Case 7 analysis
1. What can the historical income statements (case Exhibit 1) and balance sheets (case Exhibit 2) tell you about the financial health and current condition of Krispy Kreme Doughnuts, Inc.?
Krispy Kreme Doughnuts was a financially healthy company since its first initial public offerings in 2000. The company experienced a consistent growth during the period from 2000 to 2004 in terms of their total revenue, net income, and earnings per share. After going public, Krispy Kreme developed an aggressive plan that they want to expand the numbers of store from 144 to 500 in the next five years. They also want to grow internationally. However, the sweet story could not last long.
The economy began to slow down at the end of 2003. Krispy Kreme claimed that the recent trend of reduction in carbohydrate consumption and consumers’ diet plans are the primary reasons for declining in wholesale and retail sales. In addition, we believe that the intense competition from their rivals could also be blamed for reducing in sales. As we can see on the income statement, their net income for the month ended May 2, 2004 was negative 24,438 thousand dollars, which was declined from 13,001 thousand dollars on Aug 3, 2003. Krispy Kreme’s earnings per share (EPS) also began to go down near the end of 2003. Their EPS was negative 0.38 thousand dollars on May 2, 2004.
2. 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?
Financial ratios are used to transform the financial data into percentages to easily understand them, and to be able to compare historical data. Financial ratios also could be used to compare between two relatively similar companies, for example the gross margin ratio, shows us how much does the actual product or service really costs relative to revenue. Exhibit 7 shows us a set of ratios from 2001-2004, those ratios could be used to compare current year with previous years, and it could either show us that the company is doing good and getting better, or vise versa. Liquidity ratios show how fast a company can sell its current assets to pay out current liabilities. Current ratio takes into account total current liabilities and assets, while quick ratio does the same thing but excluding inventory. In the exhibit 7 both liquidity ratios are increasing over time, which poses whether the cause is current assets or the current liabilities. In this case both assets and liabilities are increasing, but assets are increasing in a bigger proportion, which explains the increasing ratios. Profitability ratios raise lots of questions, when considering return on assets ratio, is the net income driving the ratio fluctuations or is it the assets. Is it the shareholder’s equity that’s changing, or is it the sales that are increasing. To fully understand those ratios, more information is needed, to see the changes in all of these line items, to determine whether the company is earning more profit or not. Exhibit 8 shows the financial ratios of a set of companies, but when you are trying to compare a certain company with a competitor, one has to keep in mind that the difference in the company size. For example a big company will have more debt and equity than a smaller company, owning several branches compared to owning only one. Also, when comparing those ratios, looking at the financial statements is essential because the ratios between two competitors could be really similar but the drivers of those ratios could differ. Exhibit 9 shows common sized financial statements; line items turned to a percentage of sales, or assets. Those percentages could highlight the key driver of expenses, even though it’s not very specific, but using the same...