PP1-Samantha-Coomer

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FIN 601: FINANCIAL MANAGEMENT AND MARKETS Dr. Jinsuk Yang Spring 2023 Project Part One SAMANTHA COOMER / SNCOOMER@EAGLES.USI.EDU

Business of Costco Wholesale Corporation The business of Costco Wholesale Corporation is a global chain of membership warehouses that carry brand-name products at a lower price than found at a commercial or retail store. Costco is a members-based, retail industry, offering three types of memberships that is based out of Issaquah, Washington. These include Executive, Business and Gold Star. Each membership comes with its own perks and offer a variety of services and benefits to fit each person’s individual needs. For example, members who sign up for the Executive membership receive auto and home insurance, check printing, identity protection, payment processing and bottled water delivery. Whereas the Gold Star Members are for individuals who plan to shop at Costco for personal use with an annual fee. Business members on the other hand qualify by owning or operating a business but can use their membership to shop for both business and personal use with an annual fee. Costco warehouses offer an array of category selections including groceries, hardware, toys, apparel, furniture, health and beauty, tires, etc. They are known for offering lower prices than other retail competitors by having low overhead cost that allow customers to receive a larger amount of savings. Throughout the entirety of this document, Corporate Governance, a SWOT analysis and a Financial Statement Analysis will be presented on Costco Wholesale Corporation. According to Costco’s website, Costco Wholesale went public on December 5, 1985. At this time the company was offering $10 per share before stock splits, with their initial price per share at approximately $1.67 prior to adjusting for stock splits (Costco Wholesale Corporation, 2023). Costco generates revenue from several streams such as, pharmacy and optical services, product sales, and their primary source of revenue from membership dues. Although, most of their merchandise is bulk items at a low cost, they are quality items that attract families and businesses for more cost-effective shopping. Providing high quality products at a lower price is one of their main goals. Obtained from Costco’s 2022 Annual Report, net sales for the fiscal year totaled $222.7 billion, an increase of 16% with a sales increase of 14%. Net income of $5.8 billion, or $13.14 per diluted share, an increase of 17%. Revenue from membership fees increased 9% to $4.2 billion (Costco, 2023). Corporate Governance Corporate governance can best be defined as the system by which companies are directed and controlled by mechanisms, processes, and relations (ICAEW, 2023). It is the connector relationship between board, shareholders, and upper executive management. This leadership team of Costco is made up of one chairman and ten directors. The board of the company is responsible for the success of the overall company, and how it sets its values while accomplishing company objectives is key to contributing to prosperous corporate governance. The board of directors hold many responsibilities, one of which includes to maintain and present the company with strong financial stability, reliability, and transparency. When outside investors are seeking to invest, the first place they will look at is the corporate governance of the company to determine if the company is headed in the right direction for a long-term investment. Now, to assessing some components involved in who makes up the governance, the chairman and directors. The most important stakeholder within the governance is the board of directors, and these board of directors are elected by the shareholders. These shareholders elect who they believe has the best interests of the company in mind and uphold the reputation of the 1

company in a good light. They are responsible for overseeing all of the activities being done throughout the company and deciding between who continues to perform well at maintaining the priorities of the company and who is not and moving forward accordingly. The board of directors are responsible for the governance of the company; however they aren’t all inside directors. The inside directors can be identified as executors or stakeholders while outside directors may not be employed or affiliated within the company but are committed to assisting in the future of the company moving forward. Both of these type of directors will still be given the same responsibilities and roles for the company. Furthermore, the corporate governance within Costco Warehouse Corporation follows the same logistics. Their board of directors are selected on the status of their knowledge, skills, experience, expertise, integrity, diversity, ability to make independent analytical inquiries, etc. They are expected to be present and attend meetings of the board regularly. If they are unable to attend a meeting, they must notify the Chairman in advance. The board is the one who appoints who will be the chairman and can replace the individual in that position as well. They can also appoint an independent director during specific circumstances. A few responsibilities expected of these board members include weighing on matters such as strategic planning, mergers and acquisitions, share repurchase programs, declaring dividends, and nominating future board members (The Motley Fool, 2019). Conclusively, the Costco board of directors are given the open opportunity to build a strong and stable governance with the proper tools and resources. They are given control to engage in any equity securities of Costco. With this power, they created guidelines to avoid any negative encounter between the management and the board members. There is another guideline that requires the rotation of committee members to annually assess and review the committee assignments and consider rotating the Chairman and determine if all members have a beneficial view towards balancing the benefits derived from continuity against the benefits derived from the diversity of experience and viewpoints of the various directors. SWOT Analysis of Costco Warehouse Corporation When analyzing the overall accomplishments of Costco Warehouse Corporation it is evident the large business corporation it has become with a members-based only attraction. As well as being presented as one of the largest retailers worldwide. They have been able to effectively offer quality products at a discounted rate to its customers. When conducting a SWOT analysis, strengths, weaknesses, opportunities, and threats will all be evaluated. By completing a SWOT analysis and analyzing the components assessed, there are further opportunities for growth in adjusting any concerns or issues found within the business strategy to transpire into a successful business plan. Strengths An internal factor that demonstrates strength and has deemed successful for Costco has been their strategic marketing. Although, it’s been repeatedly addressed, one of the main factors that makes Costco stand out from other retailers is that they offer low prices for high quality, name brand products. Their products prove to be substantial and attract consumers to feel exclusive to these offers through a membership offering. They have even continued on to have their own brand, Kirkland, that offers a high success rating among consumers. By offering the 2

