Finance and Accounting - McDonalds - Case Study Example

Finance and Accounting: MacDonald’s April 23, Finance and Accounting: MacDonald’s Environmental scan refers to a systematic process of analyzing and interpreting relevant environmental data so as to determine opportunities and threats to the company (Fabozzi, & Grant, 2000). An environmental scan is crucial to the company since information regarding various factors in both the internal and external environment are gathered. This data help the company be aware of any changes in the environment either positive or negative changes. Internal environmental scan focuses on the strengths and weaknesses of the company while the external environment scan focuses on the threats and opportunities. External environment scan comprises six factors called the PESTLE analysis (Fabozzi, & Grant, 2000). PESTLE is an acronym for political, economic, social, technological, legal and ecological (geographical) factors. These six factors affects the decisions made by the company in the long-term and therefore an in-depth analysis of the factors is fundamental to all the stakeholders of the company who are affected by the operations of the company. Investors for instance, needs to know the kind of environment that the company is operating under as a way of assuring them of the benefits they ill gin from investing in the company. a) MacDonald’s environmental scan and risk analysis MacDonald’s is a global restaurant industry that serves various products to the clients at various prices in more than 100 countries in the world. The products they offer include cheese burgers, chicken sandwiches, oatmeal etc. with the wide range of products they company offers, they have become a household name across the many regions thus improving their brand name. MacDonald’s Company creates employment opportunities to quite a large number of people with 440,000 employees as of year-end 2013. This summarizes the strengths of MacDonald’s Company. Consequently, the company has some weaknesses facing their operations ranging from the high prices for the products they sell making it difficult for the average customers to buy. Additionally, some employees tend not to perform their duties satisfactorily thus affecting the quality of the products they sell to the customers. The opportunities and threats facing the company can be descried by the PESTEL analysis as follows; Political MacDonald’s Company are fully aware of the effects of political interferences in the business. The company involves itself in the political world with an aim of forming links with prominent people in the political scene and also seek government initiatives for example the focus by the US and other overseas governmental authorities on climate change. Economic Recession in the economy affected the revenues generated by the company since the demand for the food products declines significantly thus reducing revenues. MacDonald’s Company was not affected by the recession in a big as compared to other companies. During the recession period, the company shifted its attention to a more expensive menu options for the foods available and also increased the marketing expenses by 7% Social The social factor has posed a threat to MacDonald’s Company due to the health risks associated with their products and this caused a negative publicity for the company. This situation saw many customers shift to other companies in the same industry that are more health conscious with their products. Technological The continued technological advances has provided many opportunities to businesses. The internet has provided a platform for business to market their products and achieve great success as in the case of MacDonald’s Company despite the negative hoax. Environmental (geographical) A business is mandated with the environmental control measures such as pollution control measures and waste disposal methods. The company should ensure the surrounding environment is kept safe. MacDonald’s Company has incorporated corporate social responsibility aimed at reduction of environmental effects of the business. They have also ensured their products are packaged in biodegradable materials as a way of minimizing environmental damage, this is done through reducing the usage of paper used to wrap their products. Another initiative by MacDonald’s on reduction of environmental impact, is the management of the animals reared for the supply of their meat product, this is done to ensure no cruelty or inhumane treatment is taking place. The company ensures that the waste products from the animals are properly disposed or reused as manure. Legal Every country has an independent legal framework that governs and regulates business operations in the market. Since MacDonald’s has diversified its operations to different countries in the world which have dependent policies there is no specific legal environment for the company rather they operate in some framework related to health and safety. These legal frameworks requires the company to establish measures to the employee’s capabilities and also food hygiene. MacDonald’s has established a control system required by law for their employees and also their products: beef and chicken undergo thorough before being used to prepare food for the customers. Other legal requirements for a business include employment laws which spells out the duration of employee’s working hours and