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Financial management analysis - A case of McDonald's corporation

Financial Management Analysis: A Case of McDonald’s Corporation

Table of Contents

1.0   Introduction………………………………………………………………………………..4

1.1 Company background …………………………………………………………………….4

2.0 Critical analysis of ratios…………………………………………………………………..5

2.1 Profitability ratios………………………………………………………………………….5 

2.1.1 Gross profit margin……………………………………………………………………...6

2.1.2 Net profit margin………………………………………………………………………...7 

2.1.3 Return on Equity (ROE)…………………………………………………………………8

2.2 Liquidity ratios…………………………………………………………………………….9 

2.2.1 Current ratio……………………………………………………………………………..9

2.2.2 Quick ratio……………………………………………………………………………...10

2.2.3 Cash ratio……………………………………………………………………………….11

2.3 Capital structure ratios…………………………………………………………………...12

2.3.1 Debt-to-equity ratio…………………………………………………………………….12

2.3.2 Times interest earned ratio……………………………………………………………..13

2.4 Stock market performance………………………………………………………………..14 

2.4.1 Earnings per share……………………………………………………………………...14

2.4.2  Price-earnings………………………………………………………………………….15

2.5  Efficiency ratios…………………………………………………………………………16

2.5.1 Accounts recievables turnover…………………………………………………………16

3.0 Weaknesses of ratio analysis……………………………………………………………..17

4.0  Conclusion and recommendations……………………………………………………….18

References……………………………………………………………………………………20

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1.0 Introduction

The objective of this report is to examine McDonald’s Corporation financial health. This objective is achieved by integrating the ratio analysis technique. The information used in undertaking the ratio analysis is sourced from extracts of the firm’s balance sheet and income statement. The rationale of integrating the financial ratio analysis is underline by the fact that as a public limited company, McDonald’s is required to publicly report its financial performance by publicising its financial statements. However, the usefulness of the information presented in the financial statement is limited by the fact that the figures might convey no meaning to a significant proportion of users of financial statements (Denny 2003). To overcome this challenge, this report integrates the ratio analysis technique as an approach of improving the meaning and significance of the firm’s financial statements.  Subsequently, different categories of financial ratios are calculated in order to suit their information needs.  The report is organised into different sections, which include; a brief background information on McDonald’s Corporation, a comprehensive analysis of the firm’s financial health on the basis of different ratios and evaluation of the weaknesses associated with the ratio analysis technique. Finally, a conclusion and a set of recommendation on the report’s findings are outlined.

1.1 Company

            McDonald’s Corporation is a public limited company that was founded in 1940 in the United States food and beverage industry. The company has developed an extensive product portfolio in an effort maximise profitability by meeting the product needs of diverse customer groups (Roger 2016).  McDonald’s has expanded into the global market through integration of the franchising strategy. Through the franchising strategy, McDonald’s has developed market presence in over 100 countries (United States Securities and Exchange Commission 2014).  Under the franchising strategy, McDonald’s has organised its operations into three main structures that include conventional franchise, affiliate or developmental franchise system. The company progressively reviews the performance of its franchise outlets and undertakes the requisite adjustments   (United States Securities and Exchange Commission 2014).

Despite the risk factors that characterise the global food and beverage industry such as intense competition and change in customer eating habits, McDonald’s has managed to depict positive performance which underlines its resilience. A study conducted by Euromonitor International, a renowned market research firm, there were over 8 million firms established in the ‘informal Eating Out’ segment in which McDonald’s operates. In 2013, the total sales in this market segment amount to $1.2 trillion of which McDonald’s accounted for 7.5% of the total sale, which is significant (United States Securities and Exchange Commission 2014). Copulsky (2011) identifies McDonald’s as one of the most resilient brands. The positive firm performance has been spurred by the firm’s commitment in adhering to its four strategic growth priorities (United States and Exchange Commission 2014). The priorities include offering innovative and differentiated customer products, providing customers unique experience, brand development and offering unparalleled convenience (United States and Exchange Commission 2014). These growth priorities have played an essential role in driving the company’s results.  However, the growth in intensity of competition might adversely affect the businesses financial performance. McDonald’s management team should develop adequate understanding on the firm’s historical financial performance in order to adequately plan on its future performance. Erdogana, Erdogan and Omurbek (2015) argue that ‘companies need to make various forward-looking financial decisions in order to achieve their main goals’ (p. 36). Additionally, gaining knowledge on the firm’s historical performance is essential for potential investors because it forms the basis on which they can project the firm’s future performance (Chandra 2011).

