Costco Wholesale Corporation
- baiyi999
- Jul 16, 2024
- 21 min read
Updated: Nov 7, 2024
What is COSTCO
Entering COSTCO with our membership card, we immediately felt the spacious layout filled with a wide range of products. We started in the electronics section, quickly browsing the latest TVs and discounted appliances—typical of COSTCO’s big-ticket deals.
In the food section, we sampled rotisserie chicken and fresh bread, adding a whole chicken to our cart. COSTCO's bulk-sized items stood out, so we grabbed large packs of organic fruits and frozen steaks, ideal for stocking up.
We filled our cart with essentials like oversized paper towels and detergent, showcasing COSTCO’s value on everyday items. A quick checkout and a complimentary hot dog and drink completed our efficient and satisfying COSTCO visit.
Beyond the products, COSTCO's membership benefits and flexible return policy give us peace of mind when shopping. Overall, COSTCO provides not just quality products at great prices but also a convenient and stress-free shopping experience, making it our go-to place for all our household needs.
Introduction
800+ Locations: COSTCO operates over 800 warehouse locations worldwide, making it one of the largest membership-only warehouse club chains globally.
120 Million Members: COSTCO has more than 120 million members who enjoy exclusive access to its bulk products and discounted prices.
1 Million Products: The typical COSTCO warehouse stocks around 4,000 items at any given time, with a constantly rotating selection, ensuring variety and fresh offerings.
$5 Billion in Annual Membership Fees: Membership fees alone contribute approximately $5 billion annually to COSTCO's revenue, underscoring the loyalty and value members find in their services.
50% Discount on Average: COSTCO’s bulk buying and efficient operations allow it to offer products at prices that are often 30-50% lower than those found at conventional retail stores.
$1.50 Hot Dog Combo: The iconic COSTCO hot dog and soda combo has remained at $1.50 since its introduction in 1985, serving over 100 million hot dog combos annually.
4,000 Square Feet Per Store: Each COSTCO warehouse averages about 146,000 square feet, offering vast space for a wide range of products from electronics to groceries under one roof.
90% Member Renewal Rate: COSTCO enjoys a high member renewal rate of about 90%, reflecting strong customer satisfaction and loyalty.
$200 Billion in Annual Sales: COSTCO generates around $200 billion in annual sales, making it one of the largest retailers in the world by revenue.
Overview of Costco's history:
1. Founding and Early Development (1976-1985)
1976: Costco's history can be traced back to the Price Club, founded by Sol Price and his son Robert Price in San Diego, California. Price Club was the world's first membership-based wholesale warehouse, designed to provide low-cost goods to small businesses. Its innovative model achieved rapid success, attracting many small businesses and individual members.
1983: Former Price Club executives James Sinegal and Jeffrey Brotman opened the first Costco warehouse store in Seattle, Washington. Costco's philosophy was to provide high-quality, low-priced goods to individual members and small businesses. The first store was an immediate success, inspiring plans for further expansion.
2. Growth and Merger (1985-1993)
1985: Costco expanded rapidly in the western United States, opening many branches. The company's success attracted significant attention from members and investors. By 1985, Costco had opened more than 10 stores in the United States and Canada and continued to grow its business.
1993: Costco merged with Price Club to form PriceCostco, resulting in over 200 stores across the United States and Canada. The combined company began to further expand its market share and strengthen its supply chain and logistics systems.
3. Rebranding and International Expansion (1993-2000)
1997: The company changed its name to Costco Wholesale Corporation and began focusing on rebranding and global expansion. After the name change, Costco entered international markets, opening branches in Mexico, the United Kingdom, South Korea, and Taiwan. During this period, Costco's international business grew rapidly and became a significant revenue source.
2000: Costco had more than 300 stores worldwide and held an important position in the U.S. retail market. The company strengthened its member service system, offering more exclusive discounts and high-quality products, attracting additional members.
4. Continuous Expansion and Technological Innovation (2000-2010)
Early 2000s: Costco continued its international expansion by entering new markets such as Japan and Australia. The company also enhanced its e-commerce platform to provide more online shopping options. During this period, Costco explored digital transformation to improve supply chain efficiency and customer experience.
2008: Despite the global recession, Costco maintained steady growth and continued to attract new members. The company ensured profitability and market competitiveness through refined management and cost control.
