McDonald's: Financial Analysis Essay Example

McDonald's is an international leading fast food restaurant with its headquarters in Illinois, United States. The firm sells a variety of fast foods which include hamburgers, milkshakes, cheeseburgers, and chicken products. However, the hamburger is the restaurant's principal product which has earned the firm success and reputation. McDonald's operates its restaurants either as a franchise, affiliate or by the entity itself. This paper will examine the corporation's financial statements through ratio analysis, a comparison of its performance with other peers in the industry, and a review of its year-over-year trends.

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Ratio Analysis

Liquidity analysis evaluates the capacity of a firm to pay off the short-term debt on the due date using current assets. A higher ratio is preferable as it suggests better financial health of an entity (Atrill, McLaney & Harvey, 2014). McDonald's had a current ratio of 1.84 in 2017 which was an improvement from 2016 when the ratio was 1.40 (see appendix 1). The high ratio in 2017 indicates the firm has sufficient short-term assets to cover the near-term obligations. Subsequently, the firm was financially healthy in 2017 since it had 1.84 times more short-term assets than short-term liabilities. Additionally, since the ratio is not too high, it means the firm is efficiently utilizing its assets. Similarly, the quick ratio increased from 0.78 in 2016 to 1.54 to in 2017. The ratio was above one which suggests that the corporation has sufficient liquid assets to cover current liabilities.

Profitability ratios evaluate the effectiveness of a company's performance as they show the ability to transform sales value into incomes. The operating margin indicates the profit an entity generates after paying variable costs of production including production costs (Atrill, McLaney & Harvey, 2014). McDonald had an operating margin of 42% in 2017 which was an 11% improvement from 2016 when the ratio was 31%. The increase indicates a significant improvement in the corporation's profitability. McDonald's recorded a net profit margin of 19.03% in 2016, however, in 2017 there was an improvement in this ratio to 22.75% (see appendix 1). The increase was due to the rise of the firm's net income from $4.68billion in 2016 to $5.2 billion in 2017 (McDonald's Annual Report, 2017). The return on asset ratio in the year 2016 was 15.1%, but the ratio increased to 15.36% in 2017 which suggest McDonald's earned more in 2017.

The debt to capital ratio evaluates the financial leverage of an entity hence it shows the portion of a firm's total capital that is debt. McDonald's debt to capital ratio was 1.09 in 2016 but rose to 1.12 in 2017 following an increase in the corporation's loans from $25.8billion in 2016 to $29.5billion in 2017 (McDonald's Annual Report, 2017). The interest coverage ratio was high over the two years, in 2016, the ratio was 8.8 times, but in 2017 the ratio increased slightly to 10.4 times which indicate the firm was able to cover the interest expense on outstanding debt 10.4 times with the operating income.

Efficiency ratios evaluate a firm's utilization of its assets and management of liabilities to efficiently generate income. Over the two years under review, the inventory turnover was extremely high suggesting strong sales, therefore, improving liquidity (Vrat, 2014). In 2016, the ratio was approximately 216 times, but there was a decline in 2017 to 177 times which implies that the corporation was holding inventory longer in 2017 than in 2016. Consequently, there was a decline in the total revenue from $24.6billion in 2016 to $22.8 billion in 2017 (McDonald's Annual Report, 2017). McDonald's receivable turnover ratio deteriorated over the two years. In 2016, the ratio was 10.37 times but declined to 6.44 times in 2017 which signify a problem in collections. Subsequently, the firm's receivable collection period increased from approximately 35 days in 2016 to 57 days in 2017 (see appendix 1). The payables turnover slightly decreased from about 17 times in 2016 to 11 times thereby increasing the average payment period from approximately 22 days to 32 days in 2017. A higher payment period enhances liquidity since the firm took longer to settle payments.

McDonald's Performance Compared with Industry Peers

Regarding liquidity, though McDonald's had a high current ratio of 1.84, Wendy's recorded a higher ratio of 1.97. The other peers Starbucks and Yum! Brands had lower ratios of 1.25 and 1.66 respectively (see appendix 2). Save for Starbucks whose quick ratio was 0.84, Wendy's and Yum! Brands had higher quick ratios of 1.95 and 1.65 compared to McDonald's 1.54. Concerning profitability, McDonald's scored substantially high on operating margin at 41% compared to its peers Starbucks, Wendy's and Yum! Brands with ratios of 17.65%, 18%, and 28.6% respectively. Looking at the net margin, McDonald's and Yum! Brands performed well however Yum! Brands had a slightly higher net margin of 22.8% compared to 22.75% (see appendix 2). Starbucks and Wendy's had a substantially low score at 12.89% and 9% correspondingly. McDonald's return on asset was the second lowest at 15.4% only beating Wendy's 3.16%. Yum! Brands and Starbucks recorded higher ratios of 24.84% and 20.11% respectively. The low ratio suggests that McDonald's was not efficient in utilizing its assets to generate sufficient income (Stice & Stice, 2011). Regarding solvency, McDonald's has more debt in its capital structure since its debt to capital ratio was 1.12 while its peers Starbucks and Wendy's had lower ratios of 0.422 and 0.83 respectively. Despite high debt levels, McDonald's can only cover its interest payments ten times, although the coverage was higher than its peers Wendy's and Yum! Brands, Starbucks had the highest coverage ratio of approximately 41 times. McDonald's turned over its inventory 177 times which was higher than Yum! Brands 118 times and Starbucks 6 times, however, Wendy's was the best since it turned its stock 200 times (see appendix 2). McDonald's was not efficient in collecting its debtors since it took on average 56 days while its peers Yum! Brands and Wendy's took on average 26 days. Sherman (2011) suggests that a high collection period implies lax policy regarding credit payment terms which may affect the business if the customers are unable to pay. Starbucks was the most efficient taking the least number of days (14) to collect outstanding debts.