2.0 Critical analysis of ratios

Financial ratio analysis is one of the techniques that can be used to interpret the financial results presented in a firm’s financial statement (Fred 2015). Financial ratios provide   firms’ management teams a basis of benchmarking their firms’ performance relative to its competitors (Jose, Fernando & Manuel 2003). Through benchmarking, McDonald’s will be able to identify its strengths and weaknesses with regard to financial performance (Vasigh, Fleming & Humphreys 2014). Thus, the firm’s management team can use the ratio analysis results to make improvements on the areas of weaknesses hence strengthening its performance. There are different categories of financial ratios that can be used to evaluate a firm’s financial performance. Some of the categories include profitability, liquidity, efficiency, capital structure and stock market performance (Vasigh, Fleming & Humphreys 2014).  

2.1 Profitability ratios  

The profitability ratios depict a firm’s ability to conduct its business operations profitably. Thus, profitability ratios depict a firm’s operational efficiency (Visgh, Fleming & Humphreys). A firm’s profitability can be gauged by assessing it profit margin ratios and rate of return ratios (Kesavan, Elanchezhian & Selwyn 2005). The profit margin ratios include gross and net profit margin ratios. On the other hand, the rate of return ratio indicates the relationship between a firm’s profit level and its investment. The two types of rate of return that can be used in assessing a firm’s profitability include return on equity (ROE) and return on investment (ROI) (Kesavan, Elanchezhian & Selwyn 2005).  

2.1.1 Gross profit margin

This ratio can be used to assess the degree to which a firm can reduce the selling price of its products without incurring losses on arising from its operations (Rathod 2009)   Gross profit margin ratio is calculated using the formula below.

 
 

Gross Profit Margin Ratio = Gross Profit ×   100%                    

                                                      Sales

 

 

 

 

 

 

 

Table 1 below and appendix 1 illustrate the company’s gross profit margin. Similarly, graph 1 illustrates the trend in McDonald’s performance with regard to gross profit margin.

Year

Gross profit margin

2015

38.51%

2014

38.10%

2013

38.80%

2012

39.23%

2011

39.57%

Table 1

 McDonald’s has experienced slight fluctuation in its gross profit margin ratio over the past five years.

2.1.2 Net profit margin 

            According to Rathod (2009), net profit ratio can be used evaluate a firm’s operational efficiency. The net profit ratio is calculated using the formula below.

 
 

Net Profit Margin Ratio = Earnings after taxes                       

                                                      Sales

 

 

 

 

 

 

 

Appendix 2 indicates the calculation of McDonald’s net profit margin using the formula above. Between 2011 and 2015, McDonald’s net profit margin declined slightly as illustrated by table 2 and graph 2 below. However, the firm’s net profit margin has been relatively stable over the past five years.

Year

 Percentage net profit margin

2015

17.82%

2014

17.33%

2013

19.87%

2012

20.16%

2011

20.38%

Table 2

2.1.3 Return on Equity (ROE)

This ratio is used to evaluate a firm’s ability to use the shareholders’ investment in generating profit. The ratio is calculated using the formula below. Appendix 3 illustrates the calculation of the firm’s rate of ROE.

 
 

Return on Equity = Net Income ×   100%                    

                                       Sales

 

 

 

 

 

 

Year

                     Rate of Return on Equity

2015

64

2014

37

2013

35

2012

36

2011

38

Table 3

According to graph 3, McDonald’s rate of return on equity declined slightly between 2011 and 2013 from 38% to 35%. However, the rate of ROE has increased significantly from 37% in 2014 to 64% in 2015. McDonald’s is characterised by a relatively high rate of ROE, which indicates the firm’s effectiveness in using the shareholders’ equity to generate cash internally. Hirschey and Bentzen (2016) emphasize that ‘when ROE is at or above 10% to 15% per year, the rate of profit is generally sufficient to compensate investors for the risk involved with a typical business enterprise’ (p. 423). Therefore, the high rate of ROE indicates that McDonald’s is sufficiently able to compensate the shareholders for the risk taken by investing in the company’s stocks (Hirschey & Bentzen 2016).