5. Global Leader Status (2010-Present)
After 2010: Costco further expanded its international business by opening new stores in Spain, France, and China. The company strengthened its supply chain and logistics systems to ensure product quality and customer satisfaction. During this period, Costco began applying digital technology on a large scale to enhance operational efficiency and customer service levels.
2020: In response to the global pandemic, Costco quickly adapted to market changes by expanding its online business and implementing in-store safety measures, maintaining stable sales and membership growth. The company introduced several measures, including expanding delivery services, offering more online shopping options, and reinforcing health protocols to ensure stable operations.
Fundamental
Costco's consumer promotion system is based on a membership model. This operating model, centered around the member experience, combined with a strong brand and efficient supply chain management, enables Costco to stay ahead of its competitors.
(1) Excellent Member Experience:
Costco focuses on delivering an outstanding member experience, which not only provides a significant source of revenue but also fosters high customer loyalty.
The membership model allows Costco to keep overhead costs low while offering products at discounted prices.
It also helps Costco manage inventory more efficiently by predicting demand and adjusting its supply chain accordingly. This enables Costco to offer a wider range of products at lower prices, making it a one-stop shopping destination for customers.
The model has attracted many customers willing to pay for Costco's products and services, resulting in a very high membership renewal rate.
Here’s how Costco creates a high-loyalty member experience:
Membership
Business Model:
Costco operates on a membership system where customers pay an annual fee to access exclusive shopping benefits. This model helps build strong customer loyalty and provides members with a unique shopping experience.
Psychological Perspective:
By becoming members, customers feel part of a special community, enjoying exclusive prices and services that fulfill their desire for a sense of belonging and privilege.
Financial Perspective:
The membership system provides Costco with a stable revenue stream while enhancing customer loyalty. Because of this model, customers are more likely to continue shopping at Costco over the long term.
Low profit product policy
Business Model:
Costco deliberately maintains low profit margins to ensure low prices, which is one of its core business strategies. The membership system requires customers to pay an annual fee, but in return, they receive significant discounts and services. This approach helps members feel that the savings they gain from shopping at Costco outweigh the cost of the membership fee.
Psychological Tendencies:
Costco taps into customers' desire for savings and value. Members know that Costco provides high-quality products at discounted prices, meeting their shopping needs and delivering a strong sense of value, which makes them feel they are getting good value for their money. The urge to save money is a common psychological need, and the discounts offered through the membership model satisfy this need, creating a sense of satisfaction. Additionally, members feel they are receiving exclusive deals, which motivates them to shop more frequently.
Financial Perspective:
Costco’s strategy makes members feel that joining is worthwhile, boosting loyalty while the attractive discounts draw in new members and increase product sales.
Treat consumers as members, not customers
A. Membership Fee Full Refund Policy
Business Model:
Costco's full refund policy for membership fees is designed to attract new members by lowering the psychological barriers to joining, thereby encouraging more people to sign up.
Psychological Tendencies:
This policy appeals to customers' need for security and reassurance. Knowing they can receive a full refund if unsatisfied makes potential members feel more comfortable about joining.
Financial Perspective:
By building trust, this policy increases the likelihood of new memberships and enhances cash flow.
B. Flexible Product Return and Exchange Policy
Business Model:
Costco treats its customers as valued members, offering a flexible return and exchange policy to cultivate long-term relationships.
Psychological Tendencies:
This approach fosters loyalty, trust, and satisfaction among members, strengthening their confidence in Costco's products and services.
Financial Perspective:
The policy promotes long-term relationships and enhances member loyalty, contributing to sustained revenue growth.
Additional value-for-money membership services
Business Model:
Costco offers members additional services, such as tire replacement, fuel, and more, typically at lower prices specifically for members. This business model expands Costco's value proposition, allowing members to meet multiple shopping and service needs in one place, thereby enhancing convenience.
Psychological Tendencies:
These added services make members feel they are receiving a comprehensive range of value and benefits from Costco, beyond just shopping. As a result, members may become more reliant on Costco for various needs, which helps increase loyalty.