employee’s allowance for leave. MacDonald’s Company has adhered to these laws to the latter even in those countries with less harsh laws and regulations. Competition MacDonald’s Company competes with other providers of food products at an international, national, regional and local markets. The major areas of competition are based on the price of the food products, convenience to the customer, and the quality of services. The risks that MacDonald’s need to address in conducting it daily business is the low wage rates to its employees which may affect the future of the company due to strikes and resignations of other employees. MacDonald’s should increase the wage rate of its employees to avert possible strikes that tend to tarnish the brand of the company and consequently customer dissatisfaction increases due to the deteriorating picture of the company that is portrayed during the strikes. The low wage rate issue possess a threat to the company and it should be addresses with immediate attention. b) Financial statement analysis of MacDonald’s using ratios Financial statement analysis gives a clear picture of the financial records of the company. Ratio analysis refers to a way of comparing and quantifying variable in the financial statements (Vandyck, 2006). Ratios are classified into: liquidity, leverage, activity, equity and profitability ratios. Liquidity ratios refers to the ratios that measure a company’s ability to meet its short-term obligations as and when the fall due. A lower liquidity ratio implies higher liquidity risk and the converse is also true (Vandyck, 2006). The ratios include; Current ratio = current assets/current liabilities = 5,050.1/3,170 = 1.59 times Quick ratio = (current assets - inventory)/current liabilities = (5,050.1 – 123.7)/3,170 = 1.55 times Leverage ratios are those ratios that determines the extent to which a company uses non owner supplied funds. These ratios are measures of financial risk of the company, the higher the leverage ratio, the higher the financial risk and vice versa (Vandyck, 2006). These ratios include: Debt to equity ratio = (long term debt/equity)*100% = (14,129.8/16,009.7)*100 = 88.26% Debt ratio = (total long term debt/capital employed)*100% = (14,129.8/33,456.3)*100 = 42.23% Activity ratios measures the efficiency of a company in utilizing its assets to generate sales. They indicate the extent at which assets are converted into sales in a particular time (Damodaran, 2012). Examples of these ratios include; Debtors turnover = credit sales/average debtors = 28,105.7/1,319.8 = 21.29 times Fixed asset turnover = sales/total fixed assets = 28,105.7/25,747.3 = 1.09 times Profitability ratios are the ratios which establishes the effectiveness of the company managers in generating profits (Damodaran, 2012). They include; Net profit margin = (net profit/sales)*100% = (5,585.9/28,105.7)*100 = 19.87% Return on equity (ROE) = (earnings attributable to shareholders/equity)*100% = (5,217.1/16,009.7)*100 = 32.59% Equity ratios are used to evaluate the overall performance of the company (Damodaran, 2012). They comprise of; Earnings per share (EPS) = earnings attributable to equity shareholders/number of ordinary shares = 5,217.1/3,500,000 = $0.0015 per share Dividend retention ratio = (retained earnings/earnings attributable to equity shareholders) *100% = (41,751.2/5,217.1)*100 = 800.28% c) Financial statement analysis of MacDonald’s utilizing free cash flow, market value added and economic value added Market value added (MVA) refers to the value of a company compared to the amount of capital invested. It is the excess value that the company has achieved from the resources invested to the company (Grant, 2003). From the financial statements of MacDonald’s for the year 2013 and 2014, MVA is calculated as follows; 2014 2013 Fair value of debt 16,700,000 15,000,000 Present value of operating leases 10,332,652 10,820,625 Market value of common equity 91,287,051 95,523,553 Macdonald’s fair value 118,319,704 121,344,178 Less: capital invested 40,707,452 41,456,725 Market value added 77,612,251 79,887,453 The market value added for 2013 was $79,887,453 while for 2014 was $77,612,251, this shows a decline in MVA in 2014 and therefore it implies that the company gained more value from utilizing the capital invested in 2013 than in 2014. MacDonald’s did not fully utilize the readily available resources to achieve their full potential. Economic value added (EVA) also known as economic profit is a performance evaluation measure which compares the returns generated to the expected returns by the investors using the various sources of capital (Grant, 2003). Based on MacDonald’s financial statement analysis, EVA for the year-end 2013and 2014 is obtained as follows; EVA = net operating profit after tax (NOPAT) – (cost of capital * capital invested) In the year 2013; EVA = 6,260,518 – (5.34%*41,456,725) = $4,045,701 In the year 2014; EVA = 5,343,074 – (5.30%*40,707,452) = $3,186,219 From the above computations of MacDonald’s EVA, it is evident that there was a decline in the value of EVA from 2013 to 2014. MacDonald’s generated fewer returns to the investors in 2014 compared to 2013, the company is profitable to the investors since it is generating positive returns but the decline in returns is a major concern to the investors that need immediate consideration. Free cash flow is another performance evaluation measure that determines the