2.2 Liquidity ratios  

            The objective of calculating these ratios is to evaluate a firm’s capacity to meet its short-term obligations. Examples of liquidity ratios include current ratio, quick ratio and net working ratio (Vasigh, Fleming & Humphreys 2014). McDonald’s financial performance can be evaluated on the basis of the identified liquidity ratios.

2.2.1 Current ratio

            This ratio is used in assessing the relationship between a firm’s current assets and current liabilities in order to determine whether the firm can sufficiently meet its short-term debt obligations. A firm can use the current ratio in standardising its current assets and current liabilities by comparing it with the industry average ratio (Vasigh, Fleming & Humphreys 2014). Current ratio is calculated using the formula below. Appendix 4 illustrates the calculation of McDonald’s current ratio.

 
 

Current ratio = Current Assets                       

                        Current Liabilities   

 

 

 

 

 

 

 

Year

                              Current ratio

2015

3.3

2014

1.52

2013

1.59

2012

1.44

2011

1.25

 

Table 4 and graph 4 shows that McDonald’s has experienced a considerable growth in the level of its current ratio between 2011 and 2015. From table 4, it is evident that McDonald’s has maintained its current ratio above 1, which indicates  the firm is capable of meeting its current liabilities using current assets (Vasigh, Fleming & Humphreys 2014). The company experienced a significant increment in its current ratio in 2015 compared to the previous years.

2.2.2 Quick ratio

            According to Kuppapally (2010), the acid ratio examines the ease with which a firm can use short-term assets in addressing short-term debt obligation. Quick ratio is calculated using the formula below. Appendix 5 illustrates the calculation of McDonald’s quick ratio.

 
 

Current ratio = Cash +cash equivalents +investment +Account receivables                       

                                   Current Liabilities   

 

 

 

 

 

 

 A high quick ratio is preferred because it indicates that a firm has adequate liquidity to efficiently address liquid liabilities (Kuppapally 2010).  A quick ratio of 1:1 is mainly considered as an ideal ratio for a firm. However, it is imperative for a firm to maintain a relatively high quick ratio.  Kuppappally (2010) argues that ‘the quick ratio is the true test of a business’s solvency’ (p. 210). Table 5 shows that McDonald’s has managed to sustain its quick ratio above the ideal ratio of 1:1. The firm’s quick ratio has over the past five years experienced positive growth despite the slight decline in 2014 as illustrated by graph 5 below.

Year

               Quick ratio

2015

3.01:1

2014

1.2:1

2013

1.3:1

2012

1.09:1

2011

1.05:1

 

2.2.3 Cash ratio

In addition to quick ratio and current ratio, a firm’s level of liquidity can be evaluated by calculating the cash ratio. Bragg (2012) argues that ‘cash ratio uses only cash and short term marketable securities and is the best way to assess what proportion of liabilities absolutely or positively can be paid right away’ (p. 83). A cash ratio of 1:1 is considered most ideal and reasonable indicator of a firm’s liquidity. The cash ratio is calculated using the following formula. Appendix 6 illustrates the calculation of McDonald’s cash ratio.

 
 

Cash ratio = Cash and cash equivalents                        

                                   Current Liabilities   

 

 

 

 

 

 

 

Year

Cash ratio

2015

2.6:1

2014

0.76:1

2013

0.88:1

2012

0.69:1

2011

0.67:1

 According to graph 6, McDonald’s has improved its cash ratio from a low of 0.67:1 in 2011 to a high of 2.6:1 in 2015. However, between 2011 and 2014, the company’s cash ratio is below the ideal ratio of 1:1. This indicates that the firm’s level of liquidity is relatively low despite the positive indication by the quick ratio and current ratio (Michael & Albert 2015).

2.3 Capital structure ratios

Capital structure ratios are used to evaluate a firm’s long-term solvency. Maintaining a healthy capital structure or leverage ratio is vital in assuring long-term creditors of a firm’s ability to meet the periodic payment of instalment and interest on loan issued (Khan & Jain 2005). A firm’s capital structure can be assessed by determining two main ratios that include  debt-to-equity, equity-to-assets,  and debt-to-assets ratios (Khan & Jain  2005).