Financial Perspective:
Offering these additional membership services not only boosts Costco's revenue but also encourages members to visit stores more frequently. This strategy helps increase sales and strengthens member loyalty by allowing them to meet multiple needs at a single location. Moreover, these services provide Costco with a competitive advantage, attracting more members and potential customers. Therefore, from a financial perspective, providing additional member services helps Costco build a high-loyalty member base and enhance potential long-term revenue.
Featured Products
Business Model:
Costco offers a curated selection of items carefully chosen to meet the needs and preferences of its members. This approach simplifies the shopping experience, as members do not need to spend time deliberating among numerous choices; they can quickly find and add their preferred items to their shopping cart.
Psychological Tendencies:
This product selection strategy addresses members' psychological needs by helping them avoid decision fatigue. Customers trust Costco's choices, knowing that the items have been carefully filtered for quality. This trust allows them to find what they like quickly, fulfilling their needs for convenience and value.
Financial Perspective:
The curated merchandise strategy increases sales by making it easier for members to make purchasing decisions without spending too much time browsing. This, in turn, boosts Costco's revenue and profits. Additionally, by focusing on high-demand products, Costco can better manage its inventory, reducing the risk of overstock and expired goods, and thereby lowering inventory costs. This strategy has positive financial implications, contributing to cost efficiency and profitability.
Excellent shopping experience, word-of-mouth marketing
Business Model:
Costco focuses on delivering an excellent shopping experience, which helps build a strong reputation and reduces the need for extensive marketing efforts.
Psychological Tendencies:
Trust and word-of-mouth. A positive shopping experience encourages customers to spread the word and become loyal supporters of Costco.
Financial Perspective:
Lower marketing costs while attracting new members.
Bulk packaged goods
Business Model:
Costco sells goods in large packages and provides oversized shopping carts to encourage members to buy more.
Psychological Tendencies:
Social comparison and a sense of value for money. Large-package products meet family needs while satisfying the desire for social comparison, making customers feel they are getting good value for their money.
Financial Perspective:
Enhances the shopping experience, increases average checkout amounts, attracts mid- to high-end customer groups, and improves financial stability.
Fun shopping experience
A. Changing Product Displays
Business Model:
Costco regularly changes the display locations of its products to create a sense of novelty.
Psychological Tendencies:
Curiosity and reward-seeking behavior. Changing displays stimulate customers' curiosity, increasing their attention and shopping satisfaction.
Financial Perspective:
Enhances the shopping experience and drives additional sales.
B. Fast Product Replacement Cycle and Exclusive Offerings
Business Model:
Costco frequently updates its merchandise and offers exclusive items to satisfy customers' desire for novelty and uniqueness.
Psychological Tendencies:
Envy, jealousy, and fear of missing out. Rapidly changing merchandise and exclusive items create a sense of envy and desire, encouraging customers to make purchases.
Financial Perspective:
Stimulates shopping behavior, triggers fear of missing out, and boosts product sales.
Delicious dining
A. Providing Delicious Meals
Business Model:
Costco offers a variety of delicious meals as part of its catering services.
Psychological Tendencies:
Appeals to comfort and pleasure. Providing tasty meals attracts members and enhances their shopping satisfaction.
Financial Perspective:
Generates additional revenue and improves the overall shopping experience.
B. Classic Hot Dog and Cola Combo
Business Model:
Costco has maintained its low-priced hot dog and cola combo for decades, attracting a loyal customer base.
Psychological Tendencies:
Fosters a sense of loyalty and satisfaction. The classic hot dog and cola combo appeals to customers who know they can always enjoy this staple treat at Costco.
Financial Perspective:
Helps maintain member loyalty, attract new members, and increase food and beverage revenue.
Marketing
A. Offer Free Trials
Business Model:
Costco provides free samples to spark customers' curiosity and encourage additional purchases.
Psychological Tendencies:
Curiosity and reciprocity. Free samples stimulate customers' curiosity, offering them a chance to try new products, while also creating a sense of obligation to return the favor by purchasing more.
Financial Perspective:
Enhances shopping satisfaction and boosts product sales by leveraging the tendency for reciprocity.
B. Placing Items at the End of the Shelf
Business Model:
Costco places products at the end of shelves to draw customers' attention and increase the visibility of these items.
Psychological Tendencies:
Attention guidance. Strategically placing items at the end of shelves captures customers' attention, encouraging them to make purchases.
Financial Perspective:
Increases product exposure and drives sales.
