Background
A lease is a financial arrangement in which the lessor (the owner of an asset) purchases the asset and grants the lessee (the asset user) access to the asset in exchange for recurrent payments. The leasing agreement specifies all of the lease’s conditions. There are two leases: capital and operating (Saptono & Khozen, 2021). With the asset transfer, the risk and reward in a capital lease are transferred to the lessee.
An operating lease, on the other hand, does not transfer the risks and benefits to the lessee when the asset is transferred. Therefore, leasing is an alternative to paying cash or borrowing money to buy the asset. One of the key distinctions between a capital lease and an operating lease is that the latter can be terminated by the lessee during the lease’s primary period, while the former cannot.
Costco uses operating leases, which implies that the rights may be comparable to the owner’s. Still, neither the leased asset nor the associated liabilities appear on the lessee’s balance sheet. Only the lessee recognizes lease payments as lease expenses on the income statement.
An operating lease is a commercial transaction in which the lessor purchases or produces property and transfers it to the lessee on terms other than those of a finance lease. The owner and lessee essentially have the same rights to use the property, but have separate costs and obligations to maintain the structure and pay taxes. The lease impacted the company’s financial statements, increasing revenue by 7.14% over the prior year (Costco, 2022).
Leasing vs. Ownership
It is worth mentioning that Costco Wholesale’s quarterly long-term capital lease obligation increased from August 2022 ($2.482 million) to November 2022 ($2.503 million) and has increased since November (Costco, 2022). In the case of Cotsco, leasing production space has advantages, including flexibility, location independence, and no maintenance and upkeep costs. In addition, there are no land or property taxes to pay.
The requirement to coordinate the type of activity with the landlord and the impact of rent on production costs are just two examples of the disadvantages of leasing. The purchase of manufacturing space in the ownership creates new prospects for the owner, such as the opportunity to make risk-free investments in the premises’ remodeling and equipment. The facility can be rented out or sold if the production is unsuccessful. Additionally, the owner can establish a competitive price without the related rent costs and receive loans backed by real estate without worrying about rising rents and eviction of production from the stores. Building owners face additional challenges, such as paying for the building’s upkeep and operation, taxes, and insurance premiums.
Investment Outlook and Recommendations
Costco is a great company, and I would invest in it. One of its most important advantages is its ability to offer its customers high-quality products at low prices (Costco Wholesale, n.d.). This contributes to customer loyalty and a steady flow of customers to the company’s stores. A small portion of Costco’s revenue comes from its products, most from membership fees.
By selling products in bulk at lower prices to attract customers, Costco’s membership business model allows it to sell products at lower prices than its competitors. In 2021, Costco earned $3.88 billion in membership fees worldwide, up from $3.35 billion and $3.54 billion two years earlier (Costco, 2022). Thus, the company’s income is centered on membership dues, making it a safe investment. Strong buyer confidence forms a solid backbone and will help the stock grow going forward.
After studying the company’s SoCF, I have concluded that Costco’s business plan relies heavily on loyal customers purchasing memberships. Through membership sales, Costco can sell merchandise at prices that barely cover costs. Wholesale purchases are only sometimes the best option for customers, especially those who live in cities where transporting large items from the store to their homes can be difficult.
Because Costco relies on large sales volumes, it is also at risk of changing consumer tastes. Thus, a recommendation for the company’s director might be to develop a store website through which customers can shop. This would solve the problem of people from small towns and help Costco become more competitive with competing companies by offering an online shopping service.
Also, a cab service or home delivery of goods to the customer can be introduced to reduce the problem of difficult delivery of purchases. In addition, direct deliveries should be established with some companies so that Costco does not have a surplus of products. This will help to cope with the rapid change in customer tastes and avoid financial losses.
References
Costco. (2022). Annual reports and proxy statements. Costco Wholesale Corporation. Web.
Saptono, P. B., & Khozen, I. (2021). Income tax and VAT issues concerning the lease after IFRS 16 convergence in Indonesia. The Indonesian Journal of Accounting Research, 24(2), 259-288. Web.
Costco Wholesale. (n.d.). About. Web.