2.3.1 Debt-to-equity ratio

            This ratio determines the proportion of equity that constitutes a firm’s capital structure.  The debt-to-equity ratio can be used to determine whether a firm is highly geared or largely dependent on debt financing to facilitate its operations (Vasigh, Fleming & Mackay 2014). The debt-to-equity ratio is calculated using the generic formula below.

 
 

Debt-to-equity ratio = Total liabilities                         

                                   Total stockholders’ equity

 

 

 

 

 

 

 

Appendix 7 illustrates the calculation of McDonald’s Corporation debt-to-equity ratio. Graph 7 and table 7 shows that McDonald’s debt-to-equity ratio has deteriorated from 2011 to 2015. This aspect is indicated by the fact that the firm’s debt-to-equity ratio is above 1. For example, in 2014, the firm’s debt-to-equity ratio was 1.67. This means that for every $1 invested by the firm’s shareholders, McDonald’s is only able to leverage $1.67 of its debt finance. Vasigh, Fleming and Mackay (2014) affirm that the ideal debt-to-equity ratio should be less than 1.

Year

2015

2014

2013

2012

2011

Debt ratio

4.36

1.67

1.29

1.31

1.29

Table 7

2.3.2 Times interest earned ratio

This class of capital structure ratios measures firm’s capacity to meet its interest payments. Debt holders can use this ratio to examine the risk posed by reliance on debt sources of finance (Vasighh, Fleming & Mackay 2014). The times interest earned ratio is calculated using the formula below.  

Times interest earned ratio = Earnings before Interest and Taxes (EBIT)                          

                                         Total stockholders’ equity

 

 

 

 

Despite the improvement experienced by McDonald’s with regard to times interest earned over the past five years, the firm’s times interest earned ratio is relatively low. This indicates that the firm has not developed adequate capacity to cover its interest expense (Grier 2007).

2.4 Stock market performance  

The objective of calculating the stock market ratios is to examine a firm’s equity position.  These ratios enable potential investors to understand the performance of a firm relative to the stock market. Thus, stock market ratios are a critical source of insight for investors in making a decision to invest in stocks of a public company (Grier 2007).  The stock market performance ration can be calculated by determining two main ratios that include earnings per share and price-earnings ratios.

2.4.1 Earnings per share

            The earnings per share ratio is calculated using the formula below. Appendix 9 illustrates the calculation of McDonald’s earning per share

 
 

Earnings per share = Net income                        

                                   Average number of shares outstanding    

 

 

 

 

           

 

 

Year

2015

2014

2013

2012

2011

Earnings per share

4.58

4.66

3.02

2.74

2.66

 Table 9

Table 9 shows that McDonalds has experienced a considerable growth in its earning per share. This shows that the firm is an ideal company that investors should consider investing in.

2.4.2  Price-earnings ratio

            Haber (2004) acentuates that ‘the price-earnings ratio is the ultimate assessment of a company’s stock market value as it compares the relationsip between the performance of a firm according to the income stament and the stock market’ (p. 180). Table 10 and graph 10 below indicates the trend of McDonald’s price-earing ratio from 2011 to 2015.

Year

2015

2014

2013

2012

2011

Earnings per share

25.6

18.5

17.5

16.4

19.7

Table 10

McDonald’s price-earnings ratio is characterised by a positive growth trend. This depicts a positive growth in the company’s market value hence making it an attractive firm to invest in.

2.5  Efficiency ratios

            This ratio is used to evaluate the effectiveness of a firm in managing its resources (Haber). Koen and Oberholster (1999) further asserts that efficiency ratios can be used to assess a firm’s efficiency in generating cash over time. Examples of efficiency ratios that can be used to asses a firm’s effectiveness in managing resources include accounts recievable turnover,inventory turnover, and fixed assets turnover (Weil, Schipper & Francis 2014).