(2) Strong brand reputation
Costco's strong brand reputation stems from its unwavering commitment to providing value to its members. Its consistent delivery of quality products at low prices has become synonymous with the Costco brand.
Known for its high-quality products, competitive prices, and excellent customer service, Costco has built a loyal customer base, with millions of members worldwide. Its member-centric approach prioritizes satisfaction and loyalty, further enhancing its brand reputation.
Costco’s private label, Kirkland Signature, offers products of the same quality as international brands but at significantly lower prices. By providing these products at more affordable rates than comparable name-brand items, Costco attracts price-sensitive consumers, increases its market share, and diversifies its product range to appeal to new customer segments, thereby boosting both revenue and customer loyalty.
By continually expanding Kirkland’s offerings and introducing new products, Costco leverages its strong brand reputation to stand out from competitors and further strengthen customer loyalty.
Business Model:
Costco leverages its strong brand reputation and private label, Kirkland Signature, to attract customers by providing high-quality products and services at competitive prices. As a value-oriented company, Costco firmly believes that offering the best value to its members is key to earning their loyalty.
Psychological Tendencies:
A strong brand reputation instills confidence in consumers that they can find high-quality merchandise at Costco. Members may feel they are part of a special community, enjoying exclusive access to the high-quality goods and services that Costco offers, satisfying their need for a sense of privilege. Meanwhile, the Kirkland Signature brand attracts price-sensitive consumers with its combination of high quality and price advantages, providing cost-effective choices. These features help distinguish Costco from its competitors and foster increased loyalty.
Financial Perspective:
A strong brand reputation and the Kirkland Signature private label not only boost Costco's sales but also enhance member loyalty. Loyal customers tend to shop more frequently, which increases revenue and profitability. Additionally, sales of Kirkland products contribute to higher margins, as private label items generally offer better profit margins. Overall, these strategies help maintain a steady revenue stream, strengthen customer loyalty, and improve Costco's financial performance.
(3) High efficiency operation management
A. Talented and Experienced Staff Team
Talent is another key advantage for Costco. The company is known for treating its employees well by offering competitive wages, benefits, and advancement opportunities, which has helped build a team of experienced, highly skilled, and motivated staff who contribute significantly to the company's success.
Costco provides extensive training to its employees, enabling them to deliver excellent customer service and create a positive shopping experience for customers.
A strong employee team enhances customer loyalty and drives sales growth for the company.
Business Model:
Costco's strategy of developing and promoting executives from within reflects its long-term commitment to nurturing employees' growth rather than relying solely on external recruitment. This approach helps maintain the company’s culture and values while ensuring that senior management has a deep understanding of its mission and vision.
Psychological Tendencies:
Employees feel they have opportunities for advancement within the company, meeting their needs for personal development and growth. They also feel that their work and contributions are recognized and valued, enhancing their sense of satisfaction and belonging.
Financial Perspective:
Developing senior executives internally helps Costco reduce the costs associated with external recruitment while maintaining cultural consistency within the organization. This strategy fosters efficient work patterns and high job satisfaction, which in turn increases employee loyalty. Loyal employees are often more motivated to provide excellent customer service, enhancing member satisfaction and loyalty, and ultimately improving the company’s sales performance.
From a financial standpoint, cultivating senior executives internally allows Costco to efficiently manage human resources, reduce turnover, lower recruitment and training costs, maintain high employee loyalty, and ensure the company’s long-term success.
B. Commitment to Sustainable Development
Costco has a strong commitment to sustainable development. The company actively works to reduce its environmental impact on multiple levels, including minimizing waste, utilizing renewable energy, and promoting sustainable sourcing. These initiatives not only help to build a positive brand image for Costco but also attract consumers who value sustainability.
Additionally, Costco’s commitment to sustainability brings benefits such as cost savings and increased efficiency. For example, investments in renewable energy have reduced energy costs, while waste reduction measures have significantly decreased the environmental footprint, lowering waste disposal expenses. Furthermore, Costco’s focus on sustainable sourcing helps build strong relationships with suppliers who share the same values, further enhancing its reputation as a responsible and ethical business.