Year over Year Trends.

A year over year analysis plays a significant role in identifying the increase and decrease in dollar amounts from one year to another, therefore, enables one to examine any unusual trends. The income statement trend analysis for the corporation shows that total revenues decreased by $1.8billion or 7.3% over the two years (see appendix 3). The decrease was as a result of the significant drop of $2.5billion or 16% in sales by restaurants which the company operates. All of the operating costs and expenses decreased significantly save for the occupancy expenses for franchised expenses which increased by $71.60 million or 4.16% thereby improving the operating income. The total operating costs and expenses dropped by $3.6 billion or 21.4% thereby increasing the operating income by $1.8billion or 23.34%. Consequently, McDonald's net income recorded an increase of $505.8million or 10.8% (see appendix 3).

The year over year analysis of the corporation's balance sheet indicates that the cash and equivalents increased by $1.24 billion or approximately 101% (see appendix 4). Similarly, the firm's accounts receivable rose by $502 million which is equivalent to 34%. The rise was due to the increase in the receivables collection period from 35 to 57 days. Overall, McDonald's put additional investments in the current assets as the total figure increased by $478.60 million a 9.87% rise. In 2017, McDonald's made significant investments of $359.10 million between 2016 and 2017. Consequently, the entity's investments and advances in affiliates increased by 49.46%. The total other assets increased by $1.11 billion or 22.58% (see appendix 4). The year over year analysis shows that McDonald's made an additional purchase of property and equipment in 2017 since the net property and equipment increased by $1.19 billion or 5.6%. Total current liabilities decreased by $577.7 million or 16.66% since the firm fully offset the current portion of its long-term debt. Despite the decrease, accounts payable increased by $168.80 million or 22.32%. The corporation issued additional long-term debt both fixed and floating in various currencies. Subsequently, there was an increase of 14.13% or $3.6 billion in debt obligations over the two years. The two items appearing under the long-term debt increased by 134% and 9.6% respectively. Year on year there was no change in the common stock which remained at $16.6 billion. Nevertheless, both the additional paid-in capital and retained earnings increased by 4.7% and 4.5% respectively, but the common stock in treasury went further into negative territory by 8.4% (see appendix 4). The deficits in total shareholders' equity and total liabilities and shareholders' equity increased by 48.3% and 8.9% respectively. Overall, total assets increased by $2.779billion or 8.96%. Therefore, the increase in total liabilities and shareholder's equity was the same. Most of the increases in each of the balance sheet items are significant, however, all have explanations in the notes to the financial statements.

Conclusion

The analysis reveals that McDonald's is financially healthy as shown by the high liquidity ratios while profitability ratios present an increasing trend. The entity is also efficient in generating income from its assets and managing its liabilities. However, when compared with its peers, McDonald's posted mixed results. Concerning liquidity, Wendy's was more liquid than McDonald's. Two of the profitability ratios indicate McDonald's was more profitable than its peers, however, the return on assets was low compared to the peers. McDonald's had financed most of its activities using debt as suggested by the high debt to capital ratio while its competitors utilized less debt. Wendy's turned its inventory more times in comparison to McDonald's hence more sales. McDonald's was not efficient in recovering debts and took more days to collect outstanding debts which could affect the liquidity.

References

Atrill, P., McLaney, E., & Harvey, D. (2014). Accounting an introduction (6th ed.). Melbourne: Pearson.

McDonald's. (2018). McDonald's annual report. Retrieved from https://www.last10k.com/Search/LoadPDF?u=https://www.last10k.com/sec-filings/63908/000006390818000010/mcd-12312017x10k.htm.pdf

Sherman, E. H. (2011). Finance and accounting for non-financial managers (3rd ed.). New York: American Association Management.

Stice, E. K., & Stice, J. D. (2011). Intermediate accounting (18th ed.). Mason: South-Western Cengage Learning.

Vrat, P. (2014). Materials management. New Delhi: Springer.

Appendices

Appendix 1. Ratio Calculations

Ratio Formula 2017 2016

Current ratio Current assets/current liabilities 5,327.2/2,890.6

=1.84 4,848.6/3,468.3

=1.40

Quick Ratio Cash and equivalents + accounts receivables/current liabilities 4,440/2,890.6

=1.54 2,697.5/3,468.3

=0.78

Operating Margin Gross profit/revenues*100 9,552.7/22,820.4

*100 =41.86 7,744.5/24,621.9

*100 =31.45

Net Margin Net profit/revenues*100 5,192.3/22,820.4

*100 =22.75 4,686.5/24,621.9*100 =19.03

Return on assets Net profit/total assets*100 5,192.3/33,803.7

*100 =15.36015 4,686.5/31,023.9

*100 =15.1061

Debt to capital employed Total debt/total capital 29,536.4/26,268.4

=1.12 25,955.7/23,751.4

=1.09

Interest coverage Earnings before interest and tax/Interest expense 9,552.7/921.3

=10.37 7,744.5/884.8

=8...