2.5.1 Accounts recievables turnover

This ratio assesses how quickly a business collects cash from its credit sales. This ratio is calculated using the formula below. Appendix 10 illustrates the calculation of McDonald’s accounts receivable turnover

 
 

Accounts receivable turnover = Sales                          

                                         Average accounts receivables

 

 

 

 

 

 

Appendix 8 illustrates calculations on McDonald’s accounts receivable for the period ranging between 2011 and 2015.  Table 11 shows the number of times that McDonald’s is able to collect cash on credit sales per year. From table 11, it is evident that McDonald’s has been effective in collecting cash on credit sales as illustrated by the stability of its accounts receivables turnover ratio.  .

Year

2015

2014

2013

2012

2011

Accounts receivables turnover ratio

19.56

22.6

21.29

20.04

20.23

Table 11

3.0 Weaknesses of ratio analysis

Despite the fact that ratio analysis on a firm’s financial statement can provide critical insight regarding a firm’s financial performance, this technique is characterised by a number of weaknesses as evaluated herein (Taparia 2003).

  1. Quantitative oriented; the ratio analysis technique only integrates the quantitative dimension in assessing a firm’s financial performance. The technique does not take into consideration the qualitative dimension of financial statement analysis. Therefore, investors might miss important aspects relating to the firm’s operations. Bagad (2008) asserts that ‘while conducting the credit analysis of a customer seeking credit, the investor may deserve a credit to be granted on the basis of financial statements submitted by him but in reality his character, or creditworthiness may be doubtful’ (p.15). Therefore, ratio analysis ignores qualitative factors which are critical in the decision making process of different users of financial statements.
  2. Historical analysis; the ratio analysis technique is based on a firm’s past financial performance.  This means that the ratios are historical in nature, which limits their efficiency in assisting investors project a firm’s future performance. For example, the accounting figures in the balance sheet are not adjusted for inflation, which distorts the values of the balance sheet (Taparia 2003).
  3. Bias; ratio analysis is conducted on the basis of the financial information provided by the financial statements. However, the financial statements may not be free from bias because of variations in the techniques used by the accountant in computing different accounting entries such as the method of depreciation.

4.0 Conclusion and recommendations

            The franchising strategy adopted by McDonald’s has greatly stimulated the firm’s financial performance. The franchising strategy has enabled the firm to be efficient in generating sales from the international market. The firm’s financial performance is illustrated by the financial analysis conducted. The financial ratio analysis shows that McDonald’s has been relatively resilient to changes in the global food and beverage industry. In spite of the intense competition in the global food and beverage industry, McDonald’s has been able to maintain a positive financial performance. However, the firm has experienced slight fluctuations in its financial strength as indicated by the different categories of financial ratios.  The profitability ratios such as gross profit and net profit margin show  that McDonald’s profitability has declined slightly over the past the five years. Nevertheless, McDonald’s rate of ROE has increased significantly during the period under consideration, which indicates that the firm is able to compensate the shareholders for the risk taken by investing in the company’s stocks. The liquidity ratios show that the firm has adequate liquidity capacity to meet its short-term financial obligations. This underlines that the firm is able to sustain its daily operations without interruption.

   The capital structure ratios show that the firm is highly geared. This means that McDonald’s is over-dependent on credit finance as opposed to equity finance in undertaking its operational activities.  This aspect is underlined by the high debt-to-equity ratios. In spite of this, McDonald’s is an attractive firm that investors should consider investing in as indicated by the stock performance ratios. The firm has managed to progressively grow its earnings per share and price-earnings ratio. Therefore, investors can generate high returns by purchasing the firm’s stocks hence maximising their wealth.

On the basis of the report’s findings, the different users of the firm’s financial statements should consider the following issues.   

  1. McDonald’s management team should focus on improving the composition of its capital structure. One of the issues that the firm should take into consideration entails improving the proportion of equity capital for example by issuing shares in the stock market. This move will limit the firm’s dependence on debt finance. Therefore, the firm will be able to efficiently finance its operations without increasing the risk associated with debt finance such as high interest rates.
  2. Potential investors and credit financiers should ensure that their decision to invest in McDonald’s shares or advance credit finance to the firm is not solely based on financial ratios. On the contrary, it is imperative for potential investors to consider undertaking a qualitative analysis of the firm’s financial analysis in order to effectively determine the firm’s financial health.

 

 

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