Business Breakdown Part II: Financial Statement Analysis

Last week, we kicked off a multi-post series working through a case study, Starbucks Corp. to be precise. We covered the business model, profit model, and unit economics and today we're moving onto financial statement analysis.

1. (Part I) Business model and unit economics
2. (Part II) Financial statement analysis
3. (Part III) Projections and planning

The goal for today is to show you how to pick apart a set of financial statements with ease.

Quick recap — Starbucks is a vertically integrated (translation: they source, roast, and package their products) retailer of coffee, tea, and food through a 50/50 mix of company-owned and licensed stores. Their profit model works out to 14-15% operating margins from high-margin licensing revenue and retail store sales.

There's a lot we could cover when it comes to financial statement analysis, but to keep things simple, we'll focus on 4 areas:

1. Income statement
2. Balance sheet
3. Cash flow
4. Ratios

1) Income statement

We'll be reviewing condensed and reformatted financials for every section.

Some takeaways from the P&L:

• Sales grew 6.8% per year from 2016-2024 but slowed down in 2024 (essentially flat)
• Gross profit and operating income grew slower than sales indicating both gross margins and operating margins went down
• Overall operating margins are down in 2024 compared to 2016-2017 but generally look healthy from 2018-2024 (averaged 15% per year when excluding 2020)

2) Balance sheet

Onto the balance sheet. Again, we've condensed our information down to the most important accounts.

Takeaways from the balance sheet:

• Remember sales grew 6.8% annually from 2016-2024
• The liability side of this balance sheet is growing faster than sales — A/P grew ~14% per year and debt grew 20% per year!
• Technically, gift card balances are a liability, but last week we noted they earn a nice stream of interest income from this "float"
• Equity went negative in 2019 — we'll see why in a moment

3) Cash flow

When it comes to cash flows, I prefer to see total or cumulative cash generation Instead of growth rates, this gives me a summary view of how management is spending cash.

Takeaways on cash flow:

• Great cash flowing business — a combined $50bn of cash flow from 2016-2024 (that's $5.5bn per year on average)
• Capex looks very stable
• Paying out dividends totaling ~40-50% of cash flow each year
• With the exception of 2018, working capital is consuming cash flow (i.e. a cash outflow) as they grow sales
• Management is borrowing money regularly (every year except 2021) to buyback stock (a form of owner distributions) — more on this later as it looks like a potential risk — the large buyback in 2019 turned equity negative

4) Ratios

Now that we've looked at each statement, let's pull together a simplified ratio scorecard (note: this isn't quite as robust as what we cover in Module 2 of Profit Mastery):

To help you see the trends here, I've numbered each ratio comment:

1. Current ratio — Ability to pay bills is on the downtrend
2. Margins — Both gross and operating margins are falling. Gross margin trends look more worrisome as they continue to fall from 2018-2019 levels while operating margins are pretty stable.
3. Debt-to-equity — This ratio went negative and is not likely the best way to measure leverage going forward
4. Working capital — Average A/P is getting paid in 62 days (up from 40)
5. Cash conversion cycle — The growing A/P timeframe sent CCC negative (meaning Starbucks gets paid before they pay their A/P!)… likely not a sustainable trend
6. Return on assets — A measure of overall efficiency and profitability, is on a downward trend since 2016-2019... more assets are needed to generate the same level of profitability here

A few things you'll notice I'm doing here...

1. Reformatting and simplifying financial information — with every financial statement, I want to simplify my view before analyzing, this makes it easier for me to spot trends
2. Longer periods of time — more data = more reliable ratios and trends... a single month's P&L is far less reliable than 3-years
3. Noting takeaways — In each statement and in my ratio analysis, I'm taking notes of my findings... this is how I build an action plan or investigate further

Key takeaways — Overall, this is a profitable and growing business with good margins (I consider 15% pre-tax margins as the gold standard for most businesses). There are some concerning trends worth monitoring (slowing growth, margin decline, working capital, capital allocation) and from that list an action plan to build.

Your homework — Grab your financial statements; as far back as you can. Condense them down to a simple view and grab a notepad. Open up Module 2 of Profit Mastery and revisit the section on ratios to build your own detailed financial scorecard.

P.S. if you're looking for someone to build this type of financial analysis for you and your business, drop us a note!

Quick disclaimer: this is NOT intended to be financial advice, it's for educational and entertainment purposes only; be sure to do your own research if considering an investment in Starbucks!