General Financial Health of Krispy Kreme - Case Study Example

General Financial Health of Krispy Kreme Introduction: This essay aims at analysing the financial health of Krispy Kreme over the last few years. Thecompany statements and the management’s announcements are analysed to understand the company’s standing in cash flow, income, depreciation and stock. The management is also analysed to understand the company’s long term plans. The importance of these analyses in understanding the financial health of a company is also discussed in the following sections. Cash Flow Analysis: Cash flow in a business plays an important role, as it affects the liquidity position of the company. In the case of Krispy Kreme, it is evident that the main source of cash was from operations and the line of credit from bank until 2000. The company increased its ability to generate cash to a great extent when Krispy Kreme went public in April 2000. The net working capital has seen steep increases after 2000. The equity financing has played a great role in its expansion, as its net cash from financing increased from $ 398,000 in fiscal 2000 to $ 39 million in fiscal 2001, which is almost 1000% increase. The cash obligations in terms of loans and debts for the net few years till 2004 are very limited. Krispy Kreme has announced plans for expansion of its stores and also reduction in the joint ventures. This requires a high amount of cash to be generated. Krispy Kreme is confident of generating sufficient cash through its operations. However, the management has not considered inflation in its cash flow analysis and it can have adverse effects, if the company does not include inflation in its cash flow forecasts and analysis. The other important aspect to be considered is that the company does not segregate its cash flow statements and uses a consolidated analysis. A better option will be to consider each entity as a separate business and consider its cash flows. This will throw more light on the operational effectiveness. Besides these minor facts, the company has a very strong liquidity position and is capable of generating sufficient cash to manage its expenses and also focus on its expansion activities in the next decade. Income Statement Trend Analysis: The company has grown in the last few years to a great extent and is reflected in the income statements for fiscals 2000, 2001 and 2002. Krispy Kreme has increased the number of franchisee stores to a great extent (91 franchisee stores) in 2002 and evidently they contributed 55% increase in revenue. Moreover, the gross margin from the franchisee stores in 2002 is 65% compared to 18% gross margin for the company owned stores. In spite of other demerits, the franchisee operations have had a great effect on the net income of Krispy Kreme. However, in the long term, the company owned stores will contribute more to the net income and with this strategy in mind; Krispy Kreme is focussing on increasing the number of company owned stores and reduction in the number of new franchisee stores, as stated earlier. This will have greater effect on the value of the company and once the fixed costs are realised the income will again shoot up. With the increase in the number of franchisee operations, KMM & D has also managed to attain economies of scale and has managed to reduce the margin of operating expenses. The operating expense to revenue ratio has reduced by almost 2% in 2002. All these factors have contributed to the increase in the net revenue of Krispy Kreme in 2002. As far as the short term trend is concerned, 2001 saw a steep rise due to the company’s initial stock offering and a very good response from the public. Year 2002 also saw an increase in the value of the company, as the management has focussed on expanding its operations and also on cutting down costs. In the short term, as the company has plans to open more owned stores than franchisees, the income is bound to rise slowly or might even reduce. However, in the long term, the company’s value is bound to rise as the assets owned by the company will be very high and the asset generation ratio will also increase due to its effective operational activities. Depreciation Analysis: Depreciation analysis will reveal the company’s assets and their age factor; and also the performance of the assets. It is essential for a company to manage and renew its assets; and also add new asset and properties in order to maintain the value of the company in a steady manner. Krispy Kreme’s depreciation and amortization expenses grew from $4.5 million in the year 2000 to $6.5 million in the year 2001. This was a massive rise of almost 42%. The percentage of the depreciation in terms of the total revenue totaled to a mere 2.1% for both the years. The company included a number of new capital assets during the year, as well as the company faced an accelerated depreciation expense of about $690,000 which were related to the anticipated store relocations which shortened the useful lives of the stores hence increasing the depreciation. Looking at the statements of the company between Janurary 2000 and Feburary 2002, it is quite clear that there has been a steep increase in the depreciation from $4,546 to $7,959 (both in thousand dollars). Krispy Kreme currently utilises straight line depreciation methods for building and properties, and assets. This might skew the income statement to a great extent as the method used is straight line whereas the assets depreciate to a higher degree in the first few years after purchase. As the numbers increase, the straight line method and the current accounting policy will make the estimations close to perfect actual values by reducing the error percentage. Despite these minor drawbacks, the company has managed its assets and invested in new properties and other buildings (stores) in a constant manner. Hence the depreciation analysis indicates that the Krispy Kreme has a number of relatively new assets and buildings; however it has been actively increasing the number of company owned stores and also the equipments, indicating that the assets are renewed regularly. Company Stock Analysis: The stock analysis is very essential to understand the company’s financial health, as the company is valued from the stock value in the market. The company managed to raise a lot of capital by its IPO and thereafter there has been a steady rise in its stock value. Krispy Kreme has devised a strategic stock option plan for its employees wherein the employee can defer 1% to 15% of the basic pay to obtain the common stock of the company. The earnings per share have also been steadily increasing (about 49%) from fiscal 2000 to fiscal 2002. The basic earnings per share in 2002 amounted to $ 490, a 300% raise over the 2 years. The information on options outstanding indicates that the average contract life is about 8 years and there are various exercising values on the prices of the stock options. This initial analysis of the company stock indicates that the value has grown in the last 2 years after IPO and that the company is effectively utilising the share capital in its ventures. Management Analysis: The management’s policy and the skills are an essential element in analysing the company’s financial stability and growth, as the major decisions are taken by the management and these have great impacts on the financial health of Krispy Kreme. The management has actively involved in raising capital by various sources of financing over the last few years. The company’s major turning point was the IPO in April 2000. The management has effectively utilised the funds generated, the revolving credit and the borrowings to generate and expand its business operations to a larger scale. The period from 2000 – 2002 can be evidently addressed as the rapid expansion period where the net working capital and the income have taken a steep raise. The management has been actively involved in joint ventures by equity as well as cash methods with various organizations, in order to gain rapid entry to the markets. This has resulted in a steep raise in the operations of the company. The management has also devised a strategy for its long term success and growth, instead of focussing on short term profits. The employee plans are also strategically placed to retain the valuable resources for a long term. Attractive common stock options and pension schemes have been made available to the employees, thus motivating them. All these steps taken and also the future plans set by the management clearly indicate that the management is highly effective and the company is financially stable. Conclusion: The above discussions indicate that, in order to understand a company’s financial health, it is essential to analyse all the financial aspects, including cash flow, income trend, depreciation, stock and management. Krispy Kreme was analysed under these heads and the financial health of the company in each of these aspects were discussed. The discussions indicate that the company is financially sound and is expected to grow financially in the next few years. Read More