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memberships, members are exclusive to shopping at their warehouse and getting their low-priced deals on products. This sets them apart from other retailers, while also increasing their revenue. Some contributions that have held impact on the success of the company has been being able to streamline distribution networks and expand their supply chain so quickly. Weaknesses The one major internal weakness that I can quickly identify is the inventory at Costco. Since Costco is a wholesale warehouse corporation, the products sold are limited and the inventory given to them is much lower than other retailers. This factor will ultimately hinder Costco from being able to achieve maximum revenue. Whereas companies like Walmart, are given more inventory of products and outreach to consumers not just in person but also online. Therefore, if an item is out of stock at Costco, it is very unlikely that they will get a replenishment of stock fulfilled. Furthermore, although membership-based has deemed successful for Costco in revenue throughout the years, they will still not reach maximum revenue with this internal factor either. It is an attraction to some people that the company offers memberships for entry because of the exclusivity that it offers, however this also poses some negative factors as well. Nonmembers are not allowed to enter or purchase products sold at the company which restricts some profitable revenue from being attained. However, in this situation the pro outweighs the con of this circumstance as majority of Costco’s revenue comes from membership dues. Opportunity Living in a generation where technology is taking over and continuously evolving and transitioning aspects to everything based online, it’s essential for the success of any retail company to offer online services. As other competitors like Target or Walmart transition to offering online based shopping, it’s essential for the success of Costco to stay up to expectations. As this factor considers to be an external factor, it offers an opportunity for Costco to invest and expand their services further globally while expanding their membership-based entry. By still requiring a membership to purchase products sold at this company, it can reach individuals worldwide that can sign up. By Costco becoming a company operating e-commerce websites, they have opened the realm for new opportunities and possibilities. Threats There is no surprise that the United States drives some of the most competitive markets when it comes to business. Having so much competition may drive prices down, but it will still increase economic growth, while ensuring the GDP is prospering. There will always remain a competition between retailers such as Costco, Sam’s Club, and Target. While all companies retreat to using low pricing strategies, sometimes the lowest price may not always be found at Costco due to this factor. Ultimately, this poses a threat to the sales of Costco when also considering the membership-based component as well. It gives consumers the opportunity to go to other retail companies that may have a similar price match and not require a membership entry. Major competitors would be Target, Walmart, Sam’s Club, Amazon, Lowe’s, Aldi, and Home Depot. 3

