McDonald’s Inventory Analysis Team Members: Sijia Hou, Yuhao Huang, Jialin Zhou, Jie Wang • Part 1 Identity the inventory system • Part 2 Costs in JIT environment • Part 3 Data Analysis (Margins & Ratios) • Part 4 Cost structure Identification and Comparison with Competitors 2 Part 1 Identity the inventory system Identity the inventory system • McDonald’s Corporate • JIT (Just-In-Time) inventory system: An inventory system is designed to produce efficient output with minimum lead time at the lowest possible cost, minimizing waste, with great consistency. 4 JIT • Objective: • Create only want the customer wants at the rate the customer needs them • Produce at products of consistent high quality • With minimal waste of labor, material, and equipment 5 Identity the inventory system • Company should disclose their inventory system in their financial report and also disclose the LIFO Reserve if they use the LIFO inventory method. • However, MCD didn't disclose that. • Why? 6 Identity the inventory system 7 Identity the inventory system 8 1. Inventory Management • Fast-food restaurant • FIFO: First in First out, to remain the food fresh and unwasted 9 2. Inventory Accounting System • May be different between the management and the accounting method • Can the company use LIFO? 10 LIFO vs FIFO vs WA 11 Identity the inventory system • In fact, the choices of LIFO and FIFO have a small influence in the company because their JIT system. • Finally, we identity the inventory system of MCD is FIFO Inventory System. 12 Part 2 Costs in JIT environment Backflush Costing • Backflush method is a costing method where the cost of particular goods and services is determined after the goods or services is produced or sold. • Costing process will be delayed until the productions of goods or services is completed, The cost will be applied to the operation when the production cycle is completed. 14 Backflush Costing • Utilized in JIT environment • Delays the costing process • Eliminating the work-in-process accounts 15 Three Conditions for Backflush Costing • No detailed tracking of direct material and direct labor costs. • Every product has a set of standard costs. • Material inventory levels are either low or constant. 16 McDonald’s Cost of goods sold 17 McDonald’s Cost of goods sold • • • • Food and paper expense : $4,033.5 millions Payroll and employee benefits expense : $3,528.5 millions Occupancy and other operating expense : $2,847.6 millions Franchised restaurants occupancy expense : $1,790 millions • Cost of goods sold : $4,033.5 + $3,528.5 + $2,847.6 + $1,790 • COGS = $12,199.6 millions 18 Part 3 Data Analysis (Margins & Ratios) Data Analysis (Margins & Ratios) • Critical margins, turnover rate and ratios can show the profitability and operating efficiency • Gross Margin, Operating Income Margin, Net Income Margin, Inventory Turnover and Days in Inventory 20 Data Analysis (Margins & Ratios) Is pursuing high inventory turnover or days in inventory good at all the time? 21 Part 4 Cost structure Identification and Comparison with Competitors Cost structure Identification and Comparison with Competitors • Cost structure in fast food industry refers to variable cost and fixed cost • Variable costs like bread, meat, cheese and so on • Fixed costs like occupancy expenses, fixed interest rate, amortization of patents, property taxes and so on 23 Cost Structure Identification and Comparison with Competitors • McDonald’s cost structure could be divided into three main categories--Food & paper, payroll & employee benefits and 65757657557 expenses 24 Cost Structure Identification and Comparison with Competitors • Burger King is one of leaders in fast food industry • Comparing their cost structure and inventory stock level 25 Summary • McDonald’s Corporate use the JIT strategy which makes the inventory at the lower level. FIFO may be the better choice for its inventory system. (FIFO inventory system) • Then, we discuss the Backflush costing system which applied in the JIT environment and calculate the Cost of goods sold. (Backflush costing) • Turnover is high, margin vs turnover (Ratio analysis) • Zijixie(lalalalalala) 26 Thanks for your attention. Fin 545 Advanced Corporate Finance McDonald’s Corporate – Inventory Identify the inventory system We identity the inventory system McDonald choose is the weighted average method. McDonald’s Corporate is one of the biggest fast food restaurants which uses the typical JIT (Just-in-time) strategy. JIT inventory management has helped in reducing the cost by remaining the inventory at the lower level and cutting down the wastages. In fact, we can figure out that McDonald usually cook all food in advance and place them under the lamps to keep them hot. They spend the least time to deal with the food producing to make the food fresh and unwasted. Also, this method helps them reduce the cost and the inventory level. Unlike other companies, McDonald’s Corporate doesn’t have too much inventory due to this special materials requirement planning (MRP). Besides, we found that there are no footnotes about the inventory system they used. However, SEC request that all companies should disclose their inventory system in their annual report and also mention the LIFO reserve if the company use the LIFO method. We find some reasons below. From the inventory management part, McDonald’s Corporate uses the FIFO system to operate the logistic process. Because the restaurant always focuses on the food quality, they use first in first out method which can make sure the food is fresh and unwasted. However, it’s not necessary that the inventory management method must be same as the accounting inventory system, so we cannot be sure the accounting method yet. From the accounting part, McDonald’s Corporate has very low inventory like we mentioned before. The ending inventory amount will have a quite small influence in the key numbers like net income or cost of goods sold. From the balance sheet and statement of cash flow, we can prove that the inventory amount and the changes in the working capital related to the inventory part are very small. Therefore, the choices of the inventory system is not very important to McDonald right now. In fact, most of the companies who use the JIT system are not very care about the inventory system