Business Model:
Costco is actively committed to sustainability and has integrated it into its business model. This includes reducing waste, utilizing renewable energy, and promoting sustainable procurement. Sustainability is not just part of Costco's strategy but a key factor in business decisions to ensure that the company operates in an environmentally and socially responsible manner.
Psychological Tendencies:
Costco's commitment to sustainability appeals to consumers who prioritize environmental and social responsibility. This allows members to feel that they are supporting a business that actively focuses on sustainability, aligning with their ethical and environmental values. Such alignment enhances member loyalty, as they are more likely to continue shopping at a place that reflects their beliefs.
Financial Perspective:
Costco’s focus on sustainability not only strengthens its brand image but also results in cost savings and efficiency improvements. These sustainability initiatives help boost member loyalty, as customers prefer to support an environmentally conscious business. From a financial perspective, this strategy helps Costco maintain a competitive advantage, increase sales revenue, and reduce operating costs while fostering positive relationships with suppliers. It also attracts more consumers who value sustainability, further enhancing the company’s long-term growth and loyalty.
(4) Highly efficient supply chain management
A. Diversified Product Supply
Costco’s diverse product offerings are another significant advantage. By providing a wide range of products, including groceries, electronics, furniture, and apparel, Costco appeals to a broad customer base, from households to businesses. The focus on offering high-quality products across various categories at low prices has helped Costco become a one-stop shop for many customers, maintaining its competitive edge in the retail industry.
The variety of products available at Costco helps generate higher sales and build strong customer loyalty. Additionally, some of Costco’s products are often exclusive to its stores, further differentiating it from competitors and enhancing its appeal to customers.
Business Model:
Costco offers a wide range of products, including groceries, electronics, furniture, and apparel. This diverse product selection attracts a broad spectrum of customers, from households to businesses, who can find all the products they need in one place. This approach makes Costco a convenient one-stop shop, enhancing the overall shopping experience.
Psychological Tendencies:
The diverse range of products makes customers feel that Costco can meet all their needs—from food and household items to electronics—all in one location. This sense of convenience and variety satisfies customers' psychological needs, making them more inclined to shop at Costco.
Financial Perspective:
Offering a diversified product range helps boost sales, increase customer loyalty, and maintain Costco's competitive advantage in the retail industry. This strategy strengthens the company's financial performance and attracts more customers to become members.
B. Efficient Operational Processes
Costco has developed efficient processes, from inventory management to checkout, that help keep costs low while providing a seamless customer experience.
These operational efficiencies allow Costco to maintain a lean organizational structure, reduce administrative costs, and offer products at lower prices than many of its competitors. A streamlined checkout process, which often results in minimal wait times, has become a hallmark of its brand and a key driver of customer loyalty.
Costco's focus on continuous improvement and innovation in its operational processes has helped it stay ahead of the competition and maintain its position as a leader in the retail industry. Additionally, practices such as checking membership cards at the entrance and verifying invoices and merchandise at the exit, along with a single design for entrances and exits, effectively reduce the rate of merchandise theft.
Business Model:
Costco has developed efficient processes, from inventory management to checkout, that help reduce operating costs while providing a seamless customer experience. This model allows Costco to offer products at lower prices, attract more customers, and maintain a competitive advantage. The company maintains a lean organizational structure, which reduces administrative costs and enables Costco to offer products at lower prices than its competitors.
Membership cards are checked at the entrance, and invoices and goods are verified at the exit. The single design of entrances and exits effectively reduces the theft rate of goods, enhancing safety, reducing losses, and increasing members' trust, resulting in a better overall shopping experience.
Psychological Tendencies:
A streamlined checkout process, which often requires minimal wait times, has become a hallmark of the Costco brand and a significant driver of customer loyalty. Members and customers feel their time is respected, which helps strengthen loyalty.
Financial Perspective:
Efficient operational processes allow Costco to maintain a lean organizational structure, reduce management costs, and offer products at competitive prices. This approach helps keep the company financially sound, increases customer loyalty, and lays the foundation for long-term success.
C. Efficient Supply Chain Management
Costco is known for its ability to effectively manage inventory and distribution, maintaining high levels of product quality while keeping prices low. Its warehouses are strategically located to minimize transportation costs.
The company negotiates directly with manufacturers to secure the best deals, and its bulk purchasing strategy allows it to negotiate favorable terms with suppliers, passing the cost savings on to customers.