Financial Statement Analysis Short-Term Solvency Ratios The purpose of short-term solvency ratios is to determine the adequacy of liquid assets for obligations set in the short-term as they come due. The current ratios allow for the ability to figure out the current liabilities to pay to meet its debt requirements. Current liabilities refer to the debts that are more urgent and need to be addressed first. Current assets in most circumstances refer to the prepaid expenses of the company. By concluding current ratios, it allows for the investors to understand how to determine maximizing the current assets to eliminate their current debt. Costco’s current ratio is 1.0218 for 2022. This assumes that the current assets for Costco can pay for the current liabilities 1.0218 times. For 2021, the current ratio was 1.0022 and for the year prior, 1.1319 for 2020. There was a slight increase from 2021 to 2022, most likely resulted from total current assets increasing for 2022 being more than the value of total current liabilities. As for 2020 to 2021, there is another shift in ratios. 2020’s current ratio being the highest among the three-year period and slowly increasing by 2022. These ratios are result of fluctuations between total current assets and total current liabilities shifting each year. As for quick ratio, the total can be determined by subtracting the total current assets with inventory then divide by total current liabilities. Therefore, for the year 2022 Costco had a quick ratio of 0.4622. This number means that the current assets could pay total current liabilities 0.4622 times. The main difference between current ratio and quick ratio is that inventory takes a larger portion of current assets and takes more time to convert to liquid with current assets, while the other does not. As for Costco, it can be determined by these ratios that they are able to pay for current liabilities in the short-term. The quick ratio increased since cash equivalents, net receivables, cash, and other current assets increased. The increase in quick ratios occur when the value of the total current assets increases more than the value of the total current liabilities does. This can be supported by the quick ratio in 2021 being 0.5193 and 0.6391 in 2020. Furthermore, cash ratio determines the ratio of cash and cash equivalents to its current liabilities. The company’s ability to repay its current liabilities by only using cash equivalents and cash is measured through cash ratio. It calculates the company’s liquidity and if the company has the ability to pay off their debt in the short term. Costco’s cash ratio for 2022 was 0.3189. What this ratio signifies is the total current liabilities that can be paid 0.3189 times by cash equivalents or cash. Since the number is less than one, it can be assumed that Costco has a large amount of cash equivalents and current liabilities. If the number is over 1, the company is showing that they have more cash than current liabilities. In previous years the cash ratio is still below one with it being 0.3824 in 2021 and 0.4942 in 2020. This shows investors that there isn’t enough cash to pay short term debts. Long-Term Solvency Ratios Long-term solvency ratios help us determine a company’s ability to meet its long-term financial obligations. Total debt ratio can help assess the company’s assets that are used through debt. For example, in 2022 Costco had a total debt ratio of 0.6782. This means that 67.82% of total assets were funded by debt. In 2021, 0.6950 (69.50%) was funded by debt. This is 0.0168% 4

less from 2022. In 2020 the total debt ratio was 0.6633 (66.33%) that was funded by debt and 0.0149% from 2022. The total debt ratio goes down when value of total liabilities goes down to total asset. Whereas total debt ratio goes up when the value of total liabilities goes up to the total asset. Debt- equity ratio is determined by dividing the company’s total liabilities by its total equity. In this case, Costco’s debt-equity ratio for 2022 was 2.1078. What this means is that the total liability is 2.1078 more than total equity of the company. Costco is demonstrating to be less reliant on equity to fund the company, however they are using debt to operate the company. The debt-equity ratio is important to the success of the company because it determines the companies funding operation through debt and not their own funds and also allowing us to understand the term financial leverage a little more clearly. For 2021 the debt-equity ratio was 2.2785 and 1.9701 in 2020. These ratios exhibit that the total liability of the company was 2.2785 more than total equity in 2021 and 1.9701 more than total equity in 2020. Equity multiplier can be determined by dividing total assets of the company by total equity. What this will show is that Costco’s assets are funded by shareholders. For 2022, Costco’s equity multiplier was 3.1078. This tells us what the risk is for the company to creditors. Since we have determined that debt is what is financing the company, it can be concluded that there will be high debt services. With the equity multiplier showing 3.1078, Costco finances over half of its assets with equity and the other half with debt. However, this is also showing us that Costco is using a very good amount of debt to fund their total assets. The same can be said for the equity multiplier ratios in previous years. In 2021, 3.2785 and 2.9701 in 2020. Both results contribute to the same conclusion. Time interest earned ratio allows for us to measure the company’s ability to meet debt obligations through current income. This ratio can be found by dividing earnings before interest and taxes by interest expense. In 2022, the time interest ratio earned was found to be 49.3228. Costco can finance the interest charges with pretax earnings since the higher the ratio, the more likely it determines you are able to cover its debts many times over. The time interest earned ratio in 2021 was 39.2281 and 33.9688 in 2020. These numbers demonstrate the freedom that Costco has from their limitations on their debt. Asset Utilization Ratios Days’ sales in inventory ratio assesses the length of time that a company has to change inventory into sales. In 2022, the days’ sales in inventory ratio were 32.7816 from 30.3981 in 2021. These ratios show that it would take 32.7816 days to sales items in inventory in 2022 and 30.3981 days to sales items in inventory in 2021. The lower the number, the less time it takes to clear the inventory and vice versa. When looking at Costco’s numbers they are hitting right at the average of delivering this ratio as 40 days is deemed average. In 2019 the ratio was 30.8290, therefore the days’ sales in inventory ratio have remained relatively around the same but has showed an increase over the three-year period. These ratios have shown that it has taken Costco about one to two more days to sell its stocks. Days’ sales in receivables ratio demonstrates how long it takes in a day to collect accounts receivable for the past year. This ratio can be found by dividing accounts receivable by total revenue then times it by the number of days in that period. Costco uses a 365-day time period. Costco had a ratio of 3.6041 in 2022. Meaning that Costco will take about 3.6041 days to get accounts receivable for the past year. In this case, the lower the number, the more the company is favorable and shows how effective the accounts receivable practices are for the 5

