Introduction
The primary source of information for assessing financial health of a company is the company’s financial statements, which are divided into three parts, namely, the Income Statement, Balance Sheet, and Cash Flow Statement. An Income Statement, also known as ‘Consolidated Statement of Operations’, shows trends in money growth. It will also show where the money is spent. A Balance Sheet shows the current state of assets and liabilities of the company. On a Balance Sheet, shareholders’ equity must equal total assets less liabilities. From Balance Sheet, one also learns whether the company has enough working capital on hand. A company is in serious difficulties if its shareholders equity is in negative- that its total liabilities outweigh its total assets. A statement of Cash Flow will tell how the company has been able to fund its activities and how it will continue to fund activities. Investors use financial statements to research potential investments; bankers base lending decisions on company’s financial statements; and valuation experts utilize financial statements to determine a company’s net worth. A routine scrutiny of financial statements helps management to improve company’s performance and ultimately its value.
A comprehensive financial health review of a company involves company’s financial ratio analysis to measure its past and current operations and compare the results to its industry. Ratio analysis review offers insight into historical growth, profitability, debt capacity, and overall liquidity of the subject company in the context of its industry. There are a number of ratios to choose from. Some of the more common measure liquidity, debt coverage, leverage, assets’ performance, and operating and profit performance. Financial health can also be measured by converting financial statements into common size. Common size financial statements are simply company’s financials expressed in the form of percentages rather than dollars. A common size format readily identifies tends and growth pattern. In this study financial ratio, tools have been adopted in order to assess the general financial health of Krispy Kreme. To analyze large amount of financial data contained in financial statements of Krispy Kreme, the data has been summarized in some key financial ratios as shown in the table below. This will shed light on important issues relating to financial health of Krispy Kreme.
Financial Leverage
When a company borrows, it promises to make a series of payments. Because the shareholders get only what is left over after the debt holders have been paid, the debt is said to create a financial leverage. Debt Equity Ratio of long-term debts to equity capital measures the financial leverage of the company. The debt equity ratio of Krispy Kreme presents a fluctuating trend. It came down from 50% in 1998-99 to 0% in 2000-01 and again rose to 22% in 2002-03. It appears that Krispy Kreme paid of its long term debts in 2000-01, perhaps taking advantage of liquidity position represented by 17% working capital to total assets ratio. But the fact is the company has not fully utilized the long term debts at its disposal to its fullest potential. There is always a possibility that Krispy Kreme may not get long term debts again on same favorable terms in future. The company’s zero debt equity ratio in 2000-01 is not justifiable basically for following two reasons.
- First, there is no benefit being extended to equity shareholders, as the company has not improved upon its zero payout ratios despite a constant return on equity. This may be due to some liquidity crunch created by the repayment of long-term debts in 2000-01.
b) Further, immediately in coming years Krispy Kreme again borrowed long term debts to the extent from 2% in 2001-02 to 22% in 2002-03.
This gives the impression that that the borrowing policy of the Krispy Kreme is not part of its planned long-term strategic objectives.
Liquidity assessment
Bankers and suppliers remain extra careful so far liquidity of the company is concerned. They know that illiquid firms are more likely to fail and default on debts. Another reason that analyst focus on liquid assets is that figures are more reliable. Except for working capital to total assets ratio, all other liquidity ratios have been calculated only for 2001-02 and 2002-03 due to non- availability of figures. The balance sheet analysis of Krispy Kream brings a mixed result. Though ‘Quick ratio’ has increased marginally from 1.39 in 2001-02 to 1.69 in 2002-03 and also the ‘Cash ratio’ has improved from 0.71(2001-02) to 0.92(2002-03), but the ‘Current ratio’ of Krispy Kream has in fact gone down to 0.24 (2002-03) from very sound 1.94(2001-02). This gives the impression that it is the policy of Krispy Kreme to keep its current in liquid shape as far as possible. The company probably does not its trade debtors or probably the company has most stringent credit terms that results into comparative low account receivables. Strict credit policies certainly affect credit sales and thereby regular growth of the company. Such conclusions are drawn only because of regular improvement in the working capital to total assets ratio that has increased from 9% in 1998-99 to 20% in 2002-03. If current ratio is not improving despite improvement in working capital to total assets ratio, the working capital utilization of Krispy Kream is certainly not aggressive. The company is playing very safe and more concerned with the liquidity of assets. But earning in a business improves only with more risk taking exploitations that are not being undertaken by the company. Krispy Kream’s business approach is certainly not an optimistic approach and needs a review.
Productivity of Assets
An analysis about the productivity of assets generates the effectiveness of the use of investments in fixed and current assets. The sales- to assets ratio shows how hard the firm’s assets being put to use. In case of Krispy Kream, each dollar of investments in assets is generating one and half-dollar of revenue turnover in the year 2002-03. This ratio has come down from 1.94 in 1998-99 to 1.2 in 2002-03. Krispy Kream has made progress but its assets have remained under utilized. Generally speaking, investments in assets must generate manifold revenue turnover. However, the correct picture can be arrived only when these ratios are compared with standard of the industry.
The speed with which a company turns over its inventory is measured by number of days it takes for goods to be produced and sold. Inventory turnover for 2001-02 and 2002-03 is 33.24 and 33.74 respectively. Inventory turnover is same for both years suggesting that probably industry standard is being followed. Days in inventory ratio express inventories as a multiple of daily cost of goods sold. Here Krispy Kream has not been able to maintain its own standard in 2002-03 as set 2001-02.
Profitability
‘Net Profit Margin’ describes the proportion of sales revenue finding its ways into company’s profits. Krispy Kream has really made strides from a loss in 1998-99 of (-) 0.03% to profit 11% in 2001-02 and 2002-03. Various tax implications are dependant on this profit margin. Other stakeholders must also feel satisfied over such increasing performance of Krispy Kream, but there is always a room to improve upon. Bankers and other investors are keen to know about Return on investments (ROI) or Return on Assets (ROA), that in fact is logical measure of performance of assets. Krispy Kream is earning 8% on average total investments in 2002-03. This is a very reasonable return after taxes. Another measure that concerns the common stockholders is “Return on Equity’. Krispy Kream is yielding on an average of 12% on its equity. This position has reached from a dismal negative return in 1998-99 to a very healthy 12% in 2002-03. Krispy Kream has shown a remarkable performance over the period. The worst part of assessment is that Krispy Kream is not paying any earning to shareholders. The payout ratio is zero for a long time and this will definitely put equity holders in dilemma about their prudence of investment in Krispy Kream.