Costco also invests heavily in technology to streamline its supply chain operations and ensure products are delivered to its warehouses in a timely and efficient manner.
These efforts help Costco maintain a competitive advantage in the retail industry and provide value to its members.
Business Model:
Costco is known for its efficient supply chain management, which helps the company maintain optimal inventory levels, reduce management costs, and ensure a quick supply of products. This allows members to consistently find the products they need when shopping at Costco, enhancing their overall shopping satisfaction.
Psychological Tendencies:
While members may not know the specifics of supply chain management, they perceive the high-quality products and competitive prices offered by Costco, which satisfies their sense of value. They trust Costco because they know the products are carefully selected and efficiently managed.
Financial Perspective:
Efficient supply chain management enables Costco to reduce operating costs, including inventory management and transportation expenses. Additionally, by negotiating directly with manufacturers and purchasing in bulk, Costco can secure more favorable trading terms, allowing cost savings to be passed on to members through a low-margin pricing strategy. Moreover, efficient supply chain management improves inventory turnover and ensures product freshness, further increasing sales and revenue.
Financial introduction
Let us quickly understand Costco’s financial status through a few questions.
(1) Is the company making money?
Are profits growing or declining?
How is its competitiveness performing?
Observe the performance of Income Statement:
First, let’s briefly understand whether Costco’s business is good or not from the table below:
To put it simply, for a 100 dollars product, the final profit after selling is 2.6 dollars. It is indeed not easy to maintain such low profits and make money every year for many years, which shows that Costco's management capabilities are really excellent.
In the two charts above, the YOY of Total revenue and Net Income are both positive growth, indicating that the company continues to grow.Moreover, Net Sales, which sells goods and services, and the annual membership fees that must be paid to join Costco, are both growing year by year and in a positive cycle.
As can be seen from the above figure, Net Income is growing year by year, and Net Margin (%) is making steady money.In line with the company's product low gross profit policy, the Gross Margin remains below 14%, and the Net Margin can still grow year by year, and will remain so for many years, which means that Costco's operations and management are very good.
From the above charts, we can simply know that Costco is indeed making money every year.
Then,
Costco's revenue comes from Net Sales and Membership fees, which are revenue from the sale of goods and services and membership fees respectively.The above table, Membership fees / Net Income, has increased from 112% in 2013 to 73% in 2023, indicating that Costco has changed from the past Net Income that all came from membership fees to also generating profits from product services and sales, which has increased the company's The source of cash comes from revenue growth and proper control of operating expenses, creating room for making money.
Product competitiveness mainly depends on gross profit margin, which is the profit after deducting the cost of goods from operating income. From the above table, we know that Gross Margin remains stable, between 12 and 13%.
Costco deliberately maintains a low gross profit policy for products, one of its core competitiveness: Attract members, improve customer satisfaction and loyalty, increase sales, maintain competitive advantage, and maintain high turnover rates.
(2) Profit from your own business or make profits from outside the business?
As can be seen from the table above, profits (losses) outside the industry only account for a small part of income before income taxes.You can know that Costco focuses on serving members (collecting membership fees) and selling goods, which means it focuses on its own business.
(3) Where did all the money made go?
(amounts in millions)
Examining Costco's cash flow over the years from the cash flow statement, as shown in the two charts above, cash from operating activities is significantly greater than net income. This indicates that the cash flow generated by the company's operating activities is healthy and much higher than its net profit, meaning Costco can generate sufficient cash from operations to support its activities, repay debt, and invest in future growth.
Moreover, the free cash flow is consistently positive, with the income converting into profitable cash flow for the company, reaching a new high of $6,096 million in 2023. This represents the amount of cash remaining after covering all operating expenses and necessary capital expenditures (such as equipment acquisitions and repairs). This cash can be used to pay down debt, distribute dividends, repurchase stock, or make other investments.
With consistently positive free cash flow, the company has sufficient capital to support future growth without heavily relying on external financing to maintain operations.
(4) What is the return on investment?
Business management focuses on profitability, specifically return on assets (ROA) and return on shareholders' equity (ROE). However, invested funds do not directly generate profits; profits are achieved through sales, making operating income the intermediary between invested funds and profits. DuPont analysis helps explain this relationship, particularly the connection between net margin and return on assets.