choices because this inventory management has already made the profit maximum. With the market background of inflation, FIFO method can help company to reduce the COGS and to increase the ending inventory. This method will get more net income but also will have more tax to pay. We can even ignore the disadvantage of the added inventory because the company’s inventory is very small compared to other assets. Otherwise, LIFO method can help company tax reduction but will increase cost of goods sold. That will increase the company’s cash flow which can make more investment. McDonald’s Corporate spend lots of money in other investment to make mainly profits. All in all, these two methods bring advantages and disadvantages to the company. After the evaluation, we think McDonald’s Corporate should use the weighted average inventory system which can maintain the biggest profits. Cost Structure (Inventory & COGS) McDonald utilizes a specific accounting system for JIT environment which is backflush costing and it will change the way the company records their cost of goods sold. Backflush costing delays the costing process until the production of goods is completed. By eliminating work-in- process accounts, backflush costing simplifies the accounting process. Companies using backflush costing generally meet the following three conditions. First of all, management seeks a simple accounting system and no detailed tracking of direct material and direct labor costs. Secondly, every product has a set of standard costs. Lastly, material inventory levels are either low or constant. When inventories are low, the bulk of manufacturing costs will flow into costs of goods sold, and it is not deferred as inventory cost. After we analyzing the financial statements, we find out that McDonald meets all the criteria. Since backflush costing is used, the manufacturing costs will flow into COGS without going into inventory account. COGS will be Food and paper ($4,033.5 million) + Payroll and employee benefits ($3,528.5 million) + Occupancy and other operating expenses ($2847.6 million) + Franchised restaurants-occupancy expenses ($1790 million) = $12,199.6 million. Data Analysis (Margins & Ratios) Critical margins, turnover rate and ratios can show the profitability and operating efficiency of McDonald’s corporation. Gross margin, operating margin and net income margin are always meaningful when we analysis influences of company’s inventory because different inventory management could bring a different profit, ending inventory and cost of goods sold. In this way, we can utilize the data analysis to compare McDonald’s inventory operating with other company. We calculated recent two years ratios in the following. By comparing McDonald’s last two years profitability and turnover. Although the inventory turnover and days in inventory in 2017 were disadvantage comparing to 2016, the gross margin and the company's profitability in 2017 are better than the performance in 2016. It might illustrate that blind pursue high inventory turnover is improper in the standpoint of shareholder’s interest. We also can notice the administration cost was lower in 2017. Cost Structure Identification and Comparison with Competitors Cost structure in fast food industry refers to variable cost and fixed cost. Variable costs like bread, meat, cheese and so on. Fixed costs like occupancy expenses, fixed interest rate, amortization of patents, property taxes and so on. The fixed costs remain the same during a year, the variable costs would change depending on production volume. Considered McDonald’s used JIT inventory management. So, its cost method more likely is backflush, which means McDonald’s do not have any WIP account and very few inventory holding cost. Overall, for the cost of goods sold aspect. McDonald’s cost structure could be divided into three main categories--Food & paper, payroll & employee benefits and occupancy expenses (Franchised and company operated). those three categories distributed the cost roughly equal. The biggest category is rental expenses which includes company-operated and franchised. Burger King is one of leaders in fast food industry like McDonald’s. However, Burger King used cost of sales as a category in its income statement which includes cost of goods sold and direct labor. Therefore, McDonald’s cost of sales should account for 62% of its expenses. We calculated the expenses proportion of Burger King as well. Burger King’s cost of sales weight was much higher than McDonald’s in 2017 and its franchised & property expenses account for 23.35% of its expenses. Based on roughly identical variable costs in fast food industry because their raw materials cost and direct labor costs are almost identical. Low occupancy fees might represent Burger King do not have same operating strategy with McDonald’s. McDonald’s was prefer to locate their restaurant near busy places, Burger King might be not. In the inventory aspect. We also noticed those two companies keep their inventory in a very low level compared to their capital size and sales. We can deduce most companies in the fast food industry would like to increase inventory turnover and decrease holding days of inventory. Fin 545 Advanced Corporate Finance McDonald’s Corporate – Inventory Identify the inventory system We identity the inventory system McDonald choose is the weighted average method. McDonald’s Corporate is one of the biggest fast food restaurants which uses the typical JIT (Just-in-time) strategy. JIT inventory management has helped in reducing the cost by remaining the inventory at the lower level and cutting down the wastages. In fact, we can figure out that McDonald usually cook all food in advance and place them under the lamps to keep them hot. They spend the least time to deal with the food producing to make the food fresh and unwasted. Also, this method helps them reduce the cost and the inventory level. Unlike other companies, McDonald’s Corporate doesn’t have too much inventory due to this special materials requirement planning (MRP). Besides, we found that there are no footnotes about the inventory system they used. However, SEC request that all companies should disclose their inventory system in their annual report and also mention the LIFO reserve if the company use the