in projects that will have higher returns on capital in future. To make decision on the most appropriate investment, the management must evaluate the future value of investment and spend on the project with potential to increase shareholders funds (Ross & Westerfield, 2010). The IRR method analyzes the return on the investment by comparing expected return of the investor from different projects.
Costco uses various method to analyze and determine future value of a project. Net present value (NPV), payback period, and internal rate of return (IRR) are the main options available. The net present value estimates the current value of the future expected cash flows. The management chooses the investment with the highest NPV.
“The IRR method calculates the return on the investment and compares to what the investors get in future” (Ross & Westerfield, 2010). The payback period calculates future returns by determining the amount of time taken before the company recovers the amount spent on investment in the project (Ross & Westerfield, 2010).
The company restricts debts and equity, but the management ensures that these variables are maintained at the most economic level. Restrictions are in terms of creditors instituted by the tight debt requirement and adoption of appropriate capital budgeting technique that limits the management to invest in projects that will give hire returns.
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Brigham, E. F., & Houston, J. F. (2009). Fundamentals of financial management. Mason, OH: South-Western Cengage Learning.
Ross, S. A., & Westerfield, R. W. (2010).Fundamentals of corporate finance (9. ed.). New York, N.Y.: McGraw-Hill/Irwin.