extra amount of cash that the company generates after facilitating for its growth at the current state. It is calculated as; Free cash flow = operating cash flow – capital expenditures. From the financial statements analysis of MacDonald’s, the free cash flow in 2013 amounts to 4.3 billion while the free cash flow for 2014 amounts to 4.15 billion. This shows a slight decline in MacDonald’s free cash flow from 2013 to 2014. This implies that the cash generated by the company is sufficient to pay the shareholders and also to cater for other assets of the company. However, the cash generated is decreasing which implies the amount of dividends paid to shareholders will also decrease to enable the company have some cash left to cater for other assets. The financial performance evaluation techniques: free cash flow, MVA and EVA for MacDonald’s Company shows a decrease from 2013 to 2014. This should be a cause for alarm to the company and they should review the items in the financial statements and reduce on the expenses while increasing on the revenues generated. Otherwise, a decreasing trend is not favorable to the both the company and the investors who have entrusted their resources to the company expecting greater and consistent returns. d) Calculation of weighted average cost of capital Weighted average cost of capital (WACC) is the overall cost of using the various forms of fund by the company with most companies using debt and equity as their source of funding. It is also referred as the average rate that the company is expected to pay all the shareholders to finance its assets (Patterson, 1995). WACC is calculated as; WACC = (cost of debt*proportion of debt in the capital structure) + (cost of equity * proportion of equity in the capital structure First, the various elements of the capital structure are calculated that is, cost of debt (Kd) and cost of equity (Ke). The value of the firm is then obtained from which the proportion of each element is determined. MacDonald’s current weighted average cost of capital is calculated as follows; Kd = annual interest charges/market value of outstanding debt = (570.5/14,559.75) = 3.92% After-tax cost of debt = 3.92% * (1-33.69%) = 2.60% Ke = risk free rate+ (beta*market premium). This is the Capital asset pricing model (CAPM) formula = 1.9% + (0.77*7.5%) = 7.67% The market value of MacDonald’s is given by value of debt plus value of equity = 91,181.328 + 14,559.75 = 105,741.078 The proportions of debt and equity are therefore obtained as follows; Weight of equity = equity/market value = 91,181.321/105,741.078 = 0.86 Weight of debt = debt/market value = 14,559.75/105,741.078 = 0.14 WACC = (2.60% *0.14) + (7.67% *0.86) = 6.98% MacDonald’s WACC of 6.98% implies that the company generates higher returns on investment compared to the costs incurred for the investments. e) Conclusion As one of the most recognized names in the fast food industry, MacDonald’s understands the need for financial analysis and performance evaluation techniques so as to determine the financial trends and the viability of the company in the future as well. Financial ratio analysis provides an insight of how well the company is performs with regards to revenue generated and the use of company assets to finance its operations. Ratio analysis also determines the liquidity position of the company in addition to leverage levels. From the above ratios for 2013 for MacDonald’s, it is evident that the company is performing well in terms of its ability to use non supplier funds to finance company’s operations, efficiency in generating sales for the company and improved profitability. This implies that the company has a good and stable financial health which need to be maintained or improved to ensure no occurrence of losses. Economic value added and market value added has also proved to be fundamental tools for business performance evaluation. Despite the fact that the values declined from the year 2013 to 2014, they are positive which implies that the company is generating returns to their investors thus this portrays a good image of the company’s performance and also its financial position. However, the company should take stringent measures to enhance the performance by improving its operations on quality service delivery to avert the declining trends in the future. MacDonald’s sales levels have over the past years decreased although the earnings have been increasing, this is due to reduction of costs by the company and buying back its stock as way of convincing the investors that the business is good. The company has seen it customers move to other companies which offer expensive but quality and healthy foods. I would therefore recommend the sale of the company’s stock to preserve the gains from stocks and finding better investments to redirect that capital (Saxena, 2009). References Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset. (Investment valuation.) Hoboken, N.J: Wiley. Fabozzi, F. J., & Grant, J. L. (2000). Value-based metrics: Foundations and practice. New Hope, Pa: Frank J. Fabozzi Associates. Grant, J. L. (2003). Foundations of economic value-added. Hoboken, NJ [u.a.: Wiley. Patterson, C. S. (1995). The cost of capital: Theory and estimation. Westport, Conn: Quorum Books. Saxena, R. (2009). Marketing management. New Delhi: Tata McGraw-Hill. Vandyck, C. K. (2006). Financial ratio analysis: A handy guidebook. Victoria, B.C: Trafford. Read More