LIFO method. We find some reasons below. From the inventory management part, McDonald’s Corporate uses the FIFO system to operate the logistic process. Because the restaurant always focuses on the food quality, they use first in first out method which can make sure the food is fresh and unwasted. However, it’s not necessary that the inventory management method must be same as the accounting inventory system, so we cannot be sure the accounting method yet. From the accounting part, McDonald’s Corporate has very low inventory like we mentioned before. The ending inventory amount will have a quite small influence in the key numbers like net income or cost of goods sold. From the balance sheet and statement of cash flow, we can prove that the inventory amount and the changes in the working capital related to the inventory part are very small. Therefore, the choices of the inventory system is not very important to McDonald right now. In fact, most of the companies who use the JIT system are not very care about the inventory system choices because this inventory management has already made the profit maximum. With the market background of inflation, FIFO method can help company to reduce the COGS and to increase the ending inventory. This method will get more net income but also will have more tax to pay. We can even ignore the disadvantage of the added inventory because the company’s inventory is very small compared to other assets. Otherwise, LIFO method can help company tax reduction but will increase cost of goods sold. That will increase the company’s cash flow which can make more investment. McDonald’s Corporate spend lots of money in other investment to make mainly profits. All in all, these two methods bring advantages and disadvantages to the company. After the evaluation, we think McDonald’s Corporate should use the weighted average inventory system which can maintain the biggest profits. Cost Structure (Inventory & COGS) McDonald utilizes a specific accounting system for JIT environment which is backflush costing and it will change the way the company records their cost of goods sold. Backflush costing delays the costing process until the production of goods is completed. By eliminating work-in- process accounts, backflush costing simplifies the accounting process. Companies using backflush costing generally meet the following three conditions. First of all, management seeks a simple accounting system and no detailed tracking of direct material and direct labor costs. Secondly, every product has a set of standard costs. Lastly, material inventory levels are either low or constant. When inventories are low, the bulk of manufacturing costs will flow into costs of goods sold, and it is not deferred as inventory cost. After we analyzing the financial statements, we find out that McDonald meets all the criteria. Since backflush costing is used, the manufacturing costs will flow into COGS without going into inventory account. COGS will be Food and paper ($4,033.5 million) + Payroll and employee benefits ($3,528.5 million) + Occupancy and other operating expenses ($2847.6 million) + Franchised restaurants-occupancy expenses ($1790 million) = $12,199.6 million. Data Analysis (Margins & Ratios) Critical margins, turnover rate and ratios can show the profitability and operating efficiency of McDonald’s corporation. Gross margin, operating margin and net income margin are always meaningful when we analysis influences of company’s inventory because different inventory management could bring a different profit, ending inventory and cost of goods sold. In this way, we can utilize the data analysis to compare McDonald’s inventory operating with other company. We calculated recent two years ratios in the following. By comparing McDonald’s last two years profitability and turnover. Although the inventory turnover and days in inventory in 2017 were disadvantage comparing to 2016, the gross margin and the company's profitability in 2017 are better than the performance in 2016. It might illustrate that blind pursue high inventory turnover is improper in the standpoint of shareholder’s interest. We also can notice the administration cost was lower in 2017. Cost Structure Identification and Comparison with Competitors Cost structure in fast food industry refers to variable cost and fixed cost. Variable costs like bread, meat, cheese and so on. Fixed costs like occupancy expenses, fixed interest rate, amortization of patents, property taxes and so on. The fixed costs remain the same during a year, the variable costs would change depending on production volume. Considered McDonald’s used JIT inventory management. So, its cost method more likely is backflush, which means McDonald’s do not have any WIP account and very few inventory holding cost. Overall, for the cost of goods sold aspect. McDonald’s cost structure could be divided into three main categories--Food & paper, payroll & employee benefits and occupancy expenses (Franchised and company operated). those three categories distributed the cost roughly equal. The biggest category is rental expenses which includes company-operated and franchised. Burger King is one of leaders in fast food industry like McDonald’s. However, Burger King used cost of sales as a category in its income statement which includes cost of goods sold and direct labor. Therefore, McDonald’s cost of sales should account for 62% of its expenses. We calculated the expenses proportion of Burger King as well. Burger King’s cost of sales weight was much higher than McDonald’s in 2017 and its franchised & property expenses account for 23.35% of its expenses. Based on roughly identical variable costs in fast food industry because their raw materials cost and direct labor costs are almost identical. Low occupancy fees might represent Burger King do not have same operating strategy with McDonald’s. McDonald’s was prefer to locate their restaurant near busy places, Burger King might be not. In the inventory aspect. We also noticed those two companies keep their inventory in a very low level compared to their capital size and sales. We can deduce most companies in the fast food industry would like to increase inventory turnover and decrease holding days of inventory.
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