STRATEGIC FINANCIAL MANAGEMENT

CASE STUDY: KRISPY

KREME DONUTS


Asma Sikander 9954


SUBMITTED TO
SIR NASEEM AKHTER




SUMMARY
Krispy Kreme donuts were established in 1937 in North Carolina. It used to sell donuts to supermarkets
in the form of wholesale. Then with time it started to be sold as retail product directly to its customers.
As it started gaining popularity, in 1950s it opened in more than 12 states. It was known as Hot
Doughnuts. Till 2003 it was going perfectly fine but then in 2004 problems started to arise because of
the stock price which fell due to which the company faced 80% loss. In 1973, the company was taken
over by Beatrice Foods who started to use cheap quality ingredients and introduced a new product line
of sandwiches and soups. In 1982, the company was fully debt financed but then in 1989 it became debt
free company and slowly began to expand. The product line of soups and sandwiches were finished and
branded coffee was introduced in 1996. In 2000 the company became public.
The company generated revenues from four sources which includes on premise sales to the company
owned stores (27%), off premise sales to grocery and convenience stores (40%), manufacturing and
distribution of product mix and machinery (29%) and franchise royalties and fees (4%).
In 2004 the company as it went into public started to face problems as its major earnings were 10% less
than expected which put the company into the state of anxiousness. For this reason they started to
reduce their outlets and increase the investment from 35 million dollars to 40 million dollars. Other
than this it started to exchange its prices in the income statement like it used to record interest expense
as interest income. Wrong recordings were done both in income statement and balance sheet due to
which the company faced a lot of problems. Therefore the companys share declined further 15% and
thus it has $15.71 per share. Therefore the analysts were afraid to invest into this company because of
their wrongdoings. Therefore in the first attempt Krispy Kreme invested heavily and thus opened many
franchises at one time in order to become attractive and for each and every outlet, new equipments
were needed which made it difficult for the company to maintain its profitability.
Therefore in order to correct itself and bring back its position in the market it restated that it would
correct all its records, it would reduce the number of stores, would reduce pretax income.








MAJOR PROBLEM
The main problem which Krispy Kreme Doughnuts faced was that its stock price fell down because of
going into public by investing a lot in multiple outlets opened at one time together affecting the net
income and other factors.
ANALYSIS AND INTERPRETATION OF RATIOS
1) LIQUIDITY RATIOS
By observing at the current and quick ratio, it can be analyzed that with time both have increased which
means that it is bad for the company the payables is increasing, expenses are increasing because of
payables not being paid on time. There is a lot of fluctuation in the current assets. Receivables are
increasing as the customers are not paying on time either because they are unable to pay back on the
credit term period or they are having financial problems. There is a lot of investment in inventories too
due to which expenses are increasing. This asset maybe nonproductive and it is causing a low rate of
return on investment due to which cash is tied up. If these assets are not working they can be sold out
and those cash can be used to pay back the loan amount to the creditors.
2) LEVERAGE RATIOS
Krispy Kreme Donuts leverage ratios with time is fluctuating but in 2004 Feb the current liabilities have
decreased maybe because the company is able to pay back the loan to the creditors as soon as possible
but on the other hand the long time liabilities are increasing maybe because of high investment in new
equipments due to which the debt is being taken and interest amount is being earned on the debt being
taken. Therefore because of it the company is unable to pay back the taxes which are increasing also. As
compared to its competitors Krispy Kreme Donuts is on the safe side as it has low leverage rate. In order
to payback the long term debt the company either needs to sell nonproductive assets and use that
money to pay the amount back to the creditors and also pay the tax amount.
3) ACTIVITY RATIOS
It shows that with time sales have increased as well as accounts receivables have also increased. This
may be because the customers are unable to pay the amount back to the company on time maybe due
to their personal reasons or because of the time of the term period.
As for the inventories, there was a high investment in the inventories as with time it is increasing. It may
be nonproductive and it can be a problem for the company to have a high rate of return on investment
as receivables are also high and inventories are also high. Therefore the company should use such
inventory either to be used at full capacity or should purchase only when there is a season of having
yummy donuts as this would reduce the cost of inventories which are not useful for the company.
The total assets turnover ratio is declining which means that the company is not generating sufficient
amount of business in its total asset investment. Either increase the number of sales or sell assets which
are not useful for the company as it is affecting the return on investment. It maybe because the
company for every new outlet invested heavily into new equipments, machineries etc due to which the
company was unable to cover up its sales that affected the income and the return on investment.
The cash turnover ratio has decreased a lot in 2003 but in 2004 it increased double than 2003 which
indicates that there has been a lot of cash outflow which means that the company has used a lot of cash
in its operations and there is no inflow. This may be because of opening of number of stores together at
multiple places due to which there has been continuous operations being done and the company has
been continuously using cash in its operations and there are less chances of return on investment. And
because of a lot of cash being used the companys accruals were increasing with time. Expenses were
also increasing because of continuous operations being held in the company and it was difficult for the
company to maintain its position in the market.
4) PROFITABILITY RATIOS
In 2002 there was high return on assets but then in 2004 when the company went into public
and started to invest heavily its return on asset declined because the company was
continuously using its cash in its operations due to which net income is being affected. This
maybe because there maybe nonproductive assets in the company which are not beneficial for
the company. Same is the case with return on equity that because of heavy investment in
unnecessary equipments, machinery etc the company is unable to achieve the return on
investment on the sales.
Net profit margin is high because of equal proportion of sales and costs are rising and on the
other hand there is no use of high debt and the company is mostly equity financed. Interest
expenses are also as it is not much debt financed and taxes are also high which are not being
paid on time due to which net income is increasing.
COMMON SIZE ANALYSIS OF INCOME STATEMENT
By observing the data it can be seen that in 2001 operating costs are high than its competitors which
mean that costs have been increased gradually as compared to the previous years. As the company is
mostly equity financed and not debt financed so therefore interest expenses are low but deferred taxes
are high maybe because the company has invested so much in its operations and franchises and assets
that is it unable to pay the taxes on time.
COMMON SIZE ANALYSIS OF BALANCE SHEET
As it shows accounts receivables are higher than the competitors and have low debt. Equity is more than
debt. As debt is low therefore interest expenses are also low. There is high use of inventories which
maybe nonproductive and which may lead to low return on investment and create a problem for the
company.

CONCLUSION AND RECOMMENDATIONS
As the main problem was heavy investment in nonproductive assets and in outlets which have
opened together at multiple places which affected the companys reputation due to which its
stock price was affected. Therefore the overall case can be concluded by saying that the
company was mostly equity financed and not much of debt financed due to which interest
expenses were low but taxes were high which were not being paid on time that affected the
income statement. Besides this the company was able to make profit but there was not much
return on investment because of too much cash outflow in its current operations. For every
new outlet new equipments were purchased which increased the balance sheet current
operations and fixed assets and because of this depreciation expenses were also increasing
even for those equipments which were not providing any benefit to the company.
Therefore the company in order to maintain its position in the market should do the following:
1) Increase the number of sales
2) Sell out non productive assets as because of it depreciation expenses are also increasing
so by doing so it can try to pay back the creditors their loan amount on time
3) Instead of investing all at once, it should try to invest at small scale in order to maintain
and balance the companys assets and liabilities.
4) After the company has tried to bring back its position in the market, it should increase
its stock price so that the investors should invest in the company so that the company is
able to have high return on investment
5) As the company is not much debt financed but still it is maintaining some debt so in
order to make it debt free it can borrow additional funds to overcome such issue.