Finance - Case study

Question 1

Outline the strategic role of financial management in McDonald’s

Answer 1

• McDonald’s, although one business, operates globally using multiple legal entities
• 95% of McDonald’s stores around the world are owned independently by franchisees
• McDonald’s is paid regular rent and royalty payments from franchisees. The company makes far more money from this than it does actually selling burgers at its own stores
• McDonald’s have planned to add around 8,000 stores to its system over the next 4 years

Question 2

Provide examples of McDonald’s objectives of financial management

Answer 2

• profitability: aims for consistent operating margins in the mid-40% range
• growth: McDonald’s has the goal of increasing systemwide sales growth annually by 3% to 5%
• McDonald’s has the goal of reaching 50,000 stores by 2027

Question 3

Provide examples of external sources of finance that influence McDonald’s financial management

Answer 3

• overdraft: McDonald’s has an overdraft facility of US$4 billion
• commercial bills: McDonald’s issues “commercial paper” to raise funds, and also raises funds through its global medium-term notes facility (borrowing and returning a fixed repayment), and debentures
• leasing: In 2023, McDonald’s paid about US$1.5 billion in lease payments worldwide. This includes leases for land and buildings, usually on 20-year contracts
• equity: As of 31st December 2023, 722 million shares were still in the market and McDonald’s had 938 million shares in its own treasury. Around 4,500,000 separate individuals and institutions hold shares

Question 4

Describe how government institutions influence McDonald’s financial management

Answer 4

• In 2022, the company faced an adverse tax judgement in France, costing the company US$1.3 billion
• company taxation: Under Australian tax law, McDonald’s Australia is obliged to pay income tax on profit made in Australia. The AU$4.1 billion payment to the related company in this time is essentially a tax deduction for McDonald’s Australia. This has potentially saved over AU$1.2 billion in Australian income tax

Question 5

Outline how the global market influences McDonald’s financial management

Answer 5

• economic outlook: In many parts of the world, including the United States and Australia, McDonald’s is facing increased costs of labour, energy and materials as inflation rises to its highest levels in decades
• availability of funds: the company was able to raise US$5.5 billion at the start of the COVID-19 pandemic
• interest rates: McDonald’s has fixed 96% of its total debt at an average interest rate of 3.7% p.a. As a comparison, in 2007, McDonald’s had fixed 58% of its debt at an average interest rate of 4.7% p.a.

Question 6

Describe the processes of planning and implementing in McDonald’s financial management

Answer 6

• using record systems: At the core of this record system is the Point of Sale (POS) system used at the front counter, called NP6.Information from this system is used by stores to record sales, assemble food, roster staff, order supplies, and perform other operational activities
• Records are kept (and financial reports produced) at a country level and consolidated for the entire world. McDonald’s uses these records to produce an annual report for each calendar year ending 31st December that is lodged with the NYSE

Question 7

Outline advantages and disadvantages of debt financing for McDonald’s

Answer 7

Advantages:
- Historically low interest rates worldwide made it a relatively cheap form of finance
- The interest payments are tax deductible
- Debt can be more flexible than equity finance. Large sums can be obtained in shorter time periods
Disadvantages:
- Rising interest rates increase repayments

Question 8

Outline advantages and disadvantages of equity financing for McDonald’s

Answer 8

Advantages:
- The company can simply choose not to pay dividends in a particular year, thus retaining the cash in the company for expansion projects. McDonald’s, however, has paid increased dividends to shareholders every year for forty years as a result of its continued profitability
Disadvantages:
- The market (i.e., shareholders) expects the company to provide adequate returns on funds invested and the share price may fall if this is not done.
- The raising of more equity (for example - through a share placement) will dilute the stake of existing shareholders and is a slow, costly process

Question 9

Provide examples of financial ratios in McDonald’s financial management processes

Answer 9

• liquidity: McDonald’s has decreased its current ratio significantly from 1.78:1 in 2021 to 1.16:1 in 2023
• gearing: Prior to COVID-19, McDonald’s embarked on campaigns to buy back stock from shareholders. As such, on 31st December 2023 it had negative equity - where liabilities are greater than the listed value of assets
• profitability: McDonald’s company stores’ gross profit decreased slightly in 2023. McDonald’s has stated that many of its food inputs (chicken, beef, etc.) rose in price in 2023 - and are expected to continue rising.
• profitability: In 2023, McDonald’s achieved a significantly higher net profit ratio than its competitor, Yum! Brands, Inc. and higher than the previous year. The increase can, in a large way, be attributed to the loss on the sale of the stores in Russia and a US$1.4 billion tax bill and fine in France in 2022

Question 10

Outline the limitations of financial reports in McDonald’s financial processes

Answer 10

• capitalising expenses: McDonald’s Australia stated in its 2022 Annual Report that development costs for properties are capitalised up to the date where future benefits are expected to exceed those costs
• This means that expenses for a new restaurant site are recorded as an asset (buildings) and depreciated over the useful life of that asset, therefore spreading the costs over periods of up to 40 years
• Although this is in line with standard accounting practices, it can have the effect of overstating current year profit

Question 11

Outline working capital management as a strategy in McDonald’s financial management

Answer 11

• cash: McDonald’s has contractual arrangements with franchisees for regular payments of rent and royalties. This helps McDonald’s maintain significant cash flow from franchisees
• receivables: McDonald’s has tight contractual control over receivables from franchisees. Late payments of rent or royalties may attract high interest for franchisees
• inventory: McDonald’s stores use a First In First Out (FIFO) inventory system in store - as well as eProduction.
• McDonald’s relies 100% on external suppliers for inventory. In recent years, McDonald’s has assembled burgers only when ordered by the customer.

Question 12

Outline working capital management strategies in McDonald’s financial strategies

Answer 12

• leasing: McDonald’s makes extensive use of leasing - primarily related to property. For example, the 2018 Annual Report shows McDonald’s was the lessee of 12,334 restaurant locations. Furthermore, McDonald’s has built a further US$12.5 billion worth of buildings on land that it leases. This shows a heavy reliance on leasing as a working capital strategy.
• sale and lease back: McDonald’s owns a large amount of property. As such, McDonald’s derives a significant amount of income from the property that it leases to franchisees. One strategy that some analysts say might improve McDonald’s financial performance is to sell and lease back its properties, thus releasing the full market value of its property holdings.

Question 13

Outline profitability management as a strategy in McDonald’s financial management

Answer 13

• cost controls: Controlling variable and mixed expenses for McDonald’s stores can be problematic. Royalty and rental percentages are written into contracts and cannot be changed. McDonald’s adoption of an inventory system that responds to customer orders has assisted in lowering the wastage of food and other inputs, which lowers this variable cost
• revenue controls: This is because McDonald’s derives large amounts of revenue from the renting of the premises to franchisees. This ensures that the company can earn stable income with minimal outgoings and less risk and complexity than operating its own stores

Question 14

Outline global financial management in McDonald’s financial strategies

Answer 14

• exchange rates hedging/ derivatives: By doing business in local currencies, McDonald’s can take advantage of a natural hedge to minimise risk. This is because both revenues and expenses will either increase or decrease together relative to the US dollar.
• exchange rates: At 31st December 2023, McDonald’s held US$15 billion worth of debt in countries other than the United States. This represents approximately 38% of total long-term debt.