ROE represents the ratio of profit to invested capital, but the capital itself does not directly produce profits—it must be utilized through the sale of products or services. Therefore, for a company to be profitable, it must rely on the sales process, with operating income serving as the key quantitative measure.
ROA is the core of corporate profitability because it depends on efficient operating performance and cannot be manipulated through speculative means. In contrast, a company's management can increase ROE by simply adjusting the debt-to-equity ratio. Therefore, to accurately assess profitability, one must also consider ROA, as it is the foundational source of ROE.
The following is DuPont analysis:
Return on Assets = net profit after tax/total assets
= (operating income/total assets) X (net profit after tax/operating income) = Asset Turnover X Net Margin.
Asset turnover rate represents the utilization rate of assets. The higher the value, it means that the minimum assets can be used to generate the maximum turnover and strive to reach full production capacity. Net Margin symbolizes product profit, the higher the value, the better the profit.
Return on Equity = equity multiplier X asset turnover rate X Net Margin
= equity multiplier X return on assets
The equity multiplier symbolizes leverage. The larger the value, the higher the risk. The issue of solvency must be taken into consideration.
Therefore, if the return on assets is already very small, even if the equity multiplier is high, the amplification effect will be limited.
To increase the return on shareholders' equity, there are two ways: (1) Increase the return on assets
(2) Enlarge the equity multiplier
The first priority of an operator is to run the company well so that it can have a good return on assets; then through the amplification of the equity multiplier, an astonishing return on shareholders' equity will appear.
This financial measure reflects Costco's ability to use its assets to generate profitability, demonstrating how efficiently management converts the company's assets into net profit after tax. From 2014 to 2023, this measure increased from 6.5% to 9.45%, showing consistent growth year by year. When combined with the use of financial leverage, the return on equity (ROE) also exhibits strong performance, rising from 17.79% in 2014 to 27.54% in 2023.
(5) Is the short-term cash flow good?
example:
The figure above illustrates the cash cycle (the number of days shown is an example and does not reflect Costco's actual cash cycle days). It provides a rough estimate of the time required to sell inventory, collect accounts receivable, and pay accounts.
In simple terms, it represents the average time a company takes to pay out cash
Since this is an approximate estimate rather than an exact figure, we can use the upward or downward changes in this estimate to assess whether there are any irregularities in the company's financial situation.
The table and chart above show Costco's historical figures in the cash conversion cycle. It can be observed that the payables period is almost identical to the days of inventory. In other words, the time when Costco pays its suppliers is nearly the same as when the inventory is sold. Therefore, the number of days Costco waits to collect cash is roughly equivalent to the days sales outstanding, which represents the time it takes for the bank to transfer the payment to Costco after a member pays by card.
Next, let's examine two indicators of short-term debt repayment: the current ratio and the quick ratio. These indicators do not appear particularly strong, but this can be explained by the cash conversion cycle mentioned earlier. Since Costco's cash turnover period is very short, the company effectively utilizes financial leverage. As long as it maintains stable sales and collections, short-term solvency should not pose a problem.
(6) Is the financial structure good?
The information in the above picture is derived from the balance sheet. As previously discussed in the description of the cash conversion cycle, Costco's payment to suppliers occurs almost simultaneously with the sale of inventory. This is reflected in the merchant inventories and accounts payable shown in the table. Therefore, we can temporarily disregard accounts payable as a liability, as it matches the inventory amount. Once the goods are sold, the payment is made to the supplier.
Thus, the current liabilities that truly need attention are accrued salaries and benefits, accrued member rewards, the current portion of long-term debt, and other current liabilities. The total of these in 2023 is 13,763, which is nearly equivalent to the cash level of 13,700 in the same year. This suggests that cash alone is sufficient to cover the current liabilities in 2023.
Regarding long-term debt, as shown in the table above, the expenses are spread over many years, with annual long-term debt obligations amounting to less than 2,000 million yuan. This amount is manageable for Costco.
Summary:
There is no need to worry about accounts payable, as payments to manufacturers are typically made after the inventory is sold.
After deducting other current liabilities, these obligations can be covered by the cash on hand.
Long-term liabilities are distributed over many years, resulting in relatively low annual expenses.
Therefore, as long as operations remain stable, there is no cause for concern regarding Costco's financial situation.
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