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company. The average for days’ sales in receivable is roughly 30 days. What this ratio determines for Costco is that they are doing a successful job at paying off their obligation in short time. This can be supported by the numbers from the previous years as well. In 2021, 3.3588 and 3.3926 in 2020. Days’ payable outstanding ratio illustrates the ability that it takes the company to pay payables in cash and the length it takes to do so. For 2022, Costco’s ratio was 32.6736. This result means that it took Costco 32.6736 days to pay their payables in cash. In 2021, it took 34.8098 days to do so. Meaning it took about 2 more days more last year to pay payables in cash. The fluctuation of this ratio can be resulted from the gain and loss by changes in payables turnover ratio. Total asset turnover ratio demonstrates how much of sales are created per dollar of total asset. It’s the company’s total revenue divided by the total assets. In 2022, Costco’s ratio was 3.5370 from 3.3058 the previous year in 2021. This result means that the company was able to generate $3.50 for every dollar of total asset in 2022 and $3.30 for every dollar of total asset the year prior, only a 20-cent change. Profitability Ratios Profit margin ratio illustrates what the profit generation of the company is. In other words, it shows us what the profits generate on every dollar of sales. To determine this ratio you must take the company’s net earnings and divide by the total revenue. In 2022, Costco’s profit margin ratio was 0.0257. This result means that by every dollar sale, Costco made 2.5 percent profit. Looking at 2021, the ratio was 0.0256. Therefore, making the same percent of profit between both years. Changes result from the increase in both net earnings and net sale on a yearly basis, contributing as to why these ratios are so similar. In other words, profit margin ratio will go up or down depending on the change in companies net sales and net earnings. If the company’s net earnings increase, then the net sales stay the same or decrease then the profit margin ratio will increase. If the net earning decreases or stays the same while the net sales increase, the profit margin ratio will decrease. Return on assets (ROA) ratio demonstrates how much profit the company makes per dollar of total assets. In 2022, Costco’s ratio was 0.0911 and 0.0845 in 2021. This means that Costco can make up to 9.1% profit in 2022 and 8.4% profit in 2021. The ratio fluctuates depending on the changes in net earnings and total assets. For instance, if net earnings increase then total assets remain the same or decrease, then the ROA will increase and vice versa. The company is more asset efficient when the company has higher ratios. Therefore, these ratios show us that Costco had an increase, made more money invested into net income from 2021 to 2022. Return on equity (ROE) ratio determines the financial performance of the company. It is concluded by dividing the net earnings by the total equity. In 2022, Costco had a ROE of 0.2830 and 0.2770 in 2021. This shows us that for every dollar from total equity, Costco makes up 28.3 percent profit in 2022 and 27.7 percent profit in 2021. The higher the number the more beneficial it is for the company. Market Value Ratios Market value ratios are metrics that measure and analyze stock prices and compare market prices with competitors. These ratios help understand the economic status of the company. Price-earnings ratio is determined by taking the market price per share of common 6

stock and dividing it by the earnings per share. In 2022, Costco had a price-earnings ratio of 36.3105 and 39.3320 in 2021. These ratios show us that the investor is willing to pay 36 more times for every dollar of earning for mark price of common stock in 2022 and 39 times more in 2021. These ratios demonstrate the value of shares and the higher the number, the more the investor expects to see earning growth. On the other hand, the lower the number means the company may undervalue. Lastly, market-to-book ratio is determined by taking the market price per share and dividing it by the book value per share. This ratio allows us to assess the current market price to its book value. For 2022, this ratio was 10.2532 for Costco. In 2021 it was 10.8625 and 8.0631 in 2020. This ratio shows us the perception of stock value. In 2022, the market value was 10 times its book value and roughly 11 times its book value in 2021. 7

References Costco Wholesale. (2023). Board of Directors. Retrieved from Investor. Costco. Cuofano, Gennaro. (2023, October 3). How Does Costco Make Money? Retrieved from Four Week MBA. CFI. (2020, February). Times Interest Earned . Retrieved from Corporate Finance Institute. (2019). Get on Board: Understanding the Role of Corporate Directors. Retrieved from The Motley Fool. ICAEW- The Institute of Chartered Accountants in England and Wales. (2023). What is Corporate Governance? Retrieved from ICAEW. Investor FAQ. (2022). Costco Wholesale Corporation . Retrieved from Investor. Costco. 8

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